The creation of a secondary annuities market presents bigger consumer protection concerns than the pension freedoms, the FCA warns, as it sets out the key challenges of policing the reforms.
On Tuesday Chancellor George Osborne unveiled details of another pensions overhaul that will allow savers to cash in their annuities from April 2017.
The reforms were originally due to be implemented in April 2016 but were delayed due to concerns the industry and the regulator would not have time to create a secure market.
In a wide-ranging interview with Money Marketing prior to Tuesday’s announcement, FCA director of strategy and competition Chris Woolard reveals the scale of the challenge facing the regulator as it attempts to prevent savers being ripped off.
Policymakers had originally planned to prevent providers from buying back annuities, citing the risk of insurers exploiting a “captive market” and the potential impact on their solvency.
However, providers warned this would mean customers would be likely to get a worse deal.
In June Money Marketing revealed the Treasury had backtracked and planned to allow providers to buy back annuities from existing customers.
Money Marketing subsequently revealed this would be facilitated by private sector third-parties such as annuity bureaux.
The Treasury says: “Overall, considering the benefits and risks associated with allowing buy back, the Government agrees that it should be allowed indirectly.
“The Government plans to legislate to create a further regulated activity for buying back an annuity. Annuity providers will need to hold this permission in order to buy back their annuities through a regulated intermediary.”
The Government will also allow annuity providers to buy back low-value annuities directly, although it has yet to determine the size of annuity for which this will be permitted or how this will be measured.
People wanting to sell annuities above a certain value will be required to take advice, although this threshold has not been set. Advisers may be required to obtain an extra qualification or undertake additional training if they want to advise on secondary annuities.
Pension Wise, the Government’s guidance service, will also be beefed up to ensure savers have access to information on their options.
In addition, the Treasury says it does not consider second-hand annuities suitable for retail investors “given the complex pricing and liquidity features of the products”.
Policymakers will, however, allow second-hand annuities to be packaged up and sold on after they have been surrendered.
The Treasury says: “This onward sale of annuities poses fewer consumer protection and tax avoidance risks. The Government does not propose to restrict any entities from purchasing on the tertiary market, but will be considering with the FCA whether to prevent UK retail investors from purchasing rights under annuities that are re-assigned on the ‘tertiary’ market, in order to protect them from a complex financial product.
“The Government will consider whether any further secondary legislation is required in order to allow the ‘tertiary’ market to function.”
Savers will only be able to cash in their entire annuity. The regulator says allowing people to make partial assignments would have been “highly complex and create additional costs”.
In addition, the Government intends to work with the FCA to create an online tool that allows annuity holders to enter their details and receive an estimate of the price they would get if they sold their annuity on the secondary market.
Following the March 2015 Budget Money Marketing revealed Government plans to exclude 650,000 people on means-tested benefits from the reforms.
The consultation response published on Tuesday confirms the Treasury has u-turned and people in receipt of means-tested benefits or in social care will also be allowed to sell on their annuities.
Woolard says there are three major challenges facing the FCA in policing the secondary annuity market.
He also raises the spectre of traded-life policies or “death bonds” – products that use complex investment strategies based on calculations about how long people will live.
Woolard says: “There is a big challenge for us around secondary annuities.
“When you step back and look at the secondary annuities market, the first challenge is just creating that market without running into some of the risks that we have seen in the past. So traded life products and those kind of questions. You need to make sure you have a secure market.”
However, Aviva head of financial research John Lawson says the consumer protections put in place by the Government will ensure the market is “clean”.
He says: “Entering a market which has the potential to be dragged through the mud would have been a huge risk.
“The fact the buyers are regulated and there are consumer protections in place should stop this market going bad quite quickly.”
Woolard also says creating a market that works for both savers and providers will be difficult.
He says: “How do you deal with the balance of incentives and the asymmetries of information in this market? You can hear some commentators saying the only kind of person who is going to want to trade their life product is someone who knows they are ill, for example. How do you protect both the consumer and make sure this isn’t just an excuse to have some very odd products trading in this market?”
Finally, he says the regulator will need to establish “fairly and sensibly” how annuities should be valued.
“So you have all those questions and the residual questions we have encountered in the wider pension freedoms, such as how to value guaranteed annuity rates.
“If you put all that together, from a consumer perspective it is just as complex as the original pension reforms we have seen with a number of other issues added on besides created by the fact they are actually in receipt of an annuity now.”
While the Government will create the conditions for a secondary annuity market to be established, providers will not be forced to buy annuities.
Woolard suggests there are significant barriers to entry that will limit the number of buyers, with potential knock-on implications for competition and pricing.
