At the start of the year the Association of British Insurers (ABI) slammed the government for a fundamentally flawed approach to retirement income in the UK. Faced with growing anxiety about rising longevity and the need for more flexible retirement solutions, the voice of the insurance and investment industry has started shouting for change, and its action plan focuses squarely on the annuity market.
In its retirement income policy paper published in January this year, the ABI stated: “The ABI shares the view that DC pensions savings are primarily for income in retirement, but believes important changes can be made by the government to improve people’s options for taking these benefits. We urge the government to play its part in ensuring retirement income policies are appropriate now and into the foreseeable future.”
The ABI proposes introducing more flexibility into the choices for those entering the at-retirement market, such as allowing individuals to amalgamate small pots with their partner in order to buy a joint life annuity, and exempting lifetime income guarantee products from the requirement to buy an annuity.
Such proposals have been warmly welcomed by the industry not just for pushing the retirement income market in the right direction but for reminding the government of the importance of the annuitisation process, alongside its programme of wider pensions reform.
However, introducing more choice and flexibility can only be considered if individuals and their advisers and employers have demonstrated a willingness to exercise the existing market opportunities. Recent government attempts to improve the lot of retirees by introducing legislation to protect annuitants have been widely ignored, while the wider array of savings vehicles now offered by insurers have failed to capture the same market share enjoyed by conventional annuity products.
But it is in the area of the open market option (OMO) that the greatest risks persist. According to figures released by the ABI in the third quarter 2009, when annuity rates were far from attractive, just 34 per cent of individuals took advantage of the OMO.
Bob Bullivant, chief executive at Annuity Direct, says: “There are lots of existing issues with the annuity market at the moment that need to be dealt so we can move the market on; not least of which is the woeful take up of OMO.”
If you are in this business then you should be prepared to talk and guide all clients irrespective of size
Further evidence of the apathetic and laissez-faire attitude to the annuity markets can be found in the enhanced and impaired life offerings. Providers claim they have long been attempting to respond to calls for flexibility by launching products that better reflect the variety of individual circumstances, yet in many cases savers appear to be failing to take advantage of opportunities to get a better deal.
Tim Gosden, head of Legal & General’s annuity product development, suggests the lack of take up reflects retirees’ inability to get to grips with the latest developments in the market.
“There is no question that the current annuity market is highly competitive and is evolving at a rapid rate,” Gosden says. “On the one hand this
means there is an increasing benefit to potential annuitants, in that more options are available and with more accurate pricing this is resulting in more customers benefiting from higher retirement income. On the other hand, to some degree, this period of rapid change and evolution has resulted in more complexity for consumers in terms of choosing the best annuity option.”
One very obvious consequence of this combined failure to practice the OMO and take advantage of products outside of conventional annuities is retirees settling for a significant lower income throughout their retirement.
Philip Audaer, associate in Hewitt’s benefits practice, cites a recent example where an individual with a £500,000 retirement pot secured a 39 per cent increase in their income simply by using the OMO. And although the average retirement pot is considerably less than half a million, Audaer says shopping around for the best annuity is something all retirees should do.
“In certain cases DC accounts are quite modest so you want to squeeze as much as you can, and unless you go to the open market you are never going to get access to the best rates. People need access to specialised websites and receive guidance or they won’t know
about the enhancements available,” Audaer says.
As the industry comes to realise that thousands of individuals across the retirement market stand to lose millions of pounds from choosing the wrong annuity, there is a very definite sense of unease about a potential backlash.
Laura Goodman, head of communications at Rockingham Retirement, says: “There will be a legal backlash; we are convinced we will have a mis-selling scandal with annuities just as we did with pensions. All it takes is for someone to realise that if they had an enhanced annuity they would have been better off and they will be looking to their employer or IFA for the answer.”
The threat of yet another mis-selling scandal is clearly of concern to The Pensions Regulator, which when faced with the ’woeful’ take up of the OMO, responded with a guide for trustees on their at-retirement responsibilities. In October 2009, the pensions watchdog reviewed trustees’ efforts in meeting their obligations under the 2004 Finance Act which include making employees aware of the OMO; guiding them towards independent financial advice; and making clear that different annuities are available.
One-third of trustee boards were found to be in breach of the law while more than half ’had some scope for improvement in the retirement literature sent to members’; a situation which Audaer says has ominous legal implications.
