There are growing signs that the annuity market is set for a wholesale shake-up. Both the retail distribution review and the Treasury’s own behind-the-scenes annuity review spell change for the sector sooner or later.
Sources close to the Government say the pre-Budget report later this autumn will contain some movement on the issue of whether the current annuity process, where the majority of consumers end up sticking with their pension provider, should change.
Whether this will consist of proposals for draft regulations, a further consultation or some statement of policy intention remains to be seen, but the Treasury has had a review team investigating the sector for some time now and it is understood that members of that team are sympathetic to the voices calling for change.
The idea that the system should change is becoming ever more mainstream. An increasing number of commentators, both from the advisory community and beyond, are now coming to the view that the open market should be the default position for anybody approaching retirement.
It has always been in the interests of specialist annuity advisers and providers to want the open market option as the starting point rather than just an option. However, there is now a growing number of providers offering ‘third way’ products that claim to sit between annuity and draw-down, who also want consumers to stop and think before accepting that dismal annuity rate.
What is more, consumers are also beginning to get the message that taking an annuity from the home provider should not be the default. A survey by Skandia found that today only 30 per cent of people find it acceptable to have to buy an annuity with your pension provider, compared to 57 per cent when the same question was asked in 2001.
The FSA has plans for a simplified advice regime for people crystallising benefits in pensions, even though some annuity specialists say this will lead to a dumbing down of advice. But because the vast majority of annuities are so small they are unattractive to IFAs, the FSA looks set to act.
A simplified advice regime for annuities could sit well with corporate advisers. In years to come, the amounts in defined contribution pension pots are set to grow exponentially, meaning the average £25,000 retirement fund could become a thing of the past. A scaled-down advice process would allow advisers scope to properly service DC members rather than leave them to the DIY approach that often results in poor decisions.
What this could mean for occupationally-defined contribution schemes, where trustees pay annuities out of the fund, remains to be seen.
“Members of trust-based defined contribution schemes do not always get a real chance to take the open market option at present, although the words may be buried there in the small print,” says Chris Bellers, pensions technical manager at Friends Provident. “We don’t know how the rates that trustees set compare with the open market rates, and in many cases it will be up to the trustees whether they offer better rates to impaired life members. They don’t have to, though, under the rules as currently written.”
Ros Altmann, the pension consultant and campaigner, argues that all members of occupational DC arrangements should be allowed access to the open market option as a matter of course.
“It is simply not fair that occupational schemes should get away with not telling those with impaired lives they would be able to get a better retirement income outside the scheme because they are going to die younger.”
Tom McPhail, head of pensions policy at Hargreaves Lansdown, argues that trustees not recommending impaired life annuities are taking a big risk. “We obtained legal opinion some years ago that told us that if a trustee did not obtain a competitive annuity rate the door would be wide open for a member to sue.”
Whether the Government has the appetite for overseeing a wholesale reworking of the process of taking retirement benefits within the retail distribution review remains to be seen, but it seems certain it will address the issue of commissions paid to advisers by life offices when the annuitant selects the home provider.
This practice has been criticised as one of the least defensible forms of commission, effectively rewarding advisers for remaining silent rather than informing the consumer, their client, that they could improve their retirement income by up to a third by looking elsewhere.
Changes to the way employees get their annuities seem certain. For some intermediaries, this will mean a loss of income. But the majority should see a fertile new field of business opening up before them.