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Out side edge

Can encouraging the open market option achieve the FSA&#39s objective? Yes but not as expected.

The recent decision by the FSA and the ABI to encourage the Omo in the annuity market is a welcome move. Much of the recent debate surrounding annuities has focused on the options for investment choice relevant for those with big pensions pots but of little importance to the majority with smaller pension funds.

It is clear that the difference between the rates offered to those continuing with their existing pension provider and those going with the Omo represents a market failure and deserves regulatory attention.

If the market were functioning well, we would expect those staying with their existing provider to be offered if anything preferential terms to those choosing the Omo due to the lower customer acquisition costs involved. But will disclosure of the Omo bring the gains the FSA expects?

Its diagnosis of the problem seems to be accurate. Customers who do not choose to use the Omo reveal to their provider that they are reluctant to search and prefer the route of least resistance.

The solution the FSA is putting forward aims to show currently inert customers the value of shopping around. The objective is to make them more active in the purchasing pro-cess. If, at the extreme, all customers were persuaded to change their behaviour, this would indeed make the annuity market converge and the same terms would be offered to those staying with their existing provider and those using Omo.

But there are two problems. For one thing, it will never be possible to persuade all customers to shop around. Lack of information is not the only and may not be the most fundamental reason why they do not. Second, does the FSA solution do anything for those who still choose not to shop around or only benefit those that are now persuaded to?

One reason customers fail to shop around is that, even if they are willing to consider a range of providers, they will only visit a single adviser.

Given their existing trust relationship with their pension provider, customers will reasonably want to know what annuity rate it offers and for this reason they will go to their existing provider. Rather than make the effort of shopping around for another adviser, evidence suggests that many will then decide to purchase their annuity from their existing provider.

Other customers are not prepared to shop around bec-ause they do not think it is worthwhile. A common mistake is to believe this is unique to the financial services market but a moment&#39s thought suggests otherwise.

I do not regularly check the cost of my weekly shopping in Tesco against a comparable shop in Sainsbury. No. I believe that enough people do make this effort to keep prices in line.

In my grocery shopping, I am probably right because the supermarket cannot tell that I am an inert shopper and has to charge me the same prices as everyone else in the store.

But this may well not work in the annuity market because providers know who is inert as soon as they say what they want to buy. As long as prov-iders can “segment the market” in this way, the FSA approach will not solve this problem and inert customers will still suffer.

The analysis above might suggest that I do not believe encouraging the Omo will work very well. But the FSA&#39s actions could work in an unexpected fashion.

If – and it is a big if – they encourage enough customers to go for the Omo without consulting their existing pension provider, they will force annuity providers to respond by committing to give all their existing customers the same good deal. Then I can be as relaxed buying an annuity as a washing powder.

Tim Wilsdon is principal at Charles River Associates

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