The FCA is considering making drastic changes to the rules around non-advised annuity sales in a bid to reduce consumer detriment. Concerns that consumers are paying more in commission than they would do for advice has led the regulator to explore whether there is a need to restrict it, either through an outright ban or a cap.
Its intentions were announced in its consultation paper (CP15/30) on pension freedoms rule changes published earlier this month.
So, should annuity brokers be forced to join advisers in the RDR world or is a commission-based system justified?
The case for an outright ban has been hotly debated among industry experts over the past few weeks. Head of pensions research at Hargreaves Lansdown Tom McPhail is particularly vocal in his defence of commission, saying there is “no hard evidence” to suggest it causes consumers any disadvantage.
“The FCA has acknowledged that interfering in a mediated broker market that works well most of the time could be counterproductive. It also suggests banning commission could disenfranchise people with smaller pension pots, with no evidence that there is a better system available,” he says.
Indeed, the consultation paper states consumers with pension pots worth less than £20,000, who make up around half of all maturing pots, would likely still pay less for a non-advised, commission funded transaction than for a sale with advice. In this case, commission rates would have to exceed 3.75 per cent to outstrip an average advisory fixed fee of £750.
According to research by the Financial Services Consumer Panel and evidence seen by the FCA, average commission rates start at 1 to 1.5 per cent, rising to 2.5 or 3 per cent for enhanced annuities.
Independent pensions expert Alan Higham sits firmly on the other side of the fence, however. He says the argument for small pot holders is not valid, claiming most would be better of taking a lump sum given the “high fixed costs and low rates” attached to annuities. In fact, Higham believes a complete commission ban is long overdue.
He says: “Commission should be banned and replaced with explicit charges and applied to anybody selling the annuity. There should be a pounds and pence fee for the service. Then the customers know what they are paying for and it wouldn’t distort any decision-making. It would get rid of the current myth that you get a better price through the product maker as though there is no charge for the sale distribution.
“It’s quite straightforward: just ban it and condemn this last bit of commission to the dustbin.”
An alternative option to a drastic outright ban (which the regulator says it would have to consider on a wider range of investment products to avoid distorting competition) would be to impose a commission cap. Some suggest a figure, if implemented, would likely end up around 2 per cent. However, there is a concern at the FCA that introducing a cap could have unintended consequences, leading firms to price up to the maximum level.
This concern is not echoed by Retirement Intelligence director Billy Burrows, who believes the fact the discussion centres on such a thin part of the market means all the providers involved will be charging a similar amount of commission anyway and thus would not be tempted to price up. McPhail is also confident the regulator would set a cap at a level the market is already comfortable with.
But Partnership head of product development Mark Stopard warns if a cap were to become the average, it would make things a lot more difficult for customers with smaller pots. For example, a cap of 2 per cent has very different implications for someone with a pot of £10,000 compared to someone with £100,000, he says.
The FCA is also exploring the possibility that improved disclosure could tackle the problem. It proposes that, if the consumer is fully aware of the cost of commission and the implications of that for their annuity income, they will be better able to make a judgment on whether to purchase non-advised or seek advice.
Senior consultant at Barnett Waddingham Malcolm McLean is confident that this is where the problem lies. He says consumers just do not understand the concept of commission.
“Most people have thought it was free service and did not realise that the charges came out of their money. This has to be explained in very precise terms for the man in the street,” he says.
The FCA concedes the current disclosure requirements around commission on non-advised annuity sales may not be enough. However, it also highlights that any additional disclosure must not encourage consumers to focus on commission at the expense of other factors.
The regulator’s final option put forward in the paper is to improve competition. Stopard says this would be an effective solution.
“Encouraging more people to shop around would provide the volume companies need to see economies of scale and, ultimately, reduce costs,” he says.
Just Retirement director Stephen Lowe agrees. He believes the FCA would do well to push providers to offer a range of quotes from competitors in illustrations.
He says: “It is often a collection of interventions, rather than an outright ban on things like commission, that do the most to improve consumer outcomes.”
However, the FCA did not provide any details about what this option would look like in practice beyond “further work into the operation of the market” and this vagueness does not surprise McLean.
He says: “Why do people choose a company or provider in the first place? A lot of it is down to marketing and how successful you are in selling products. Introducing comparative terms or websites is a slightly tenuous process and I am not sure everybody will take notice of it, as seen with the ABI’s annuity rate examples.”
Advice versus non-advice
According to Burrows, the debate inevitably leads to the question of whether non-advised annuity sales should be banned altogether.
“It seems outrageous that advisers have to go through the effort of building up their businesses and becoming qualified, while annuity brokers can push non-advised products straight to the public.
“Many argue that advice is not necessary if a customer is clear about what they want to do but a lot of people do not fully understand and are not in a position to know all the facts.”
He says the advice gap is still a major headache for regulators dealing with non-advised annuity sales.
“Middle Britain wants something approaching advice that is not holistic or expensive. The FCA has to make it easier for people to get access to the equivalent of John Lewis rather than making choose between Lidl and Fortnum and Mason.”
Elsewhere in the FCA’s consultation paper…
- Second line of defence rules will only apply to pots under £10,000
- Advisers must report professional indemnity insurers that refuse to cover insistent client cases
- Sipp providers will be forced to outline the margin they take on customers’ cash accounts
- A change in the criteria of “certified high-net-worth investors” and “restricted investors”, to exclude money taken from pensions not used to provide retirement income
- Non-insurance products, such as drawdown, could be given the same FSCS cover as insurance products