Analysis: Pensions reform a fresh chance to talk about protection? By Harvey Jones Published 8 April, 2015 Will a surge in demand for income drawdown boost interest in life cover? Far-reaching changes to pensions legislation have been top of the financial headlines in recent weeks but what impact could they have on demand for protection? Harvey Jones reports Chancellor George Osborne s radical pension reforms have turned many financial planning assumptions upside down, but the impact on protection sales has largely been overlooked. That is hardly surprising, given the dramatic impact on complex planning areas such as annuities, income drawdown, and tax and inheritance planning. Pension companies and many IFAs and financial planners are only just getting to grips with the scale of the upheaval. So do the reforms give advisers a fresh and topical reason to talk about protection? Neil McCarthy, sales and marketing director at LifeQuote, which provides services to intermediaries across the UK, reckons they do. He says the anticipated surge in demand for income drawdown from newly-liberated pensioners will also boost demand for life insurance. While annuities give you a guaranteed income that will last for as long as you live, with cover for any spouse if you buy a joint life annuity, you don t get that guarantee with income drawdown. Potential opportunities for protection McCarthy suggests that pensioners who opt for drawdown may consider taking out life insurance as well to protect their partner, in case they have depleted their pot by the time they die. On average, British people live more than 20 years in retirement, so if they use up all their pension funds, they or any surviving partner will be left without retirement income, he says.
Mike Morrison, head of platform marketing at AJ Bell, the advisers, can also see a potential opportunity. He says: When an individual buys an annuity he buys certainty and if he buys a joint life annuity he buys some certainty for a spouse as well. By choosing income drawdown, you sacrifice that certainty. How can you replace that? Possibly with life insurance, either term or whole-oflife, Morrison adds. But other retirement specialists are more downbeat about the likely impact on protection sales. Rod McKie, head of retirement propositions at Zurich, says that in the early years of income drawdown many will see the return of the residual fund as sufficient protection for a spouse or dependants. It certainly gives the spouse more cover than a single life annuity, where the income ceases altogether when the policyholder dies, McKie says. But pensioners could run into problems if their drawdown pot depletes faster than expected. At that point, they might belatedly regret going without protection. By the time they realise they do need life cover after all, however, it may be too expensive, given their increased age, McKie adds. Zurich has been offering drawdown products for years and has seen little demand for linked life insurance sales, McKie says. We aren t expecting a significant spike as a result of the new pension freedoms either. It will take time for advisers and their customers to adjust to the new freedoms and work out how protection can help as part of a holistic solution. But he predicts that another element of pension reform could drive demand for protection. As the retirement age rises to 66 and beyond, and more people work beyond the state pension age, older people may want to protect their continued earning power. McKie says: They may want to buy an income protection or critical illness cover policy after leaving an employer s scheme to pursue other work, such as contracting or self-employment. He says the best way to protect a spouse in retirement is to ensure they have sufficient pension saving provision in their own name, because far too many have next to nothing.
One option is to set up an annuity with a spouse s contingent pension to cover essential spend, alongside some form of level or decreasing life cover to provide a lump sum to supplement any residual drawdown fund. Alternatively, a whole-of-life plan would give the spouse or other dependants some money to fall back on, he says. Tax implications Andrew Tully, pensions technical director at MGM Advantage, the retirement income solutions provider, says pension reforms have eased the punitive taxes previously imposed on pension pots at death, and that could reduce demand for life insurance. The Chancellor has abolished what the tabloids called the pension death tax, which swallowed 55% of any residual drawdown pot at death. Now if you die before age 75, any remaining pension, whether in an annuity or income drawdown, can go to your family free of tax, Tully says. If the pension holder dies after age 75, recipients pay income tax on the money at their personal rate. Tully says this makes drawdown a practical way of cascading wealth down through generations. You can leave funds to say, your partner when you die, and they can leave funds to children or grandchildren in the same way, he explains. As pensions aren t included in the family estate for inheritance tax purposes, this can be a taxefficient way of looking after your family. Given that pension contributions attract valuable tax relief, this makes pensions an increasingly attractive way for financial planners to reduce family inheritance tax liability, Tully says. Justin Modray, IFA at Candid Financial Advice, doubts that people who opt for income drawdown will feel a greater need to buy life cover as a result. Drawdown is likely to provide a higher pension for a surviving spouse than buying an annuity, based on current rates, and of course the pot can be passed on free of tax if one partner dies before a 75, Modray says. Personal responsibility There may be exceptions, such as pensioners who blow their entire pot on a Lamborghini, but again, Modray is sceptical. Frankly, if they are not responsible enough to manage their pension I doubt life cover will be particularly high on their list of financial priorities, Modray says.
The other challenge is that the cost of term insurance will be increasingly prohibitive as people advance into their 60s and beyond, he explains. You would really need whole-of-life cover to ensure a payout irrespective of how long someone lives, and that is even more costly, he continues. Rather than buying life cover as back-up, Modray says the key is to manage the pension sensibly. In a worst-case scenario, you even have the option of downsizing property, he adds. Matthew Gledhill, managing director of Beagle Street, the life office, says pension reforms will have little impact on protection sales. In fact, they may even hinder them, as advisers already have more than enough to occupy their attention. Pension advice takes up such a considerable amount of time that protection doesn t usually get much airplay, Gledhill says. With the average pension pot just 36,800, according to the Association of British Insurers, there isn t actually that much to protect either, Gledhill points out. People are more likely to use any cash they take from their pension to reduce debt, pay off their mortgage, buy a new car, or take a holiday, rather than buy life insurance, he says. But Gledhill does see one potentially optimistic opportunity, as more employers set up auto-enrolment schemes in the workplace, and many then take the next step of offering protection as well. Patrick Connolly, certified financial planner at Chase de Vere, says new pension rules create fantastic financial planning opportunities but they also mean more complexity and they increase the risk of something going wrong. People should only go into drawdown if they have a secure income to cover their basic living costs, and those of their dependants, Connolly says. This may come from a combination of state pension, defined benefit schemes and an annuity, to protect their standard of living whatever happens to money in drawdown. According to Connolly, life insurance shouldn t be seen as a way of compensating people who misuse their pension cash. We only recommend clients take out drawdown if they have a large enough pension and the associated risks won t affect their or their family s standard of living, Connolly says.
Another challenge is that life assurance can be very expensive for older people, especially if they ve had prior health problems, and so is often the last resort. There is an even bigger risk for whole-of-life contracts with reviewable premiums because these could become unaffordable at some point in the future, he says. If leaving a spouse destitute is a concern for any couple, Connolly would suggest that drawdown isn t the right solution, and they should probably buy a joint life annuity instead. If retired people are making the right choices at retirement, most won t need protection policies at all. Any adviser who recommends drawdown to clients must make sure they have a sensible investment and income withdrawal strategy, and review it regularly, Connolly says. While some voices such as LifeQuote s Neil McCarthy are hoping that pension reform will spark a protection revival, others suspect the reverse could happen.