Despite the FSA's requirement that advisers should make investors aware of all the special annuity rates on offer, many investors are still being kept in the dark
The majority of defined contribution (DC) pension investors are still not receiving independent advice for their annuity purchase. This is despite the FSA requirement that all providers must mention the availability of the open market option (OMO) in pre-retirement annuity quotations.
This has particularly serious implications for those who might qualify for an enhanced rate. Unless their pension company happens to offer enhanced and impaired life annuities, those who accept a straightforward conversion from pension plan to annuity may never know that there were better rates elsewhere.
Standard Life, for example, has a client retention rate of about 93%. In other words only 6% of its pension clients uses the OMO. While the company generally offers attractive standard annuity rates it does not yet offer enhanced and impaired life rates. Scottish Equitable has a client retention rate of about 70%, which represents about 50% of business by volume.
Like Standard Life, the company does not offer any enhancements for lifestyle factors or health conditions that are life shortening. Legal & General also has a 70% retention rate and although it does not currently offer enhanced annuities.
Andy Agar, director of pensions marketing, says the company is 'actively looking' at introducing this option. Other major pension providers that only offer standard annuities include Allied Dunbar, Canada Life, Clerical Medical, Eagle Star, Friends Provident, NPI, Royal & Sun Alliance, Scottish Life and Scottish Mutual. It is also worth noting that while Norwich Union, Prudential and Scottish Widows do offer impaired life annuities they do not offer enhancements for smokers.
According to Britannic Retirement Solutions about 40% of the population may qualify for an enhancement. At a time when annuity rates are perceived as comparatively low, the additional 10%-20% available to smokers, for example, represents a significant uplift. Companies that offer this enhancement include Axa Sun Life, Britannic Retirement Solutions, GE Life, MGM, and the Pensions Annuity Friendly Society (PAFS).
Enhanced rates for smokers assume that the annuitants on average will die five years earlier than non-smokers ' hence the 20% uplift on the rate for a male smoker age 65, compared with the rate for a non-smoker.
What consumers would find most surprising here is that smokers qualify for a better rate than those who have had a triple heart bypass in the past 12 months. Medical advances have now enabled insurance companies to relegate the triple bypass to the 'slightly impaired' annuity category.
The point about high client retention among companies that do not offer enhancements is important. Standard annuity rates are based on average life expectancy so it does not require rocket science to work out that those who are in poor health are disadvantaged if they go for this type of annuity.
Billy Burrows, director of annuities at William Burrows Annuities, says: 'People often fail to realise that even a comparatively minor health problem can improve their annuity rate significantly.'
In addition to smoking clients may qualify for an enhanced rate if they are overweight, have diabetes, have had a career in manual employment, and even if they live in certain parts of the country. It's not a daunting process for clients or their advisers to find out if an enhanced rate is available since this type of underwriting only requires the completion of a medical questionnaire ' not a medical itself.
There are several possible reasons why clients are not getting the enhancements for which they qualify. Agar says the main problem is the comparatively small size of the average pension fund.
'At about £25,000, the 1% commission available for advisers who work on an OMO case is not really economic, particularly as even these small funds can be complicated if they include any protected rights or transfers in from company schemes.'
But the very high retention rates suggest there is an element of apathy on the part of the adviser as well as the client. Clients are told about the OMO and advisers are copied in when pension providers send the annuity literature and quotations six months before the expected retirement date and again at six weeks.
It would help if the required FSA wording on the OMO was a tad more hard hitting and actually gave some percentage rate improvements rather than merely suggesting one might do better if one could be bothered to look around.
Just as 'Smokers are likely to die five years early' would be more effective than current health warnings on cigarette packs, so too would 'You are likely to improve your annual income by 10%-30%' help bring home the OMO message, particularly in these days of risible investment yields.
If the regulator was capable of this sort of joined up thinking and prepared to act in the consumer's favour we would not have the situation where the percentage of OMO business has fallen from 35.6% in the first quarter of 2002 to 30.6% in the first quarter of 2003 (source: ABI).
Whichever way you look at this situation it is hard to account for such high retention rates among companies that sell most of their pension policies through intermediaries.
One would imagine these advisers would be eager to get in touch with their clients at such an important time when there is the opportunity to discuss the annuity purchase itself, the investment of the tax-free lump sum, making a will, inheritance tax planning and so on. This is a good opportunity to carry out a full financial planning review.
It would be interesting to know whether, perhaps, the majority of clients have become orphans by the time they need to make the annuity purchase, following the demise or retirement of the original IFA.
If this is the case the FSA message about the OMO is further weakened. It is one thing to ask your adviser to do an OMO search but quite another to have to find a good adviser in the first place if you have not maintained the habit of using one.
If the FSA insisted that pension companies include contact details for the main IFA websites in the OMO message this might help, although one could imagine the direct sales operations being less than happy with such a requirement.
An alternative would be to include these contact details on the comparative annuity tables on the FSA website and to insist that companies include the website address in pre-retirement literature.
This would prompt investors to compare the quote from their pension company with a range of rates. They would then see that enhancements are available from some companies for various health conditions, even though specific details are not included.
The FSA should also insist that all companies that sell annuities ' especially where this is just to internal clients ' post their quotations on the comparative table. At present only about 14 companies are up there and these are the competitive ones that offer an OMO. For reasons best known to itself the FSA excludes providers that only offer annuities to existing pension clients. Surely these are the very people most likely to benefit from the OMO and least likely to know about it.
The regulator also states: 'Participation is voluntary and some providers may prefer not to show their products in the tables.' Who, one might ask, is the FSA trying to protect? The investor or the insurance company?
When it comes to impaired life annuities the need for expert advice is critical. Peter Quinton, managing director of The Annuity Bureau, says: 'Administration is particularly complicated for impaired life annuities and the rate offered will depend on the underwriter's interpretation of the medical evidence provided by a doctor. We continue to see startling variations in the rates offered by these companies, based on the same medical evidence, so we believe it is important to ask all of them for a quotation in each case.'
There is now a standard form for specialist annuities so the client only has to complete one application, which is then copied and sent to the various providers.
For those in very poor health who are concerned about passing on as much wealth as possible to their dependents, it may be worth leaving the pension fund intact and using other sources of income to cover the short life expectancy.
Quinton says: 'Where life expectancy is extremely short ' say under two years ' individuals should seriously consider whether buying an annuity is the right course of action.'
Where a client is able to leave all or part of the pension fund intact and written in trust, on death this passes on to the dependants free of inheritance tax.
Finally advisers operating in the small and medium enterprise market (SME) should ensure that trustees of occupational pension schemes use the OMO and check to see if members qualify for enhancements.
'It is particularly important that trustees of occupational money purchase schemes seek advice on enhanced and impaired life annuities,' says Burrows. 'Annuity pricing is much more complicated than it used to be and trustees can no longer rely on just one company offering good rates across the board.'
The number of pension investors using the OMO has fallen despite the fact that all providers must mention its availability in annuity literature.
Providers that do not offer enhanced rates are failing to provide the best deal for their clients.
The FSA needs to ensure its comparative annuity table includes all providers, not just those that offer competitive rates and the OMO.
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