Annuities have long been the poor relations of retirement planning. If advisers struggle to get people to engage with pension saving, trying to get them interested in the annuities process is an almost impossible task until the last possible moment, when people finally realise their retirement income needs to come from somewhere.
The consequences of getting the decision wrong can be severe. As with any financial product, the provider, the exact situation of the client and the product can affect rates substantially. However, unlike most other financial products, most annuities cannot be altered after the decision is taken.
According to recent figures from Partnership Assurance, retirees miss out on up to £1.25bn every year by selecting the wrong annuity.
A large part of this is down to a general lack of understanding of how annuities work.
According to Prudential, almost half of people approaching retirement do not understand what an annuity is, which can be a bit of a barrier to getting the decision right.
But even those who do know how the retirement process works – moving from retirement saving through a pension to retirement income through an annuity – do not seem to be aware of the freedom of choice they have when selecting their retirement income.
Earlier this year, annuity provider Just Retirement launched a campaign for better annuities to try and address some of the problems.
Announcing the campaign, group marketing director David Cooper said: “Annuity purchase is a one-off transaction so if consumers are unaware of the open market option or the possibility of enhanced annuities the first time round, there is no opportunity to learn through experience.”
Provider Partnership has also raised the issue of a lack of take-up of the open market option for annuities.
Chairman Ian Owen says: “Research conducted by Partnership earlier this year showed that despite the introduction of the open market option five years ago, 75 per cent of people nearing retirement had no idea what the Omo is and almost three in five of those already retired failed to take advantage of it – missing out on important options.”
Against this background the completion of the review of the Omo by the Government has been cautiously welcomed by some sections of the annuities business.
The review has proposed a number measures to improve how the Omo works in practice. As well as focusing on better communication with pension savers, the review included proposals on the development of an online comparison tool for consumers to be run by the Pension Advisory Service, an initiative by the ABI to encourage best practice and increased monitoring of the annuity buying process from the FSA.
Just Retirement risk director Steve Kyle says: “We believe the balance of the report is right and will encourage people to shop around. We fully support the focus on better information, rather than more information, to encourage people to take action to increase their retirement income for life.”
However, some in the industry said the announcements were a bit of a disappointment.
Standard Life marketing technical manager Andy Tully says the review had a chance to tackle the lack of transparency in the annuity market. He says: “This whole review has turned into a bit of a damp squib. This was an opportunity to give customers greater transparency when converting their retirement savings into income.”
Tully says the decision not to require all annuity providers to publish their rates is a real missed opportunity.
Some providers are also critical of the Government’s decision not to introduce measures that would encourage the development of third way annuities.
Standard Life says the lack of flexibility of conventional products is one of the reasons for the general unpopularity of annuities and allowing the further development of the new generation of products that fall part-way between annuities and drawdown would do a lot to improve the reputation of annuities.
Standard Life head of pensions policy John Lawson says the Government’s assumption that third way products are only going to be of interest to a few very wealthy pensioners is incorrect. He says: “Third way products have the potential to be enormously popular in the UK as they are in other countries and it is unfortunate the Government seems unwilling to open the door. In the US, around 80 per cent of people reaching retirement use these products rather than conventional annuities.”
Aegon Scottish Equitable was also disappointed by the Government’s decision not to change the tax treatment of third way pensions. Head of pensions development Rachel Vahey says: “If the Government had changed the tax treatment for unsecured pension, this would have helped further innovation in the field. However, third way pension products still offer the best of both worlds: control of fund and certainty of income.”
Away from the pre-Budget report, there are signs that some providers are also trying hard to introduce innovation into annuity contracts.
Legal and General recently launched a pilot to see if where someone lives can be included in the calculation of annuity rates. As well as sex and age, L&G suggest that where someone lives can have influence how long they will live and should be taken into account.
The pilot is being run in conjunction with Hargreaves Lansdown. Head of pensions research Tom McPhail says any new way of getting the maximum return from people’s pensions savings is to be welcomed. He says: “Unfortunately, many people’s pension funds at retirement can be quite small – the current average is about GBP25,000, so people need every penny of that pension fund money to buy them the best annuity they can for the future.”
The use of postcodes to determine annuities has been criticised in some quarters as being too blunt an instrument but any extra choice that advisers can offer their clients gives an opportunity for advisers to maximise income in retirement for their clients, whether this is through postcodes, enhanced annuities due to ill health, or finding a more flexible option for clients.
Owen says: “The open market option doesn’t cost anything and can deliver a considerably higher annuity rate – a win-win situation for both adviser and client.”