Steve Webb stirred up the annuity market during a BBC Radio 5 Live debate last week when he said: “This market needs a big shake-up and I am trying to poke it with a big sharp stick.” His concerns seem to be that annuities do not offer value for money and not enough are getting advice.
I don’t think it is a big stick we need but cool heads and constructive dialogue. Annuities are often good value for money and we can do more to make sure individuals get better outcomes, as I will explain below.
At a time when annuities are subject to so much criticism and scrutiny it is sensible to go back to basics and analyse the position of the various stakeholders which include; the individuals who purchase annuities, the annuity providers, the advisers and brokers, and finally the policymakers and regulators.
Of the stakeholders the most important but least understood is the end user. For those who want a guaranteed income for life there is no policy other than an annuity that can do this.
There are other ways to convert pensions into income, but they all entail an element of risk. In order to pay a guaranteed income for life insurance companies have to match their assets to future liabilities which means investing in fixed interest assets.
Therefore the problem is not with the annuity concept – it is just that interest rates are so low.
However, there is a strong argument that individuals should take a longer-term view of annuities and consider whether the income from an annuity purchased today will meet their needs in the future. This might mean sacrificing some of the guarantees for flexibility and investment-linking, but many individuals either are not in a position to do this or are not prepared take the time to consider this.
This manifests itself in the so-called risk dilemma – many individuals think they are taking no risk with an annuity, but in reality they are still exposed to the risks of inflation and that circumstances might change in the future.
Finally, there are some important behavioural things going on. If the industry is telling people to shop around we should not be surprised if people take this literally and shop using the only the currency they know – price.
The Holy Grail is to move the market from shopping purely on price to shopping for quality. It is the move towards providing a higher quality of information and better customer journey that holds the key to helping those with modest pension pots get better outcomes. In behavioural terms, this might result in more nudge techniques rather than actual advice.
From the providers’ point of view, annuities are a capital intensive business and the profit margins are not probably as high as many people think. Perhaps the providers could help themselves by showing what margins they make – after all, utility companies have started to tell us how much profit they make from customers.
If the position of customers and providers is relatively easy to understand, the role of policymakers is much less clear. There has been a lot of criticism of insurance companies and distributors, but there is little said about the environment in which they operate. If the environment was more annuity friendly, I think more clients would get better outcomes.
Two practical examples will help explain my point. First, providers would like to offer customers better value by offering the money back option, but this is not possible because of the 55 per cent tax on any capital protection payouts.
Second, RDR has created an environment that many individuals find confusing and creates an impression that advice is complex and expensive. Although those in the know recognise this is not the case, try telling that to clients who have small pots.
In my view there are probably only a couple of dozen people in the country that really understand pensions and annuities – interestingly those who are the most vocal are not necessarily the most knowledgeable. So let’s get them together with the task of producing a blueprint for the future.
Billy Burrows is head of business development at Annuity Line