Issues

FCA Thematic Review of the Annuity space reveals need for some market reforms but how much longer will we have to wait to put this right?

3 March 2014

The FCA year-long Thematic Review of the annuity market offers some clear findings:

1. 60% of annuitants fail to shop around and 4 out of 5 of these people would be better off doing so
2. The vast majority don’t bother or aren’t even fully aware they have this Open Market Option.
3. Those with the smallest pots are least served by the market and therefore are most vulnerable getting a raw deal.

At this point the finger is being firmly pointed at annuity providers themselves although it is far from clear what the problem is with providers and we will have to wait one more year before we really know what the FCA (and the Government) plans to do about it.

Possible issues highlighted in the Thematic Review and its associated commentary are:

1. The majority of annuitants are not getting access to the best possible deal the market could offer them. Several solutions are under discussion including making it compulsory to move customers’ pension pots from their existing provider to a new provider for the purposes of buying an annuity.
2. There may simply be a need for more awareness and education to ensure those approaching retirement are taking all necessary steps to prepare financially – including finding the best annuity rate for their pension. Will there be a larger role be played by employers here (particularly with Auto Enrolment) to ensure retirees get full access to the open market?
3. There is some evidence of some unscrupulous, non-advised, non-open market brokers simply charging annuitants for passing them into the hands of a small number of annuity providers. The online marketing of annuities also seems to be in the line of fire as recent FCA Guidance to annuity comparison sites indicates
4. There is also some anecdotal evidence of over-charging by some providers for standard annuities. Some commentators believe that, as the enhanced annuity market has grown, this has led to a reduction in the number of standard annuity providers left in the market. As a result competitive pressure has weakened, leading to a hardening of prices against consumers. This supposition also coincides with a period when annuity prices have been operating at historic lows partly because of the weakness of the economy and low interest rates.

The latter point is perhaps the most worrying for providers, particularly now that the next phase of the FCA’s work will focus on whether the market is serving customers in the best possible way. This competition investigation will explore providers’ strategic pricing decision-making and go further to look at technical pricing assumptions as well as their operations and risk controls. In short, within a year we should know what the average profitability of annuities is today and what is an acceptable profit on these products, in the eyes of the regulator at least.

The Pensions Minister Steve Webb is not short of ideas for reforming the market. Hot on the heels of his proposal that it should be possible to switch annuities at will, which was widely derided by the industry who said that it will force prices up to 25% lower; Webb has made the much more sensible proposal of providing a 12-month cooling off period for annuitants within which they can switch annuity providers. This idea does make real sense given the pressure-cooker environment in which many retirees might be making their initial product choice.

Webb paints the scenario of workers approaching retirement and suddenly realising their regular working income is about to stop for good and they must buy an annuity and have it in place within the first month of leaving their final job. It will take at least a month to process the paperwork to confirm the annuity and ensure an income in the first month or two of retirement. They rush headlong into taking the first offer of an annuity which invariably comes from their existing provider.

Although the ‘full employment straight to total retirement’ scenario is becoming rarer today as people tend to step back from full-time employment by stages; Mr Webb’s scenario certainly helps explain why more than 240,000 of the 400,000 or so people buying annuities each year are failing to explore the open market for the best possible deal even though 80% of that 240,000 (192,000) would definitely be better off if they did so– some of them to the tune of thousands of pounds.

So what can we expect from the FCA’s guidance and policy statements in a year’s time? As well as revelations about previous worst excesses of the market in terms of profits, might we have some sort of charges cap imposed and how would this work given the complexity of these products?

The ABI previously created the Wake Up Pack which was designed to communicate the options to those approaching retirement. Why has this worthy communication initiative not achieved its end? Are there actually two streams of communication: one encouraging use of the Open Market Option and the other getting people to explore the potential of other options including enhanced annuities?

All we know is the winds of change are not blowing hard enough or quick enough for many of us. Financial Adviser indicated the market is looking for the FCA to deliver some quick reform ‘wins’. One such might be bringing annuities properly into the RDR fold by banning excessive introduction fees and commission payments which annuitants are exposed to right now.

We should hear which way the wind is blowing within six months when the FCA reports on its initial findings. It seems a long time to wait while annuities remain in the limelight as the baby boomer bulge reach retirement at a rate of nearly half a million a year and so many of them are currently set for sub-optimal retirement incomes.