Obligatory information on the OMO could help policyholders improve their income by as much as 30% but many feel the availability of higher rates for ill-health and lifestyle choices also needs to be emphasised
From September this year, the Financial Services Authority (FSA) will require those selling annuities to explain the open market option (OMO) before they make a recommendation.
At one stroke, this could help the estimated two-thirds of those retiring with a money purchase pension, who do not currently use the OMO, to improve their income by as much as 30%.
But is the FSA going far enough? An increasingly vocal element in the specialist annuity market argues that obligatory information about the OMO provides only part of the picture. What money purchase policyholders also need is information about the availability of uplifted rates for ill-health conditions and enhanced terms for lifestyle features. Those who seek specialist advice on these annuities can increase their income by anything up to 400% (see Table 1).
Clients may be aware that annuities are based on average life expectancy and that if they are in poor health, they will be at a disadvantage. But they may not be aware of the way scientific advances have enabled underwriters to be much more precise in allocating uplifts for a wide range of conditions. Nor may they appreciate that the disclosure of a lifestyle feature such as smoking or excess weight can actually work in their favour.
It is even less likely that clients who have followed certain occupations or live in certain regions would expect to qualify for an enhanced rate.
Why is this level of ignorance so widespread? Much of the blame must fall on the non-competitive annuity providers that have made fat profits on their annuity books as a result of client ignorance. However, advisers must also bear their share of the blame. Even those who actively promote the open market option and take advantage of enhanced terms may not be sufficiently knowledgeable to negotiate individual ill-health rates.
Size of fund is clearly relevant. Specialist annuities typically pay commission of 2% of the fund, as opposed to 1% on a standard annuity. Even at double the commission, the remuneration for smaller funds would not be economic, particularly where it is necessary to negotiate on an individual basis. This is something the FSA and the Government might care to look at.
One innovative development is the advent of web-based annuity services. With its annuity supermarket, Hargreaves Lansdown is one of the most recent entrants. The company argues that with an average annuity fund size of £30,000, it is not economic to provide individual advice on the OMO, let alone specialist rates.
Its website (see below) includes an explanation of specialist annuities and the facility to download a medical form. One hopes this type of facility will become more widely available as more independent advisers recognise it is probably the only way to provide a good service for smaller funds.
William Sallitt, a consultant with the adviser Arbuthnot, points out that clients who may benefit from a specialist annuity need to plan several months earlier than their more healthy peers.
'The number of detailed application forms can be daunting for the client and time consuming for the adviser,' he says. 'Providers need confirmation from the GP and this alone can add an extra month to the procedure. I need to establish in my own mind whether the client's situation is likely to result in an enhanced annuity or a life threatening impaired annuity and then concentrate on the providers that are positioning themselves accordingly. It is not really practical to send out eight or more different forms for the client to complete, the providers to examine and the GP to respond to.'
Availability is also an issue for the market, although, fortunately, this is likely to improve as competition increases post-September 2002. Only a handful of companies currently offer impaired health annuities and enhanced terms for lifestyle conditions. These include the Pension Annuity Friendly Society (PAFS), the pioneer in this market, plus Axa Sun Life, Britannic Retirement Solutions, GE Life, the Guaranteed Underwriting Agency, MGM Assurance, Prudential Annuities and Scottish Widows.
It may seem obvious but it is important to understand when a client can benefit most from an uplifted rate. It is not necessarily only clients with just a few months to live.
Matthew Morris, chief executive of Cirencester-based adviser Rickman Tooze, says the average life expectancy for ill-health annuities is five or six years.
'For shorter life expectancies, it may be better to keep the fund in the pension plan so that, on death, the whole of it can be passed on to the dependents,' he says.
However, the adviser would need to examine the policy terms carefully before recommending this option.
Morris points out: 'Some older pension policies have little or no death value even where they are worth tens of thousands of pounds. This often applies in the case of retirement annuity contracts, the predecessors to personal pensions.'
Age is also relevant, although the medical condition is the most significant issue. Morris says that, statistically, those aged 70 or above may be the most common age group to benefit from enhanced rates.
'But,' he adds, 'there are many people in their 50s who are enjoying enhanced wealth, if not enhanced health, because of impaired health annuities.'
It is important to note that although, in theory, all the usual options are available on ill health and lifestyle annuities, joint life can be a problem for those who are looking for a rate uplift based on a medical condition. Because the spouse's health is taken into account, if he or she is in normal health, it will reduce the uplift. In these cases, advisers suggest it is better to establish some other source of income for the spouse.
Ironically, the people most likely to forgo the opportunity of taking an enhanced rate are members of occupational schemes. Where this is a money purchase arrangement, the trustees would usually arrange the annuity, and not all would be knowledgeable enough to arrange an enhanced rate.
Members of final salary schemes may be able to negotiate with their employer for an early retirement ill-health pension but, particularly where they do not have dependents, they may be better off transferring to a personal pension in order to take advantage of an individually negotiated ill-health annuity.
Ill-health annuities are clearly good news for those with a serious medical condition but it is also possible to increase the rate if the client qualifies for a lifestyle annuity. These do not usually require medical documentation but instead offer a slightly higher rate for those who, for example, smoke, are overweight or have high blood pressure or chronic asthma.
Occupation and region are also relevant here. MGM Assurance offers geo-economic annuities that favour manual workers and those that live in the North of England, for example.
Further information from: The Annuity Bureau at www.annuitybureau.co.uk; Annuity Direct at www.annuitydirect.co.uk; William Burrows Annuities at www.askannuity.com; Bestinvest at www.bestinvest.co.uk; Hargreaves Lansdown at www.hargreaveslansdown. co.uk/annuities; and Rickman Tooze at www.rickmantooze.co.uk.
Money purchase policyholders need more information about the availability of uplifted rates for ill health and lifestyle conditions.
Web-based annuity supermarkets may be the best way to ensure those with smaller funds have access to specialist rates but early planning is essential.
More annuity providers are expected to enter this market after information on the OMO becomes obligatory from September 2002.
‘Important to have an anchor’
Report to be written by TPR
Lack of innovation for solutions
Some 2,000 consumers affected