Head to head: Should the Omo be made the default option?
Behavioural economics suggest that the bigger a decision, the less likely we are to want to make it and financial decisions do not come much bigger than how to convert your pension fund into retirement income.
It is especially daunting because it could affect your income for the next 30 years and in many circumstances the decision is irrevocable. No wonder then that many people simply take the easy option and buy an annuity from their existing pension company.
However, this is exactly the reason that the default internal annuity decision opt-out needs to be removed and replaced with a process that involves customers making their own informed decisions. The ABI’s own research shows 60 per cent of customers buying an annuity in 2010 bought from their existing provider, less than 1 per cent of these contained an enhancement due to medical/lifestyle details and awareness of enhanced annuities generally was shown to be abysmal. This is clear evidence that the current process simply does not work.
Awareness of enhanced annuities generally was shown to be abysmal and shows that the current process simply does not work
Encouraging customers to engage with their retirement options provides greater benefits than simply getting a better rate. A better understanding of retirement risks and options encourages appropriate choice, whether it is the timing or shape of an annuity purchase or whether an annuity purchase is the appropriate course of action at all.
The guaranteed annuity rate is often used as an excuse to stall development of a default shopping-around process. We are not suggesting the existence of a GAR should be hidden but any rate offered by an incumbent provider should still be compared with options from other firms, particularly enhanced annuities, which may provide higher benefits than the GAR.
Let us be clear, pension providers will still have the opportunity to do business with their customers but they are just going to have to compete on a level playing field with other insurers. Surely this is not that controversial? We are already starting to see some services being developed where providers offer a shopping-around service.
There will be problems along the way such as the issues of fund aggregation and triviality and lack of customer access to impartial information or advice but they are not insurmountable. It is estimated that retirees are missing out on £3bn to £7bn of additional retirement income definitely a prize worth fighting for.
We need a game changer and the only way we are going to significantly improve the outcome for customers, particularly those with small funds who are most likely to be affected by any reduced income in retirement, is to make shopping around the default option in retirement.
We are living longer. This makes it essential that we get the “biggest bang for our buck” from our pension savings. All stakeholders agree that shopping around for an annuity must become the norm for consumers. Achieving this is urgent, as record numbers are turning 65 - almost 658,000 people this year alone. The good news is that two-thirds of people do shop around for the best deal. In the first quarter of 2011, 48 per cent bought their annuity externally. Of course, this still leaves a third of people whose behaviour we must seek to change.
However, there is considerable debate about how to bring about this change. There has been much talk about a default Omo, which could mean a number of things. For example, it could stop providers giving their customers an annuity quote, which would force consumers to obtain quotations in the market and perhaps miss out on competitive internal rates. It also makes it very difficult for them to put the quotes received into context.
Making the Omo default could also mean forcing providers to give quotes from competitors. This could be complex, as providers can only give relevant quotes if they understand the customers’ characteristics.
Making the Omo default could also mean forcing providers to give quotes from competitors which could be complex
The ABI believes we need a combination of approaches. For example, we fully accept the importance of avoiding inertia purchases. Our industry guidance therefore prevents providers from allowing customers to purchase an annuity on the basis of a tick-box in the wake-up pack. Wake-up packs must also include the indicative fund value so that customers can start shopping around early and compare offers.
However, not all consumers read the information they receive. This is likely to be especially true for those with smaller pots, who generally have lower levels of financial awareness. This is why our members have been working closely with the Money Advice Service to improve their annuity comparison tool, which is real-time and provides quotes on a postcode basis.
We also believe we need to address issues that go far beyond shopping around. Many people already have more than one pension pot, a trend set to increase with the advent of automatic enrolment. To increase their engagement with savings, we must make it easy for consumers to merge their pension pots. We are discussing proposals on how to facilitate this with the Govern-ment over the summer.
It would be great if there was a “silver bullet” but suggesting that is the case ignores the complex needs of consumers. Progress has been made but there is much more to do.