Annuity market review uncovers a fundamental flaw in pensions policy
BRITAIN’S annuity market is not working for consumers. This is the conclusion of an important report, released by the FCA today. With the advent of auto-enrolment, most people are now saving for their retirement through a pension scheme, where they and their employer pay money in and invest it to build up a fund. But despite policy changes (like raising the state pension age), we are still saving too little as a nation for the retirement we aspire to. People can ill afford to lose value from their savings, so the options chosen at retirement are critical.
When you retire, you can take up to 25 per cent of your fund as a tax free lump sum and the rest is used to provide an income for life. The annuity is the most common product bought for income, with about 420,000 sold each year. You hand over your fund to an insurer, and they pay a fixed income for life. It is the ultimate “lobster pot” – once bought, you can’t change it. But the FCA has concluded that over 200,000 people make poor decisions on their annuity. It focused on the price people pay when buying from the same pension company they saved with, and found that 80 per cent can do better somewhere else.
This highlights a fundamental flaw in UK pension policy. We default people into joining a pension at work; we set the contribution they pay and the default investment fund. We correctly realise that most people want someone to make pensions work for them. But at retirement, we send out reams of paperwork and ask the consumer to make complex decisions. Suddenly, people are expected to become pension experts.
Unsurprisingly, it doesn’t work. Most insurers you save with know exactly what drives customer behaviour. It has been rational for them to take a chunk out of people’s retirement funds by offering poor rates. The FCA report is a warning bell that this gravy train is about to be taken out of service.
There will be no immediate sanctions, but the FCA will look at each insurer’s sales practices. Over the next 12 months, it will also consider annuity prices to see if proper competition exists, given the small number of firms operating in the market. It is a big issue for many insurers, where a significant proportion of their profits come from selling annuities to captive customers. Expect resistance as the FCA begins to enforce its rules.
But the FCA also rightly questions whether the annuity should be the automatic default product. They do not provide brilliant returns when you think of them as a 20 year fixed rate saving deal, offering 2 to 3 per cent interest per annum. Annuities are appropriate for most people at some point, and are better value as you age. But it’s important that other options, such as income drawdown, are considered more often.
FCA action ought to lead to a better default setting for consumers. But consumers must also realise that it pays to take an interest in your own affairs. To get the best retirement possible involves making difficult judgement calls on complex questions. People must choose a pension company that helps them make good decisions, and reject those who look to make a quick profit at their expense.
Alan Higham is head of retirement insight at Fidelity.