How you might choose one

Past performance of With Profits funds is vitally important, particularly how they have performed during the last few challenging years for With Profit funds. Hand in hand with past performance goes financial strength – if you are going to live for another 30 years, you want to be confident that your chosen provider is going to be around that long.

What you shouldn’t do is opt for the provider offering the highest income in the first year. This initial income is irrelevant unless the company has the ability to offer potential for growth in future years.

It is not just investment returns that will dictate future bonus levels, and, therefore, your income. There are other matters, often over-looked, such as:

Ongoing charges
Mortality assumptions

If you were buying a conventional annuity neither of these would be a concern, as you have a fixed income for life. But you do need to consider them for a With Profit annuity, and they underline the complexity of the apparently straightforward With Profit annuity.

For example, take charges. Most providers will apply higher charges in the future if their costs go up. You won’t necessarily know what impact these charges have on future bonus levels, as most providers won’t break these down year by year. You have to take on trust (for 20-30 years) that any higher charges will be reasonable.

Then consider mortality assumptions, that is when the insurance company believes someone of a certain age will die. If these change over time, particularly if they believe someone of your age will live longer than they originally expected, the insurance company can reduce bonus levels to reflect this. This is an open-ended risk and not one you encounter with a conventional annuity, with its inherent guarantees.

The problem of charges and mortality assumptions can be lessened when the provider has some kind of income guarantee, such that the income won’t fall below a certain level. For example, Axa Sun Life are unique in that the income will never fall below the starting level. But even this is not all it seems – if your income had gone up over 20 years, you wouldn’t then be pleased to see it drop back to your starting level of 20 years previously. Prudential has a minimum income guarantee, depending the assumed bonus rate (ABR) you choose at the beginning e.g. with an ABR of 0%, you have a 100% guarantee, and with an ABR of 3% the guarantee is at 60% of your starting income.

Some companies offer options so that you aren’t stuck with your original arrangement. In particular :

The option to change the assumed bonus rate (ABR)
The option to switch to a conventional annuity

If you start out with an ABR of 5%, it means your starting income is relatively high (see Example section). But if bonus levels come under pressure in the future, you may prefer to reduce the presumed ABR – your income will immediately be lower, but this one-off adjustment gives your income more scope to grow as the years go on.

On the face of it, the option to switch to a conventional annuity is very valuable. For example, if bonus rates are falling you may decide that the level of risk is not for you, and wish to switch to a conventional annuity. The theory is fine. In practice it is not as clear cut. Although you have no actual fund any more, the insurance company has to calculate a notional fund, and then apply the conventional annuity rate to this figure. Our experience is that the notional fund will reflect the full stockmarket falls, and you will not benefit from any smoothing (normally inherent in with profits plans). So if the notional fund is 30% lower than the sum you originally gave to the insurance company (reflecting stockmarket falls), your switch to a conventional annuity is going to result in a fall in your monthly income.

The only situation in which the latter feature will invariably be valuable will be when stockmarkets and bonus rates have been steady-to-rising, and conventional annuity rates are higher.

To summarise the key features to consider before choosing a product, arguably in order of priority:

Financial strength
Past investment performance
Any guarantees on income levels
Option to alter the ABR
Option to switch to a conventional annuity
Do they have an impaired life option
Future charges
Current mortality assumptions

Your online registration instructions are perfectly clear....
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