Impact of the Budget on the retirement market

1. Impact of the Budget on the retirement market Gareth Evans & Ewan Smith October 2014

2. Royal London – The UK’s largest mutual life & pensions company • Around 5.3 million customers* • Established over 150 years ago • £77 billion funds under management* • 2,900 employees* * As at June 2014

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.

4. Budget Proposals for dc pensions Pension fund taX-FREE LUMP SUM CAPPED DRAWDOWN FLEXI-ACCESS DRAWDOWN SHORT-TERM ANNUITY SCHEME PENSION ANNUITY WITHDRAWAL DRAWDOWN FULL or PARTIAL

5. Initial impact of budget changes Source: Royal London By Customer By Fund Size advised customers non-advised customers • Increased proportion of advised customers taking drawdown; • non-advised customers taking cashvia the new triviality limit.

6. CUSTOMER TRENDS – UK POPulation 65+ Source: ONS • People are living longer than ever

7. CUSTOMER TRENDs – healthy expectations Source: Cazalet Consulting • 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)

8. Customer TRENDS - segmentation Source: Royal London & ONS, Data is shown for 55-64 year olds Wealthy Affluent Modest • Wealth is unevenly distributed • Segmentation is critical to understanding outcomes

9. CUSTomer trends – 4 key stages for pensions STAGE 1 Start Saving STAGE 2 Take Stock STAGE 3 Retirement STAGE 4 Late Retirement • AGE 100 AGE 25 Lifetime Pensions

10. 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

11. MAKING Decisions – risks at retirement SecondaryRisks Change in circumstances Taxation of income & capital Inheritance value Investment risk Charges & product suitability PrimaryRisks Longevity Inflation • Customers risks can vary and change during retirement

12. Making decisions - Typical Product choices Investment Risk Drawdown Levelannuity IL annuity Longevity Risk • There is a trade off between annuity and drawdown

13. Making decisions – annuities seem a poor investment 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% • Annuities seem poor value as an investment • but as an insurance product they still play an important role for customers 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

14. 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.

15. Making decisions - Inflation the thief that keeps on taking Source: Royal London 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

16. 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

17. Making decisions - Investment strategies Different investment considerations apply during accumulation and decumulation 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 • During retirement, a customer’s choice of investment strategy is critical

18. Making decisions – combining drawdown & annuities Sample figures Income requirements Possible annuity purchase? Level annuity Underpin • 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

19. Customers – How do we help them? Source: Royal London 1/3rd of customers receive advice at retirement 1/3rd of customers have small DC savings 1/3rd of customers have significant DC savings and a complex set of options to consider • 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.

20. 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.