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sked what they want from their investments, many consumers simply want a better return than cash, and the guarantee that they won’t lose money. While we are tempted to tell these consumers that they can’t have their cake and eat it, there has long been a category of retail products offering exactly these features. However, guarantees in retail products in the UK are conspicuous by their absence today – why?
The Great Risk Transfer The UK has an ageing population, and defined contribution pensions (particularly ‘pension drawdown’ products) are becoming increasingly commonplace – especially since the introduction of pension freedoms in 2015. While these products give consumers more flexibility in terms of how and when they access their pensions, they leave customers exposed to investment risk and longevity risk. Many consumers are also not accessing or receiving financial advice today, especially those who have more modest pension pots. This means they do not receive help to address the impact of negative investment returns early in retirement on the sustainability of their income (often called ‘sequencing risk’), and the resulting effect on the chance they will outlive their savings. This illustrates the issue of the Great Risk Transfer (bit.ly/2Q061Rf), the situation where financial risks previously borne by government and institutions are now transferred to individuals.
What are these products? Guaranteed products typically offer a return of capital guarantee and/or a guaranteed level of income (either fixed, or with a minimum level plus some ‘up-side’ linked to investment returns). The guarantees can be delivered through options or other types of derivatives, or through a dynamic approach to asset allocation (including algorithmic approaches such as constant proportion portfolio insurance, or CPPI). These products can be delivered to consumers through structured products offered by banks, or in insurance-based investment products (including unit-linked or with-profit style products). 22 | THE ACTUARY | MAY 2021
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Brandon Horwitz considers whether guarantees in retail products have a future in the UK Why have these products disappeared? Changes in the UK distribution market for investment products are a key reason for the absence of these products today. The Retail Distribution Review (RDR), implemented in 2013, banned commission payments from providers on new business, instead requiring advisers to charge explicit fees. Guaranteed products became less attractive to sell, with advisers focusing on clients with higher net worth, to whom they can sell ongoing advice services. With-profits – a classic guaranteed product – has been falling in popularity since the early 2000s. Reasons include a number of high-profile scandals (including Equitable Life) and links to misselling of mortgage endowments. Many with-profits providers have also found themselves in a weaker financial position, adding to the challenge of regulators’ continued scrutiny of them. Structured products have also suffered from reduced confidence since the failure of some providers, such as Lehman Brothers in 2008, as well as the fact that there are now fewer retail distribution channels, with many banks exiting the advice markets after the RDR. The Financial Conduct Authority (FCA) also introduced explicit product development and governance requirements for structured products after failings were identified in thematic work it undertook in 2012 and 2015. These requirements include treating the customer fairly, and requiring
products to have a reasonable prospect of delivering value to customers in the target market. Fundamentally, all structured products (and guarantees) depend on interest rates, which determine the cost of the capital guarantees involved (ie the price of the ‘zero-coupon bond’ element of the guarantee). With short and long-term interest rates at 30-year lows, the costs of these guarantees have risen substantially – so providing value to customers is increasingly difficult.
What did we find? Our working party identified four themes which contribute to the fact that these products are out of favour in the UK: Understanding of guaranteed products: Understanding among consumers and advisers varies considerably, especially when it comes to the benefits and opportunity costs of guaranteed products. People also have negative associations with past misselling scandals, and perceptions that these products offer poor value for money. We also noted that the traditionally ‘backward-looking’ product disclosures may not fairly illustrate the benefits and limitations involved. Limited manufacturing expertise: Relatively few actuaries (and other professionals) have the experience needed www.theactuary.com
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