“Unless trustees and companies get a grip of this they could find people passively annuitizing with the host insurance company which could lead to class action from annuitants who discover there was a better deal elsewhere.
“There is a latent danger for trustees and companies in making sure the annuity purchase process is robust and if they fail to remember that these things are regulated contracts there is a high chance this will come back to bite them.”
Of course, providing a comprehensive at-retirement service doesn’t come for free and as the challenging economic environment persists, employers may be reluctant to fund advice and support for outgoing employees.
Tim Whiting at Alexander Forbes Annuity Bureau says that for £5,000 employers can implement a whitelabelled intranet site that providescomparison tools for employees exploring their annuity options. However, he says not all finance directors are willing to make this investment.
“There is some reluctance to pay for these things especially with the corporate pressures right now; a lot of FDs will suck their breath in over £5,000 and that is just a reality we face. Trustees need to remind employers they are committing hundreds of thousands of pounds to pensions, so spending £5,000 on something to help employees at the far end is not too bad,” Whiting says.
There is a latent danger for trustees and companies in making sure the annuity purchase process is robust and if they fail to remember that these things are regulated contracts there is a high chance this will come back to bite them
Trustees, however, cannot avert the threat of legal action alone, and corporate advisers and annuity brokers must play a pivotal part in ensuring annuitants get the best deal. Rockingham’s Goodman says the role of the broker is key for trustees in practicing due diligence, particularly when securing deals for smaller pension funds.
“If [the employee has] a very small pension pot and trustees are trying to place that annuity they may not be able to do so with a limited knowledge of the annuity market. With a broker they have more purchasing power and stand a better chance,” she says.
Trustees will also turn to their advisers for information on the latest products in the market, yet given the more rapid evolution in the annuity market of late – especially the emergence of third-way annuities – questions are being asked about whether the advisory market is keeping up.
Vince Smith-Hughes, business development manager for annuities at Prudential, says: “The emphasis is on the trustees to [encourage employees to look at different alternatives] but it is also on the advisers as well. It’s probably only within the last year or so that advisers have started to wake up to these things.”
Gosden says there are only a small number of IFAs who are well equipped to deal with the specialist nature of annuities and income drawdown, although he adds: “They are more than able to handle the demands of largeDC pots and should be the first port of call for anyone requiring advice in this area.”
Gosden’s emphasis on the size of an individual’s accrued pension is an interesting one since the vast majority of DC members will not have amassed a ’large’ retirement pot. The tendency to focus on offering greater choice and higher levels of advice to those with healthier pension pots could add yet more fuel to the potential mis-selling fire.
“Advising on annuities is a low commission area so the value per client below £50,000 may be judged as uneconomic,” Whiting says. “We think if you are in this business then you should be prepared to talk and guide all clients
irrespective of size.”
However, Whiting’s view is not reflected across the industry and at the start of February financial adviser Origen said it would automatically pass corporate annuity clients with pension funds worth under £50,000 to Legal & General and Partnership Assurance.
Although it is clear trustees and advisers need to take a greater role in assisting individuals in navigating the maze of retirement planning, commentators argue that savers have to be willing to help themselves.
Prudential’s Smith-Hughes says: “People have to take a bit more responsibility for themselves and go and find out more about the options. Certainly trustees, advisers and employers can do more to help them explore the options, but people could be a lot more assertive with the choices.”
He adds: “If you have got the average pension pot of around £30,000, whether that is a small part of your overall wealth or if it’s a lot of money to you, it’s still worth exploring what the choices are.”
This is especially true once the retiree joins the post-employment world proper; they can no longer expect their employer to take control of their financial future and they need to source their own financial advice.
Smith-Hughes says: “There are the post-employment resources out there but it’s getting people to them. There are a number of specialist retirement advisers who will happily talk through the newer options but we need to make sure more people get to them.”
According to Whiting, most HR departments are keen to oversee a smooth transition for the employee, but notes: “A lot depends upon the appetite of the company and particularly the strength of the HR team.”
Whether annuities are in for a shake up depends entirely on the government’s appetite to overhaul this market.
But the very real threat of an annuities mis-selling scandal cannot be ignored and the industry, with the support of the Financial Services Authority and the Pensions Regulator, needs to ensure that savers are being properly catered for.