The annuity market will come under investigation by the Financial Services Authority (FSA) later today when a major review is announced.
The Daily Telegraph reports the watchdog is to launch an inquiry into the value pensioners receive when buying an annuity with their pension pot.
Reports indicate the FSA's probe of the £11bn annuity market will examine the pricing of annuities and how they are advertised to savers.
Politicials and industry groups have raised concerns about the failure to use the open market option (OMO), where consumers shop around for an annuity instead of taking the rate automatically offered to them by their pension provider.
The first phase of the investigation will focus on pricing. Phase two will then look at communication, particularly the OMO, according to Hargreaves Lansdown.
The FSA work will focus on providers and will:
• Estimate the cost of detriment
• Identify key risk factors that increase the likelihood of detriment
• Identify firms more likely to exhibit these factors
• Identify other contributing factors e.g. processes or communications
Tom McPhail, head of pensions research at Hargreaves Lansdown, said: "The open market option agenda has always been about improving investor's incomes and the FSA is right to scrutinise this area of market failure. With auto-enrolment under way it is essential that investors get the best possible value from all stages of their retirement saving. Important steps are already being taken to improve the OMO market.
"However, this announcement from the FSA serves notice to any insurance companies which aren't looking after their customers that the regulator has its eye on them."Hargreaves Lansdown said the DWP and The Pensions Regulator have both recently expressed concerns about the quality of pensions into which employees are being auto-enrolled. The regulators identified the annuitisation process as one of the factors.
It added the FSA will look not just at the pricing differences between annuity providers but also the volumes of business they are receiving. This will identify if a provider who is ranked lowly in the annuity pricing tables is profiting from high volumes of business.
However, firm said it the FSA could not force annuity companies to increase rates. However if the FSA found that too many investors are buying annuities with insurers who are not competitive they will act to address this as a market failure.
The second phase of the FSA annuity market review will focus on communication around the OMO.
Since 2002 the FSA has required personal pension providers to disclose to customers that they have a right to an open market option (it's been available since 1988). But only around 40% of investors actually use it.
In 2010, following representations from the lobby group the Pension Income Choice Association (PICA), chaired by McPhail, the Treasury/ DWP Open Market Option stakeholder group was tasked with looking for ways to make shopping around the default option for retiring pension investors.
As a result of this, in September 2011 the ABI announced its intention to introduce a mandatory code of conduct.
McPhail added: "The ABI Code of Conduct is a big step forward, however it is flawed in that it could result in insurers performing a very limited shopping around process for their customers. This could result in investors getting a slightly better deal than they would have done in the past, but still not as good a deal as if they shopped around the whole market.
"Hopefully the FSA review will determine whether the ABI Code of Conduct is acting effectively to improve consumer outcomes."
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