Dr. Ros Altmann CBE, independent expert on consumer finance, pensions, retirement, care funding and economic policy. Advises governments, corporations and industry bodies. Recently appointed as UK Government's Older Workers Business Champion.

There is no control on annuity pricing, profits or risk margins
People buying without an adviser at risk of poorest rates but don't realise
Insurers may be pocketing £100m each year from selling poorest value products

by Dr. Ros Altmann

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As we move towards a world of defined contribution pensions, more and more people will be reaching retirement and having to find the best way to release money from their pension savings. If we want auto-enrolment to work well, we need to address the shortcomings of the current annuity and at-retirement pension decision process. The system is failing consumers, but hugely profitable for annuity providers.

Since rates have fallen significantly, following recent Bank of England policy decisions, annuities are no longer a 'low risk' option for securing retirement income at age 60 or 65. They may provide a 'safe' income, but you could lose all your capital with no inflation protection at all. Annuity companies are making significant profits on selling annuities, which of course they are entitled to do, but is the pricing 'fair'? Customers have no way of assessing the value and if we want people to have confidence in pension saving, we must ensure that they feel they are treated fairly.

Companies do not disclose how they are pricing their annuities:
Annuity companies are exceedingly secretive about how they decide what pension income they will pay you. The way annuities are priced will depend on the insurance company's models. If you offer your £100,000 pension fund, the insurer will assess how long you are expected to live and will make an assumption about the investment return it might make on the money it receives from you. It will then add a risk margin to its estimates in case its assumptions are wrong. And then it adds a profit margin.

Annuity prices depend on variables that customers cannot gauge:
So the amount of pension income you will be offered is a function of all these variables:

  1. how many years you are expected to live - the longer the annuity provider expects you to live, the lower the pension income it will offer to pay you each year.
  2. what investment return it expects to receive on the money you hand over - the lower interest rates are, the lower the return it expects and the lower your income.
  3. a risk margin - there is no control or disclosure required on the risk margins.
  4. a profit margin - there is no control or disclosure required on profit margins. Some insurance companies' recent accounts suggest an 18% profit margin.

If a company is in the best buy tables should I assume they offer best rates?
Annuity pricing is not straightforward. It is not like most investment products, which show you a price and you can guage what you will be paying. With annuities, pricing by the same company can change from one week to the next. There will be times when an insurer will want to sell annuities and will offer competitive prices, which may put them in the best buy tables, but there will be other times when that same company may not want to take on any more annuity business for a while and will then offer poor rates, compared to the rest of the market. In order to sell annuities, companies must hold regulatory capital to back the annuity sale. Usually, this means holding a certain amount of gilts or high quality bonds to satisfy the regulators. If a firm has sold significant amounts of annuities recently, it may not have enough regulatory capital at that time and, therefore, will not want to take on much more business. It will therefore drop its rates, offering much worse value, and if you buy from the company that week, you will not get a good deal. That is why it is so important to shop around the whole of the market. Annuity pricing is not stable and even companies which offer good rates much of the time may become uncompetitive at other times.

People need advice to help them through this minefield:
An independent adviser can go through your pension and income needs and discuss your own personal situation with you. Firstly, whether you should buy an annuity at all at the moment, then individually tailored advice to find the right kind of annuity and finally to find the best rate available. You will be protected by financial services regulations and, therefore, if you are not given the right advice, you can claim compensation.

U

nless you can access the whole of the market, you may not find the best rate:
Using a specialist financial adviser can help you get the best annuity rate for your circumstances. It is important to have access to the whole of the market when you are buying an annuity. New companies are entering the market from time to time, often offering better rates in order to gather business, but only a specialist adviser will know which companies are around at the moment.

Won't I have to pay for this advice?
Of course, an adviser who is independent and an expert, needs to earn money for their advice. Just like a solicitor or an accountant, or even a plumber or electrician, if they are helping you with something complicated, they need to be paid. If you go to an adviser, you will know how much you will be charged, because the adviser now has to tell you before you start. The Financial Services Regulator (FCA) does not allow advisers to just take commission from your pension fund. They must first tell you how much you will be charged. This rule came into effect at the beginning of 2013 (following the Retail Distribution Review, or RDR which banned advisers from taking commission in order to prevent them from having an incentive to sell you products that paid them commission).

On-line brokers still charge commission when you buy:
The strange thing about annuities is, even if you do not use an independent adviser, you will normally still have to pay anyway, just to buy the annuity. If you do not use an adviser but buy direct, brokers can charge you commission, although you may not be told this until you are at the point of purchase. And this commission through a self-service broker can actually cost more than buying with the help of an Independent Financial Adviser (IFA) who will deal with paperwork, help find the right product, look at all the providers (most on-line services do not cover the whole market) and offers regulatory protection if things go wrong.

On-line services may not give access to the best rates:
On-line annuity services do not usually cover the 'whole of market'. If you buy on-line you will only be able to check the rates of the companies that are on their database.

What about enhanced or impaired life rates?
There is no transparency on these rates either. Especially with enhanced or impaired life rates, on-line quotes will often be lower than those available through an adviser who can provide more detailed information to the insurer. The on-line questionnaires are generic rather than being tailored specifically for you, so the annuity rates offered will be more general rates, based on broad information, rather than individually tailored to your own particular circumstances. If the broker does not include new entrants yet, you could miss out on the best rate, especially for impaired life or enhanced annuities. If you miss it, you will end up poorer than you need to be for the rest of your life. It is in your interests to try to make the most of your money.

It is possible to 'haggle' to get better rates, but you need an adviser:
An adviser can haggle with insurance companies to obtain a better quote for you, so the annuity rates published on-line or first offered to you are often not the best rates you can obtain. Sometimes, advisers are willing to rebate part of the commission they receive from the insurance companies and sometimes insurers will increase their quote in order to secure the sale. Providers can call back an adviser who has asked for a quote for you to see if they need to increase their offer to get your business. With an on-line service most people do not have the chance to go back and obtain a higher quote.

If you buy direct, you are charged commission anyway - £100m free money to insurers every year:
Those who do not use an adviser and do not shop around with an on-line service get the worst of all worlds. They are least able to find the right type of annuity, are most likely to get the poorest rates - and they have to pay around 2% commission anyway. But the insurance industry does not tell us how much pension fund money buys these poor value annuities each year. They have kept this a closely guarded secret. They do release the numbers of people who buy from their original provider, but not the amount. This is free money to the insurance industry, as their pension company will pocket money from their pension fund, without having to do anything except offer them the product. If we assume £5bn of annuity purchases are direct with the insurer, without shopping around (as I say, the figure is not released to the public so I have had to estimate it), that means insurers receive £100million a year from people's pension funds. (2% commission on £5bn = £100m).

Customers deserve transparency and better protection to assess value of annuities:
Buying an annuity could be the most important financial decision a person ever makes. It carries huge risks - you could lose all your money. And once the annuity is bought, it can never be changed. Therefore, it is essential that there is better transparency and customer protection against being sold poor value products, or the wrong product which they are then locked into for ever. And they pay significant charges when they buy, so they deserve fair treatment in exchange for their payments. Even when you buy a house, if you have done the wrong thing, you can sell and move on. If you buy a poor value insurance policy, you can change it. With an annuity, you can't. This demands regulatory action in order to restore confidence in pensions.


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