The FSA has announced it will be conducting a thematic review of annuities. It will consider consumer detriment from not shopping around when buying an annuity, but this is not enough. The FSA needs to consider how people can be helped to buy the right kind of annuity for themselves, rather than only focussing on the rate. Getting a better rate for the wrong product is not good enough. People need to get a good rate for the right product.
Most people only buy an annuity once in their life, it is irreversible and may last for many years. The industry and regulators know that annuity purchasers do not know much, if anything, about how annuities work or how to select the best type of product. Yet the regulator has not helped to ensure that customers are helped to identify what will be best for them given their circumstances.
Leaving aside many of the obvious problems with the annuity purchase process, problems such as the very poor rates currently offered, the low take up of enhanced annuities and the fact the many people buy single life annuities when they need to provide an income for a couple. There are a number of specific risks that are not taken into account in the annuity purchase process.
Annuities can be a very high risk purchase:Although the income an annuity pays is guaranteed for life, this does not mean it is a ‘no risk’ purchase. The sales process for annuities seems to indicate that the regulator believes buying an annuity carries no risk, except for getting a ‘good rate’. But there are, in fact, many risks that retirees face, which annuities may not mitigate.
Risk of getting ill not covered: The risk of getting ill, which would mean annuity income would be much higher later, is not dealt with when buying a standard annuity.
Risk of dying relatively soon not covered:The risk of dying relatively young is not catered for. If someone buys a five year guarantee with their standard annuity, and dies soon, then the annuity company will only have paid back less than a quarter of their pension fund savings and will keep the other three quarters. If that person had a partner, but did not buy a ‘joint life’ annuity, their partner will get nothing more.
No protection from inflation risk: The risk that inflation may erode the value of annuity income is not covered by standard annuities, because most people buy only a level income, that is fixed in money terms for the rest of their life.
No protection if interest rates rise: The risk that interest rates may rise in future and therefore annuity rates may improve is also not catered for – locking in at today’s record low rates could be a terrible investment decision, but the Regulator treats this issue as unimportant. Far from being ‘no risk’, buying an annuity could potentially be making an extremely risk investment decision with your accumulated lifetime pension savings.
Annuities only cover ‘risk’ of living a long time:The only risk that annuities really cover for is the risk that people will live a long time. So, out of all the risks that people face in retirement, annuities only deal with one. Yet millions of people lock their whole pension fund into this one product, they do not understand it, have no help to get the right kind of product and pay money to an annuity provider to have the product sold to them.
Surely the FSA must look at all these broader issues, if it really wants to ‘make the market work for consumers’.
Dr Ros Altmann was formerly director general of Saga