Pensions minister Steve Webb is right to want to shake up the at retirement market to stop 250,000 people making irreversible poor decisions on their retirement income.
His comparison with mortgages is a valid one, after all an annuity is a reverse mortgage.
The big difference is that whilst there is supply and demand for lifetime annuities, there isn’t any supply for 25 year fixed rate mortgages in the UK. Lenders including Halifax and Nationwide used to offer 25 year loans but they were roundly rejected by borrowers aghast at the idea of one lender for life.
A 25 year fixed mortgage either has to have exit charges or offer poorer rates than on offer on shorter term mortgages.
There is no law I know of that stops an insurer offering an annuity with a transfer option. So, why doesn’t anyone offer a guaranteed lifetime rate but give you a get out if you can find a better deal elsewhere?
The answer is that the insurer, like the mortgage firm, would either have to offer poorer rates or have exit charges. Insurers will have to go for the latter because no-one will buy a transfer option at a 25 per cent reduction.
There are 2 ways to calculate a transfer:
1. Fund received – pension paid – charges + returns
2. Pension being paid x factor to value remaining lifetime
In practice, insurers will look at both options to ensure they make money.
Regulators will need to intervene to stop abuse on transfer terms. It will be messy & complex.
I doubt any firm will offer these annuities willingly so Webb will have to legislate. It will be fraught with risk of unintended consequences.
50 per cent of people make bad decisions at retirement, largely because they don’t want to have to make a decision at all. Forcing them to buy a product that requires regular review points and more decisions isn’t likely to prove popular with the masses.
We do need to reform two areas and they are ones the Treasury is responsible for. Webb could do a huge service to encourage the Treasury and the FCA to look at:
1. The bias that allows annuities to be sold like apples on a buyer beware basis but layers huge regulation on other retirement income sales.
2. The lack of regulation around “non-advised” sales which encourages most of the bad practice we see.
The annuity is fine as it is. It is just being bought by the right people at the wrong time and at the wrong price with the wrong features.
Webb’s well intended idea could kill the guaranteed lifetime annuity or it could reform the market. There is no question that the market needs changing, but if it were me, I would start with the simple-to-fix distribution issues noted above first.
It would give the consumer the reassurance they need to make the right decision and the industry would get the wake-up call it needs to force it to meet standards that should have been there in the first place.
Alan Higham is non-exec chair at Annuity Direct