Last week the Financial Services Consumer Panel published some research into the annuity market. I have very mixed feelings about this, as they have generated momentum for improvements in the market, however they also failed to focus on the two most important failures in the retirement system.
As a consequence they may actually have done more harm than good, leaving consumers with the mistaken impression that shopping around at retirement is a bad thing.
The two key problems are that most people still roll-over into buying an annuity directly from their existing insurance company, and that the trivial commutation rules need reforming.
The FSCP mentioned the issue of trivial commutation but then failed to develop it in any detail. It is easy to underestimate how important this is. IFAs struggle to offer advisory services to smaller pension pots. This is because they are selling a relatively high fixed cost service.
The problem is that it is simply not economically attractive even to most non-advised service providers to deal with customers with pots much below £20,000. Yet today this accounts for over half the annuity market. This means that those customers end up either buying an uncompetitively priced annuity from their existing insurance company, or they are serviced at a loss from a broker or adviser who then has to cross-subsidise this client from another part of their business. Or they are charged an excessive fee.
None of these are good outcomes. It would be far better with these small pots just to give them their money back.
Reform of the trivial commutation rules would make pensions more attractive to investors, it would potentially generate earlier revenue for the Treasury and it would enable the pensions industry to serve its customers more efficiently at retirement. This is a reform which should be vigorously pursued now.
It is also shocking to discover that HMRC is currently keeping no record of how many people actually use the trivial commutation rules.
The media is right to highlight failings in the pension system however the negative coverage also deters future savers. Unless and until we have a pension system which makes it easy for small pots to be distributed as cash, for risk-averse retirees to find the best annuity and for risk tolerant investors to find a low-cost investment-backed solution, we should expect the negative headlines to continue.
Over half of annuity sales are still roll-over annuities direct from the insurance company to existing customers.
This means customers potentially get the worst of all worlds; no advice and uncompetitive rates. The vast majority of these roll-over customers do not benefit from an enhanced annuity – I believe it is currently around 6 per cent. This compares with over 50 per cent of customers using a good non-advised broker such as Hargreaves Lansdown. These roll-over customers very often aren’t offered alternatives such as drawdown, which may only be relevant for a minority but are still important.
Going into 2014 we will see the launch of the PICA retirement broker directory, this will help the market work more efficiently and will act as a catalyst to improve standards.
However much more needs to be done by both the Treasury and the FCA to address the structural failings in the retirement process. Without policy reform, industry led changes will only have marginal benefits.
Tom McPhail is head of pensions research at Hargreaves Lansdown