This represents the understanding of the vast majority of retirees as to the level of guarantee and protection that they can get when buying an annuity.

The fact that the remaining capital is used in the annuity pot to enhance all benefits and not the insurance companies’ profits is both difficult to explain and frequently ignored in the media.

It is not surprising, therefore, that the loudest cry of support for the idea of capital protected annuities is “Well, at least that will stop them saying the insurance company gets the money if someone dies early” and now we will be able to show the client the benefits of the mortality cross subsidy in pounds and pence.

It may be worth asking whether market and media education is a good reason for introducing a new product but, putting that aside, what other issues and advantages are there to capital protected annuities? There are two types of such annuity:

• The first where a fixed percentage of the initial capital is guaranteed to be available on death whenever that should occur. We can, therefore, envisage clients choosing at the outset 25%, 50% or indeed 100% capital protection.

• Second is an annuity which provides a variable amount of capital dependent upon how much earlier than expected the annuitant dies. With conventional annuities the income is based on using up all the capital if the annuitant reaches normal life expectancy. With capital protection, the annuitant receives a lower income but if they die early then a proportion of the capital is available to the estate. A further sophistication of this approach is to allow variable levels of income, therefore someone taking 50% of the maximum income available would generate a higher capital sum on death.

Who would or could benefit from capital protected annuities? This depends on a simple cost benefit decision – comparing the level of reduction in annuity income and the potential capital on death. Here the fixed percentage style of capital protected annuity is likely to be expensive. The variable type is going to be relatively cheap: at younger retirement ages – it could be below 2% deduction in income but, as you get older, the impact will become substantial, probably in excess of 15% at the age of 75. The essential question for any retiree is “Do I believe that the chance of dying before my normal life expectancy is high enough to sacrifice that level of expected income, particularly at a time when annuity rates are so low?”

This means that clients are essentially saying “I might be fit at the moment and not eligible for an enhanced/impaired life annuity but I believe that I will have less than normal life expectancy”. It may be that there is good familial history to support this belief. It may be simply emotional reaction. We certainly seem to divide into two camps – some pessimists expect to die tomorrow, others seem to believe in their own immortality.

Either way, the adviser should point out that a healthy person exercising the open market option statistically is likely to live beyond normal life expectancy as, in comparison to the average annuity purchase, they have already defined themselves as slightly healthier and wealthier – these circumstances leading statistically to longer life expectancy.

When capital protection is attached to a conventional guaranteed annuity it is unlikely that the resulting loss of income will be something that most clients would find affordable. Conventional annuities are more often purchased by those with smaller pension funds who are unable to take the investment advantages of with profits or investment linked annuities due to the risk of fluctuating income.

Is there a capital protected annuity for wealthier clients?

The Open Annuity from London & Colonial and marketed by Challenger does offer the possibility of capital being available on the death of the annuitant. However, the minimum income that can be taken from the policy is set at 90% of the maximum based on a single life conventional annuity rate. The opportunity for significant capital to be available at death, assuming normal life expectancy, is very limited. This policy needs to be carefully compared with alternatives such as the Prudential Flexible Lifetime Annuity with 80% ring fencing and minimum income of 50%. Again one of the key issues is the client’s own attitude to their life expectancy but advisers must ensure that they do not allow clients to make assumptions about their life expectancy out of ignorance. The reason for considering the Open Annuity in the majority of cases would be reaching their 75th birthday and not wanting to buy a non capital protected annuity. Ensuring a clear understanding of the impact of health and wealth of a 75 year old’s life expectancy may be quite challenging but in this instance is an integral part of the “financial” advice.

Capital protected annuities and longevity

Capital protected annuities may help clients who think they will die earlier than life expectancy tables indicate. They may improve the image of annuities but will not in themselves solve the major issues facing the provision of pension income.

Increasing life expectancy is a central concern with men or women now aged 50 looking forward to average retirements of 30 years. Purchasing pension annuities at older ages than the traditional 60 to 65 should become the norm and it is likely that wealthier retirees could purchase a mixture of capital protected and non capital protected annuities. While this market may become important in time, it is a consequence of increasing life expectancy rather than protection for the retiree who thinks he will die tomorrow.

Capital protected annuities may indeed assist us in educating clients and the media. Will significant amounts of capital protected annuities be sold in the near future? I doubt it.

AVERAGE LIFE EXPECTANCY FOR ANNUITANTS Expected age at death
Age now	Man	Woman
50	85	88
55	85	88
60	85	88
65	85	88
70	85	88
75	87	89

Figures based on life expectancy (PMA92/PFA92, 2001 standard mortality tables published by the Institute of Actuaries, year of use 2002.)
The values shown are for the most likely age at death. Stuart Bayliss Director, Annuity Direct 020 7684 5000