Improving annuity purchases

Mark Wood looks at the difficulties surrounding the purchasing of annuities and what can be done to improve the process

Just before Christmas a Financial Services Consumer Panel opined on the rapidly developing individual annuity market. The panel drew on “a decade’s worth of relevant research” as well as three specially commissioned original quantitative studies, individual’s experience of purchasing an annuity as well as the websites and the documentation that accompanies a quotation, which were all scrutinised.

Succumbing to their default response, sub editors concocted headlines screaming for “sweeping reform”, speculating that pensioners had been “burgled”, that the elderly were being “fleeced” and that pensioners were ”losing millions”. In reality the consumer panel is rather more focused in its concerns. This is an important study. The decision to annuitise savings is the most material financial decision the majority of us will make. The decision determines which financial institution will pay our income for the rest of our lives and the level of that income. The first two recommendations of the report focus on the importance of the open market option. Currently a very large proportion of those annuitising are not relying solely on this source of income. In a sense therefore it is unsurprising that many simply default to the pension offered by their current insurer. This is almost always the wrong decision and the consumer panel is right to highlight this. Their recommendations however fall short of blocking the automatic roll over of savings into an annuity. Placing an obligation on insurance companies to provide an indicative range of quotations along with their own quotation or alternatively to provide no quote at all would seem to be a simple and pragmatic route to ensuring that this crucial decision is properly made.

Every year in the UK some 700,000 people reach their planned retirement age, currently around 400,000 of these annuitise a defined contribution savings pot and of those perhaps as few as 100,000 do so having obtained competitive quotes. Perhaps 90 per cent of the individuals taking out an annuity ignore the need for inflation protection and 80 per cent, by our estimates, take the single life option. The vast majority of these people are of course married. The general lack of appreciation of the extent to which inflation erodes the value of money means that a safeguard against individuals making the wrong decision is a crucial component of the process of selecting an annuity. Similarly, a married person taking out a single life annuity needs to be confronted with the fact that with their demise their spouse will be left (subject to other sources of income not being available) unprovided for. The protections around drawdown perhaps provide a framework for an arrangement which would guard against individuals inadvertently ignoring the importance of providing for their surviving spouse and protecting that income against inflation.

The annuity market is rapidly becoming a fully underwritten market. More than half the annuities written currently are perplexingly ‘enhanced’. We have all learnt to shop around for our motor insurance and yet the statistics suggest we are disinclined to do the same with the far more momentous decision of buying an annuity.

Publication of a spot price that is guaranteed and in a standard format, so that the price of each insurer can be compared, would seem to be an obvious obligation to impose on the market. The amount of money accumulated in defined contribution pots is growing rapidly. We have the opportunity to create an orderly market at an early stage of its development. This is not an opportunity to be missed.

Mark Wood is CEO of JLT Employee Benefits

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