He says: “There is a question about how many providers are going to play in this market.
“Clearly, the attraction commercially to play in this market only comes if you are relatively asset rich as a firm. If you have not got a lot of spare cash hanging around you may not want to even go there in the first place.”
But Lawson says the reforms are likely to attract specialist players from abroad.
He says: “There are international markets for these kind of things, particularly in the US and Europe. I have spoken to some companies who would be interested in getting involved in a market like this.
“They are not household names in the UK but there are willing buyers out there. There are also people who have been involved in tradeable endowments who might be interested in acting on the buy-side.”
While overseas providers may well ensure the broader market is competitive, AJ Bell chief executive Andy Bell argues the Government has not done enough to ensure consumers have sufficient product choice.
He says: “There is a lot of focus on ensuring people get the best possible cash value from selling their annuity, which is important, but we’d like to see a requirement for people to have access to the whole flexi-access drawdown market if that is the option they select.
“We need to avoid a market where consumers are either forced or encouraged to set up their flexi-access drawdown with the same firm that buys their annuity or perhaps from a small panel of flexi-access drawdown providers with links to the annuity purchaser.
“This could result in consumers being forced into selecting a flexi-access drawdown provider with higher costs, a poorer range of investments, a more limited choice of retirement options or a lower standard of service. Replacing one bad egg with another is not a good outcome for the consumer.”
Peter Chadborn, director, Plan Money
In principle we would be prepared to advise on secondary annuities, provided that the market is robust.
But I am not convinced this reform will be good for consumers. We have already seen with the freedoms that only having a little knowledge can be a dangerous thing, particularly in relation to pension scams.
If that has happened already with the freedoms, it will inevitably be even worse with secondary annuities.
Luke Fernquest, independent financial adviser, Fernquest Financial Planning
This could be very similar to traded endowment policies or equity release – it sounds good in theory but providers are not going to trade for free.
There is an obvious risk that people who might have been ripped off when they bought an annuity in the first place are ripped off again when they trade it in.
There could also be a similar problem with the pension freedoms in terms of access to advice, because a lot of advisers simply won’t touch this business with a bargepole.
FCA’s Woolard on drawdown charges, safe harbours and advice costs
The FCA has set its sights firmly on the drawdown market in the wake of the pension freedoms and warns it expects prices to drop as the product becomes mass market.
The introduction of the freedoms in April has resulted in billions of pounds of pension money flooding into providers’ drawdown offerings. Most providers have launched non-advised propositions to cater for the increased demand.
Speaking to Money Marketing, FCA director of strategy and competition Chris Woolard says he expects drawdown charges to fall as a result of the reforms.
He says: “Traditionally this has been seen as a high-end, complex, quite expensive product, but the effect of the reforms is to make it mass market.
“Around 80 per cent of firms say they are coming forward with new products, and one of the interests for us will be what are the charges associated with those products and do they reflect the relative simplicity of the transactions required?
“What we would expect to see is a market develop that can meet the needs of different consumers at different levels of complexity.”
Asked if this meant the regulator expects prices to fall, Woolard replied: “Yes.”
Woolard also rules out the possibility of a regulatory “safe harbour” being created as a result of the Financial Advice Market Review.
He says: “There have been calls within the FAMR process to say ‘if I advise you to buy something, you should somehow disapply the standard to me in certain cases’.
“We would still want to see people take responsibility for the advice they offer. The question for us is ‘are there ways the existing system can be made to work properly, and also do our rules need to be modified in some way to give people greater certainty about using automated models.
“If by safe harbour we mean an adviser can tell someone what they should be buying and walk away from any responsibility, then I don’t think that can work.”
However, Woolard rejects claims the rising cost of regulation is preventing firms from innovating.
He says: “I’m not sure I agree with the idea that the cost of regulation has become the main blocker [to innovation].
“We are always conscious of costs and the overall regulatory burden but we also have to remember that, particularly in the market for financial advice, the existence of a regulator creates that market in the first place.”
Secondary annuities reforms in a nutshell
- Reforms to be introduced from April 2017
- People with annuities above a certain value will be required to take advice, although this value has not been set
- Advisers wanting to work in the market may be required to obtain an additional qualification
- Pension Wise remit expanded to cover secondary annuities
- Providers will be able to buy back existing policies, as long as an intermediary is involved
- People with small annuities will be able to sell them directly to their ceding provider. The threshold for a small annuity has not been confirmed
- Reforms are permissive, so providers will not be forced to play in the market
- Retail investors will not be allowed to buy second-hand annuities
- People in receipt of means-tested benefits will also be allowed to trade-in annuity policies