Annuity Reform Proposals
by Dr. Ros Altmann
(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)
Annuities have had very bad press recently and, if confidence is not restored, people may stop putting money into pensions, which would be a huge problem for the future. I have two suggestions for improving the way annuities work for the majority of people. These are:
1. Everyone buying an annuity should receive at least a basic level of advice (preferably independent) to help choose the right annuity and find top rates.
2. Capital protected annuities should be permitted (i.e. a ‘money-back guarantee’).
Annuities are a ‘special case’ in the financial products arena. They are the only financial products which:
– people are forced to buy and
– once bought, can never be changed.
It is, therefore, essential that people buy the right annuity at a competitive rate. Annuities are an excellent product for providing pensions. They ensure that people will never run out of money. But to most people, annuities are complicated and difficult to understand. They need help. However, it is generally only those with large capital sums who actually receive advice. The majority of annuitants are left to make this decision on their own. The result is that people often buy the wrong type of annuity, or get a poor rate, or both. This situation is a cause for concern.
But it is even worse than this. Although people obviously need advice before they annuitise, they do not get any, but they are being charged for it anyway! Around 1-1.4% of the pension pot is typically deducted for ‘commission’, whether there is an adviser or not.
My suggestion, therefore, is that all pension providers must ensure people actually get basic advice at the point of purchase. This would be a ‘hand-holding exercise’, to help people understand what questions they need to consider. For example, people need to know they can provide for live-in partners or disabled children, can choose capital guarantees or escalation, and that they might be eligible for enhanced rates or impaired life products.
This proposal would entail regulatory changes. Firstly, on polarisation, providers would have to be permitted to offer another provider’s annuities, if their own are not competitive. Insurance companies sometimes do not want to write annuities business and, therefore, drop their rates to discourage people from buying. But, due to inertia and the practical difficulties of taking an annuity from a different company, many people just buy their seeding company’s annuity. It is actually much easier not to take the open market option. Secondly, the concept of two-tier advice would need to be accepted – a lower level of advice without a full fact find; just answering basic questions about dependants, health status, guarantee period, need for escalation, other sources of income and desired retirement expenditure levels. If the person’s circumstances are simple, this should be enough to select the right annuity (often they have no other income apart from the state pension and would not be able to consider investment- linked annuities). If their circumstances were more complex, they would be told to take more advice.
The FSA already produces useful annuity information and may consider developing decision trees. This would make any advice process easier, quicker and cheaper. But, decision trees on their own are not enough. People cannot be left to understand the issues by themselves. They need someone to talk them through the relevant points, before making this irreversible decision.
This advice process should not take too long – perhaps 1 or 2 hours – and could probably be done over the phone. It could be made even easier by requiring standard forms and wording (in plain English) from providers, when writing to prospective retirees with their options. Simplification of the whole DC system would be of enormous help too. The possibilities for the Pickering Review are enormous!
The advice could be charged on a fee basis (perhaps a minimum of, say, £100 and a maximum of around £500) or by commission and would be paid by the annuity provider. For example, the 1-1.4% that is currently deducted from a £20,000 capital sum, would provide about £280. It would be interesting to hear proposals from the industry as to how this basic advice should be charged for.
Having chosen the appropriate type of annuity, the adviser could check on the various Annuities Exchanges to find the best rates. The retiree could then choose one of, say, the top 3 or top 5 rates.
If, for whatever reason, the person refused to take advice, they would need to sign a form to this effect. The default, in this case, would be to offer the person a ‘standard’ type of annuity at one of the top rates available in the market.
These proposals will make many people (typically those with small or moderate capital sums) better off. The differentials in rates are often 15% and can be 30% or even more.
For example, a man aged 60, anuitising £25,000, could buy a weekly pension of around £35 from the best provider, but only around £30 from one that is 15% below the best (a common gap). So, by not shopping around, he would lose over £5 per week for the rest of his life. If he lived for another 20 years, he would have lost over £5,000 by not taking a top rate.
Or a woman retiring at 60 with a capital sum of £100,000 could lose £20 per week by not shopping around and, if she lived to 90 – by no means atypical – she would lose a total of £31,200.
The second big change I am suggesting would potentially benefit everyone who buys an annuity, including those with very large capital sums. One of the biggest complaints about annuities is that, if people die early, the money from their pension pot is lost. A number of providers, however, are keen to offer a ‘money-back guarantee’ whereby, on death, if the annuity payments have been less than the amount invested, the balance is paid to the person’s heirs. Currently, capital protection is only permitted for up to 10 years and it also has to be paid as income, so that the estate cannot be wound up until the end of the 10 years. I suggest the rules should permit the balance to be paid out as a capital sum, which might be taxed as in drawdown. The Revenue would then get its tax sooner and the estate could be wound up promptly.
The cost of this capital protection is not high, especially at younger ages. Providers estimate that it would cost 0.3% at age 50, 1.7% at age 60, 8.2% at age 70 and 15.7% at age 75. This would be an option people could choose to take and could reduce much of the hostility towards annuities, by addressing the death benefits issue.
To sum up, then, these proposals would make a meaningful difference to the workings of the annuity market. They would ensure that many people would have much higher pensions for the rest of their lives (at no cost to the Government) and they would have the opportunity of leaving capital to their heirs if they die before getting back the value of their capital sum.