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John Taylor: Annuity providers exploit ‘vulnerable’ non-advised clients

John Taylor MM blog

Increasingly, the single biggest transaction that many consumers will make in their lives is exchanging their defined contribution pension for an annuity. Unfortunately, the annuity market is dysfunctional, generating huge profits for providers at the expense of their unwitting, loyal customers. The incentives for providers are so great that our best hope for a consumer-focussed solution has to be the recently announced FSA investigation.

When an individual wants to buy an annuity with their pension fund, they basically have two choices. One option is buying an annuity from the company with whom they have accumulated their pension fund. The alternative is to shop around and choose the best annuity from the range of annuity providers using the open market option.

Research from the Association of British Insurers shows two-thirds of consumers buy their annuity from their current pension provider.

Providers often explain this by saying their own customers are prepared to a pay extra for the “convenience” of their roll-over annuities. The justifications go along the following lines: the customers are “loyal” after having saved with us for so long; they value the security of our brand; they like the service we provide. My personal favourite is “their pension pots are so small that our uncompetitive rates don’t actually cost them a lot in pounds and pence”.

These justifications would be plausible if we were talking about engaged, well-informed, rational consumers. Yet, how many customers would meet this description when it comes to buying an annuity?

Consumers rarely understand the options open to them, and they do not have any sense as to what constitutes a reasonable price.

Returning to the point that the difference between best and worst annuity rates is so small, in absolute terms, as to be immaterial to the customer.

A healthy 65-year-old with a pot of £20,0000 could get £20 per week from the best annuity but only £15 from the worst. Some rollover annuity providers believe that such a small absolute difference, £5 per week, is so trivial that it is hardly worth the consumer’s effort to search the market. Does that really hold water? I suspect many of us would go to some lengths for another £5 per week if we were only getting £15 in the first place.

At best, these providers are naively deluding themselves; at worst, they are paying TCF lip-service while exploiting a vulnerable group of non-advised consumers.

To shine a light on the providers’ perspective, let’s look at some profit numbers from the one provider which publishes product profitability. This provider shows that the average profit margin it makes on rollover annuities is nearly 20-times the profit margin it makes on the rest of its UK business. In fact, its total profit from rollover annuity business is almost the same profit they make from their much-trumpeted corporate pensions business. Although this particular provider is unusual in publishing detailed profits, other providers of rollover annuities make very substantial profits too.

You would think these providers would want to highlight this successful, highly-profitable rollover annuity business as much as they do their other businesses. Imagine how proud they should be that their outstanding product/service/brand commands such a high profit margin amongst well-informed consumers.

However, despite innumerable shareholder presentations, I have yet to see any provider feature their rollover annuities. Maybe providers of rollover annuities are not so naive after all?

Although the ABI is shepherding providers in the right direction, it is highly questionable whether providers have the motivation to encourage customers to shop around in the face of massive incentives to sell rollover annuities. Only the regulator can impose a truly customer-focussed regime. Let’s hope it succeeds.

John Taylor is an industry consultant and was formerly Scottish Widows corporate pensions director.


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There are 10 comments at the moment, we would love to hear your opinion too.

  1. And RDR is going to improve the consumers’ position how exactly?

    Nice one Hector (again)

  2. What John Taylor hasn’t factored into this argument is the cost of advice. It’s all well quoting £5 a week difference between the top provider and the bottom for a £20,000 annuity, however I suspect it’s nearer £2 a week on average. Factor in the cost of advice which I suspect is a minimum of £600 on average, and then it takes an awfully long time for a client to clawback, after tax, this initial adviser charge.

  3. @ M Walker – valid point where advice is actually needed. But for smaller pots, working out that £20pm from provider B is better than £15pm from provider A does not require advice. They simply need to know that provider B exists and how they can access it. Communication of that is the key, as well as further roll-out of non-advised open market services.

  4. One of the largest insurance and annuity providers in the UK have their own tied sales force who are sent to advise their clients on their upcoming annuity options. These clients have been with this company probably for years? They may have been totally happy with their pension provider and their pension returns but how many of these clients really know they could be potentially better off using the ‘Open Market Option’. Oh, they’re told about it and its fully documented in the suitability report it was discussed but in reality how many clients actually know the full facts and how this could increase their pension if they shopped around? All the FSA has to do is check with this large company and ask how many of their maturing (we’ll call it that) pension plans actually transferred away under the OMO or decided they wouldn’t go down that route and prefer to stay with them after an adviser visit? I bet I can nearly answer that one. RDR better for consumers my hairy……..!!!

  5. Adrian Philips 1st March 2013 at 4:51 pm

    Surely for most people with pots of less than £250K the cost of an advised IFA service regarding purchasing an annuity is not cost effective as they will probably never recoup the cost.

    The FSA needs to sort this one out, possibly pointing people to the MAS comparison tables at the very least.

  6. Increase the trivial pension limit to 3 or even 5% of LTA and then it becomes economic and worthwhile to take and give advice. Govmnt has as much to answer for join this one as the insurers. Govt takes tax on trivial pensions anyway so people claiming benefits instead as a reason not to increase trivial limits simply doesn’t stack up. Lobbying to keep trivial limits LOW plays in to the hands of the providers of “rollover annuities” who fleece the poor

  7. Nothing will change until we have the Annuity Review. Providers think they are bomb proof; but they thought that in 1995 before the Pensions Review !
    Unquestionably millions of individuals have been mis-sold. Anyone who has been sold (and all annuities are newly sold products) a conventional non impaired/enhanced annuity who had any sort of health problem or smoked has been mis-sold. Possibly it is only a matter of time before Pensions Review II: the Annuity Review is upon us.

  8. @Adrian Philips

    You are completely wrong in your assumption.

    An adviser agreed fee may have little impact on the the annuity payments unless the plan was very small. More so if the applicant qualfies for an imparied health annuity.

    More to the point, individuals who seek no advice may reamin ignorant of phased options, income drawdown or total deferrment when it is warranted. Simply telling someone to do there own shopping around can make them miss out on all of this.

  9. A lot of the comments on here show why advice should be taken.

    The commission/fee, is deducted from the pot by the annuity provider, before they offer the annuity in the illustration.

    This means that providing an advised annuity is offering more than that by the existing provider the client is better off.

  10. Sean @ 1:07pm

    Agreed, provided the annuity quote after paying for advice is higher than the original annuity quote everyone is a winner and there is no cost of advice to recoup.

    If a client is confident in what they want and capable of exercising their open market option themselves then they can go for it. No harm done to anyone. Advice is solely for those people who don’t know what they are doing or don’t want ro deal with it themselves. As long as they know how much advice costs and what is being done for them if people want to pay that is fine.

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