As I get older, I get more cynical. And it is not just me. Some of the anecdotes I hear from advisers echo my cynicism, and since the advent of pension freedoms the issues of moral hazard seem to be more dominant in some of the scenarios that arise.
One that immediately comes to mind was in the consultation on the secondary annuity market. Although the market is not what it was, many historic annuities were purchased with a contingent to continue to a spouse or dependant. Such contracts provide for benefits to be paid to someone other than the main annuity holder in certain circumstances.
The most popular would be joint life annuities that pay an income for life to the annuitant and then, assuming the annuitant dies first, pay all or a proportion of that income to another person until their death. The other person is, therefore, a contingent beneficiary under the contract: the contingency being the death of the first annuitant.
There are a number of different ways contingent beneficiaries are defined under annuity contracts. They could be a named individual (usually a spouse) or they could be a person who will fall into a class of beneficiary at the time of death, such as “a dependant” or “partner/spouse”. The decision is made when the contract is purchased and any difference between named and possible future beneficiaries will be reflected in the annuity rate/cost at that time.
The purchase of a contingent annuity provides some degree of certainty for the eventual recipient, and on many historical contracts this could well be their only source of income in retirement. So, with discussions on the secondary annuity market well under way, this raises some important questions.
If an annuity was to be sold, any contingent beneficiary would not be able to benefit under the contract. Once sold, it seems the income due to the contingent beneficiaries would be payable to the purchaser. In this respect, should the consent of any contingent beneficiary be sought before such a sale is permitted? If it is not, is there any legal comeback for the now deprived beneficiary? Could a non-consenting beneficiary prevent an annuitant from selling their contract?
As is normally the case in pensions, there will be a lot of legacy books of annuity business and I think the legal position for providers will depend on the specifics of the contract in question.
The FCA recognises this risk and envisages a contingent beneficiary unhappy because their consent was not sought before a sale when they believe it should have been would potentially have recourse to the ombudsman service, the courts and the Financial Service Compensation Scheme.
In its consultation, the FCA proposes a rule requiring annuity providers to make sure they have, where legally required, received consent from contingent beneficiaries that could potentially have an entitlement under the annuity contract before they facilitate assignment or buy back.
There are specific points where I can see potential issues:
- I am sure contingent beneficiaries will feel their consent should always be needed. This will mean extra cost/administration and presumably would reduce any sale price.
- I am always wary of the phrase “where legally required” without some definition of what this means and how much discretion is allowed.
- Will we know who every contingent beneficiary is, or will there be more disputes?
- Can we anticipate the ombudsman’s decisions?
The FCA’s argument is that such a rule would make it easier for dispute resolution and to remedy any failing to follow legal obligations. Similarly, the requirement to get agreement from beneficiaries that sellers know they cannot get could well prevent some sales and get rid of some of the moral hazard.
I was pleased to see the FCA proposing firms contacted for the first time by a seller must tell that seller consent from contingent beneficiaries may be required prior to a sale. However, we then get a bit vague:
“Under our proposed rules, annuity providers will (where legally required) need to make reasonable efforts to obtain consent from relevant contingent beneficiaries prior to facilitating an annuity income sale.”
We must make sure we are certain on these issues or the press and the legal system will have rich pickings and, more importantly, advisers will be unlikely to want to participate in this market.
Mike Morrison is head of platform technical at AJ Bell