A failure by many consumers to shop around or switch provider to get the best annuity deal proves that competition in the retirement market is not working as well as it could be, according to research by the Financial Conduct Authority (FCA).
The regulator’s Retirement income market study, which examined products purchased by UK consumers with their defined contribution pension pots that provide an income in retirement, found that customers’ tendency to buy products from their existing pensions provider weakens competitive pressure on incumbent firms.
This also makes it harder for competing provider to attract a critical mass of customers.
The market study also found that for people with average-sized pension pots, the right annuity purchased on the open market offers good value for money relative to alternative drawdown strategies, and may therefore be a good option for those with low risk appetites.
It found a number of reasons why employees do not exercise the open market, which include:
- Being unaware of having the option to switch providers.
- Being deterred from engaging with their options by the length and complexity of ‘wake-up packs’ sent out by providers.
- Communications with employees do not encourage shopping around.
- Not believing that the sums involved make it worthwhile.
The report also sets out a number of proposed remedies to address the concerns, with a focus on stopping things getting in the way of retirement choice, as well as improving clarity and simplicity of communication between firms and employees.
The FCA wants providers to design and sell retirement income products that meet employee needs and provide good value. It expects to see more hybrid products to emerge, combining annuity and drawdown features.
The FCA has also published a thematic review into annuities sales practices, which found that eight out of 10 (80%) consumers who purchase their annuity from their existing provider could get a better deal on the open market.
It identified two groups of consumers who are particularly at risk of not getting a good deal:
- Those with small pension funds, who are generally offered lower annuity rates than those with larger funds and have less choice of providers on the open market.
- Those who would be eligible for an enhanced annuity, but do not explore this option stand to gain the most from shopping around. But they also need to be aware of and understand their potential eligibility for an enhanced annuity.
Malcom McLean, senior consultant at Barnett Waddingham, said: “It is interesting to note that the FCA is still convinced that for people with average-sized pension pots, the right annuity purchased on the open market offers good value for money.
“It is disappointing however, that after two years the FCA has still not completed its full review of the annuity sales process and will still be conducting further investigations into the workings of the market, which back in February it described as a disorderly market.
“The recommendations the FCA has made in the first report certainly have merit, in particular the need to replace the wake-up pack, which in its present form is clearly not working. Also, the idea of a ‘pensions dashboard’ or ‘pensions passport’, which advocates have previously suggested, is worth pursuing in the interests of enabling consumers to view all their lifetime pension savings (including their state pension) in one place.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, added: ”The FCA has not found any evidence of widespread misselling of annuities, there is no smoking gun. In fact it has gone further than that by explicitly endorsing annuities as good value for money, but only if customers shop around on the open market.
It has, however, established that competition does not work well in the retirement income market. Significant changes need to be made to the way the pensions industry helps its customers to get the best value from their retirement savings.
“The communications sent to retiring customers, the wake up packs and the ABI [Association of British Insurers] Code of Conduct are not having the desired effect, and the FCA has confirmed its intention for a radical rethink. This is welcome news, coming as it does just a few months ahead of the new pension access freedoms.”
The results from the FCA’s latest study on the annuity market are welcome news for consumers but in all reality it remains a shame it’s come five to six years too late as problems and issues have continuously been highlighted. Pension providers will now be very worried as the consequences for them could be considerable.
The FCA requirements of Annuity providers will greatly improve consumers’ understanding of the options which they have at retirement. We have long advocated an obligation on Insurers to provide a price comparison with their quote. This simple single step will ensure many more individuals make the right decision when they secure their retirement income in the firm of an annuity.
The FCA retirement income review has concluded that annuity quotes should include comparisons to other companies annuities as a means for the consumer to decide if they are getting a good deal. Furthermore, the FCA has recognised the weaknesses of the current wake-up pack system and is introducing a behaviourally trialled alternative to the current system.
However, the world of retirement income has changed significantly since this review started as a result of George Osborne’s Budget reforms in March.
It is now predicted that only 40% of retirees will buy an annuity yet 90% are invested in default investment funds which are designed for an annuity purchase at retirement. As such, over half of people heading towards retirement are already heading in the wrong direction and need help and support. That support really needs to be delivered 5 years from retirement so that people can understand the feasibility of their retirement plans, identify the best solution for their needs and select the correct investment ‘glidepath’ for the years approaching retirement.
Everybody’s retirement is different and we will all have a unique need for cash and income throughout our retirement. For those considering the flexibility of drawdown, it is important to understand that no two drawdown plans will be the same and to maximise the benefits, drawdown must continuously be tailored to your ever changing circumstances and needs.
Our Pathways service helps DC members engage with their retirement options and helps tailor information and actions relevant only to their needs. It is this individual tailored approach starting 5 years from retirement that is ultimately needed if we are to see major improvements in the quality of retirement outcomes.
I welcome the FCA’s Thematic Review on annuities sales practices. It highlights the enormous issue of consumers and indeed employees not shopping around when purchasing annuities and potentially missing out on higher income through the open market or perhaps qualifying for a better paying enhanced annuity. Many employers have annuity broking arrangements in place, which are often subsidised but are often based on restricted panels which is far from ideal.
Planning for retirement is not just about annuities – individuals need to consider all of their options at retirement whether that is taking some form of drawdown, buying an annuity or a combination of options. In fact, some may want to make a series of decisions over time, rather than a single choice at retirement. We believe the starting point should be providing financial education in the workplace, supported by individual guidance and regulated advice when required. Trustees need to get this onto their agenda. The Pensions Regulator has previously emphasised the need for a ‘robust retirement process’ and with the new rules around pension freedom and choices all Trustees should ensure their retirement processes are now indeed robust or risk members making poor decisions.