Posted: 16th March 2014
The Financial Conduct Authority (FCA) published its first thematic review of 2014 on annuities. This product is an insurance contract that provides a customer with a guaranteed income for life in return for a lump sum premium paid from a pension policy and, crucially, cannot be changed once it has been converted.
The FCA estimates that around 10.5 million consumers have defined contribution (DC) pension savings that will need to be converted into an income in the future either by buying an annuity or using income drawdown. Annuities are the most common product in this market, with 420,000 annuities sold in 2012, 16 times more than income drawdown products.
The regulator gathered information from 25 firms representing 98% of the pension annuity market. Of those 25, 13 offer annuities to existing pension customers only, nine offer to both existing and open market customers and three offer open market only.
Eight out of ten consumers who purchase their annuity from their existing provider could get a better deal on the open market
The aggregate benefits that consumers miss out on by not shopping around and switching has an estimated value of between £115m and £230m of additional pension savings
Consumers miss out on the benefits available from shopping around and switching due to their lack of engagement in pensions and annuities, the confusing trade-offs they face and the impact of behavioural biases
For some consumer segments, particularly those with small pension funds, there is an apparent lack of choice with lower annuity rates available to these consumers
There is a lack of access to enhanced annuity rates for some consumers annuitising with their existing pension provider and not shopping around
Annuity market facts
The thematic review revealed interesting figures about the market:
10.5 million consumers have a pension that will need to be converted at some point. The Department for Work and Pensions (DWP) estimates that auto-enrolment will add an extra 11.5 million, of which most will be in defined contribution schemes
In 2012, 420,000 annuities were sold, 16 times more than income drawdown products, with a premium value of £14bn compared to £1.2bn for income drawdown
The FCA noted the way consumer behaviour affects the numbers of those shopping around and the choice of annuity available. The review determined that inertia was the key behavioural driver. In practice, a fear of product complexity fostered consumer inaction, preventing them from shopping around, culminating in an inappropriate or poor value for money product. Additionally, the complexity of the market is confusing for customers and currently accepting an existing pension provider’s annuity is the easiest and most straightforward choice.
Initiatives for firms to note
The review highlights valuable information for firms to increase awareness of the open market, improving disclosure and facilitating shopping around. Most notably:
2002: The Financial Service Authority (FSA) introduced rules (Conduct of Business (COBS) 19.4 of the FCA handbook: Open market options) requiring insurers to inform existing pension customers that they could purchase an annuity on the open market and to improve consistency between firms in the way this was done
2013: Association of British Insurers (ABI) introduced its Code of Conduct on Retirement Choices (ABI Code) in March 2013 and began the publication of annuity rates in August 2013
Market study and firm action
The market study is a new and primary tool for examining competition issues and supports the FCA’s new statutory objective of promoting competition for consumers. In the thematic review the FCA has announced it will undertake a market study on products for retirement income. The aim is to find ways of improving customer engagement to prompt shopping around.
The study includes a review of firms’ sales practices and business strategies. Where poor practises or unfair customer outcomes are found, firms will be compelled to make changes immediately with possible retrospective work also required.
As the FCA prepares to carry out their market review, annuity providers can help themselves and their customers by looking at the manner in which they provide information e.g. use of wake-up packs. The choice environment should also be assessed by, for example, requiring consumers to make an active decision rather than offering a ‘default’ or standard offering. The way a product is framed can be considered, for example, by not making it seem easier for the consumer to simply accept the standard offering and ensuring they are options available.
Firms can use the documents and act now to be prepared for the supervisory aspects of the market review, showing they had the customers’ best interests in mind by opening them up to the best value options for their future.