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.