IMPACT OF THE BUDGET ON THE RETIREMENT MARKET

Gareth Evans & Ewan Smith

October 2014

Around 5.3 million customers*

Established over 150 years ago

£77 billion funds under management*

2,900 employees*

Royal London – The UK’s largest mutual life & pensions company

* As at June 2014

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3

IMPACT OF THE BUDGET ON THE RETIREMENT MARKET

Budget will drive material change in how people use their DC pensions savings.

Flexibility and choice helps people select what is most suitable for them.

Customers need help to make informed decisions because pensions are complex.

Guidance Guarantee is welcome but can only be part of the solution.

Real concerns that customers run out of money in retirement.

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PENSION FUND

TAX-FREE LUMP SUM

WITHDRAWAL ANNUITYSCHEME PENSIONDRAWDOWN

BUDGET PROPOSALS FOR DC PENSIONS

FLEXI-ACCESS DRAWDOWN

CAPPED DRAWDOWN

SHORT-TERM ANNUITY

FULL or PARTIAL

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INITIAL IMPACT OF BUDGET CHANGES

Increased proportion of advised customers taking drawdown; non-advised customers taking cash via the new triviality limit.

Pre-Budget Current Future ?

13%31%

72% 45%

15% 24%

Pre-Budget Current Future ?

67%45%

32%49% Drawdown

Annuity

Cash

Pre-Budget Current Future ?

26%

59%

70%

36%

Pre-Budget Current Future ?

87%62%

31%

Drawdown

Annuity

Cash

By Fund Size

advised customers

non-advised customers

By Customer

SOURCE: ROYAL LONDON

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CUSTOMER TRENDS – UK POPULATION 65+

SOURCE: ONS

2001 2011 2021 2031 2041 2051 2061

2

4

6

8

10

65-74

75-84

85+

People are living longer than ever

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CUSTOMER TRENDS – HEALTHY EXPECTATIONS

Males Females65

70

75

80

85

90

Impaired HealthGood Health

Male life expectancy at age 65 is currently 18 years (was 12 years in 1971)

Female life expectancy at age 65 is currently 21 years (was 16 years in 1971)

SOURCE: CAZALET CONSULTING

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CUSTOMER TRENDS - SEGMENTATION

SOURCE: ROYAL LONDON & ONS, DATA IS SHOWN FOR 55-64 YEAR OLDS

Wealthy

Affluent

Modest

Individual wealth

Size of segment

Share of wealth

Average wealth (£k)

Property Pension Total

> £600k

22% 52%

265 440 705

£150k – £600k

49% 43%

147 113 260

< £150k

29% 5%

23 19 42

Wealth is unevenly distributed Segmentation is critical to understanding

outcomes

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Fu

nd

siz

e

CUSTOMER TRENDS – 4 KEY STAGES FOR PENSIONS

STAGE 1Start Saving

STAGE 2Take Stock

STAGE 3Retirement

STAGE 4Late Retirement

Lifetime Pensions

AGE 25 AGE 100

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MAKING DECISIONS - CONSUMERS LACK CONFIDENCE

How Confident do Customers Feel When Making Decisions About Pensions?

2 in 3 customers lack confidence when taking pension decisions

Source: Royal London

-5%0%5%

10%15%20%25%30%

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MAKING DECISIONS – RISKS AT RETIREMENT

PrimaryRisks

Longevity

Inflation

SecondaryRisks

Change in circumstances

Taxation of income & capital

Inheritance value

Investment risk

Charges & product suitability

Customers risks can vary and change during retirement

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MAKING DECISIONS - TYPICAL PRODUCT CHOICES

Investment Risk

Longevity Risk

Levelannuity

IL annuity

Drawdown

There is a trade off between annuity and drawdown

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MAKING DECISIONS – ANNUITIES SEEM A POOR INVESTMENT

Annuities seem poor value as an investment

but as an insurance product they still play an important role for customers

0%

2%

4%

6%

8%

10%

12%

14%In

vest

men

t R

etu

rn

Investment return has been calculated as the internal rate of return of a male buying an annuity at age 65 and living to average life expectancy

Source: Cazalet Consulting & Royal London

In 1995, the annuity rate for a male aged 65 was 10.4%. If he lives to his life expectancy (80), the resulting return is 6%

In 2014, the annuity rate is 6%. If he lives to his life expectancy (83), the resulting return is about 1.5%

In 1980, the annuity rate was 15.7%. If he lives to his life expectancy (78), the resulting return is over 12%

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65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 990%

25%

50%

75%

100%

Investment Return

Capital Return

Mortality SubsidyMortality pooling

MAKING DECISIONS –ANNUITIES AS INSURANCE PRODUCT

SOURCE: ROYAL LONDON

The benefit from pooling of longevity risk is low in 60s but much more significant in mid 70s.

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MAKING DECISIONS - INFLATION THE THIEF THAT KEEPS ON TAKING

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30£k

£3k

£5k

£8k

£10k

Potential Impact of Inflation on £10,000

1.0% 2.0% 3.0% 5.0% 7.0%

Years

Purc

hasin

g Po

wer

(£ p

a) 1/3 lost after 20 years at

2% target rate

Even at low rates, inflation can

reduce spending power by 1/3 to

1/2

SOURCE: ROYAL LONDON

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MAKING DECISIONS - EQUITIES TACKLE INFLATION OVER LONG TERM

Real dividend growth is more stable than capital value Current dividend yield of about 3% isn’t enough to give customers enough income so need to eat into capital

Source: Cazalet Consulting

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Accumulation

- for regular investments, pound cost averaging reduces the volatility of the return

Decumulation - investment return isn’t enough to

meet customer needs

- when eating into capital, the inverse ofpound cost averaging applies

- the timing of cash flows can be critical

Different investment considerations apply during accumulation and decumulation

MAKING DECISIONS - INVESTMENT STRATEGIES

During retirement, a customer’s choice of investment strategy is critical

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65 70 75 80 85 90 95 100

MAKING DECISIONS – COMBINING DRAWDOWN & ANNUITIES

SAMPLE FIGURES

Level annuity

Underpin

Inco

me r

eq

uir

em

en

ts

Possible annuity purchase?

Underpin can be provided by a mix of State, DB or DC pensions Drawdown provides flexibility and inflation protection Further annuitisation at older ages can provide longevity protection

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CUSTOMERS – HOW DO WE HELP THEM?

Guidance Guarantee is helpful but can only be part of the solution. Customers need professional and impartial advice. We need to find ways to reduce the cost of advice through improved regulations and providers taking increased responsibility for their solutions.

1/3rd of customers receiveadvice at retirement1/3rd of customers have

small DC savings

1/3rd of customers have significant DC savings and a complex set of options to consider

SOURCE: ROYAL LONDON

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MOVING FORWARD

The Budget changes are welcome but there is real risk of market failure and customers running out of money.

  Pensions reform agenda needs to be progressive and strategically

focused.

Royal London would like to see the establishment of a permanent Pension Commission responsible for driving the strategic agenda, working with Government, industry and consumer bodies.

THANKYOU