Helen Morrissey asks what needs to be done to ensure people get the best deal from exercising their open market option
The open market option (OMO) exists to ensure retirees get the best deal when purchasing an annuity. However, low take up rates have led the FSA to launch a review into how the open market option works. While the results are not due to be published until July, the FSA has already released preliminary findings and the news was not good. In addition to highlighting the poor turnaround times of some providers in administering an open market option, concerns have also been raised as to how providers are explaining the open market option in so called 'wake up' literature.
In a speech to the IEA in May the FSA's Treating Customers Fairly director Sarah Wilson said that up to 40% of this literature failed to explain the benefits of the open market option to their clients in clear and simple language with some providers failing to mention whether guaranteed annuity rates applied to their annuity - of course these would be lost if the OMO was to be exercised.
So it would seem that work needs to be done if awareness of the open market option is to be improved but how much of a will is there within the industry to really see a growth in take up of OMO?
Where is OMO failing?
While the open market option has been around since 1978 the numbers of people actually exercising their right to use it has remained fairly static over time.
"The level of people using OMO last year did hit 40% but if you look back to around 2001 33% were using it so there hasn't been much of an uplift," said Nigel Callaghan, pensions analyst at Hargreaves Lansdown. "It just goes to show that the collective might of the industry hasn't been able to do much to change things."
In addition to this, Callaghan states that despite much product innovation in the annuity area, the types of annuities being bought has not changed much either meaning that many people are missing out on investment flexibility or enhanced income by locking themselves into a conventional level annuity at retirement.
"Last year more than 430,000 people bought an annuity of which 40% could have qualified for an impaired rate - however, only 10% of these people took up this option," he said. "As a result the open market option is failing hundreds of thousands of people every year."
However, such claims are vociferously denied by product providers who claim to make great efforts in highlighting the open market option to their customers. Standard Life's head of pensions policy John Lawson says providers do much to reach out to as many people as possible.
"Standard Life is competitive in the small annuities area with only us and Legal & General operating in the £5,000-10,000 space," he said. "Very few people have an annuity pot of £100,000 plus and if they did then these people tend to choose drawdown anyway so wouldn't exercise their open market option. I think there are very few people that we don't reach."
He is joined by Tim Gosden, head of annuity products at Legal & General who said that as a rule people are aware of their options at retirement and often make an informed decision not to exercise their OMO.
"We recently did research on customers approaching retirement and we found the majority of them knew they could shop around but intended to stay with their current pension provider," he said. "There's a lot of information available on the internet now and many people are using websites such as the FSA's to do their research. You might get people with smaller funds for instance who do their research and realise they are already with a competitive provider and so choose not to move. Separate research we've seen indicates that the FSA site is the most popular site for research while there are also many specialist IFA sites out there with good information on them. We shouldn't assume that people are ignorant of their options at retirement when they are actually making informed decisions."
Provider literature - what can be done?
While such evidence of increased customer awareness should be welcomed there do remain some serious concerns about the efficacy of the open market option. As FSA preliminary findings stated up to 40% of the literature providers sent out to clients was not deemed suitable and did not make clear the benefits people can gain from using the open market option. The FSA is currently engaging with those providers and remedial action will need to be completed by December.
"While some providers should be applauded for the work they've done in highlighting OMO there are some who aren't explaining the benefits properly and are not flagging up the need for advice," said Callaghan. "There needs to be some standardisation in these processes. Rather than writing 16 page wake up letters that don't work they should issue 1-2 page letters instead. These communications should point people towards resources such as the FSA's Annuity comparison website. I find that if you give good quality information and direct it in a clear manner then using the OMO isn't rocket science and people will use it."
Trefor Owen Jones, chartered financial planner at Buckles agrees, saying that providers need to do more to make people's options clear.
"Personally I think providers should be required to provide illustrations that demonstrate how the client can benefit from using the OMO as I think this is a real problem," he said. "Basically if there isn't a guaranteed annuity rate then in 95% of cases the OMO will be the best option."
Lawson believes that many providers are already making real efforts to communicate with customers and much thought goes into how the open market option can best be highlighted.
"I think our literature is pretty good as we give equal weight to four key areas - the open market option, buying a Standard Life annuity, going into drawdown and deferring your pension," he said. "I would say the open market option section probably gets more column inches devoted to it than the section on purchasing a Standard Life annuity and we place it earlier on in the literature. I think we make an enormous effort to communicate with our customers in a clear way."
Small pension pots
However, one section of people who continue to be ill served by the OMO is those with small pension pots. As the industry currently stands only Just Retirement will offer an annuity for less than £5,000 while only Standard Life, Legal & General and Living Time currently operate in the £5,000-£10,000 area. How can people be best served with so few options to choose from? Surely more can be done?
"There seems to be a battle of misinformation going on among insurers," said Callaghan. "At the end of the day if you increase demand for the open market option then the supply of decent products should go up - that's how capitalism works. Why wouldn't insurers seek to meet this kind of demand? The annuity market is estimated to hit £33 billion by 2012 - let's say 50% of these pensions are for £10,000 or less - how is the industry going to miss out on this? The fact is that this market won't be as profitable as it is for larger pots. At the moment people with small pension pots have limited if any options available to them because they aren't getting advice. The letter comes in, they tick the box and the system just keeps on going."
While Lawson agrees that those with small pots have few options available to them he doubts whether increased demand for these small pot products will increase supply and that issues of profitability affect the adviser as well as the provider.
"I know some have said that if there is increased demand then supply will follow but I'm not so sure," he said. "We do accept smaller business but I know there are providers who would say they can't make money at that level. At the end of the day it is both difficult and expensive to extract funds and we would need to cut the cost of administration if this business was to become more profitable.
"However, if advisers think they can transact this business in a profitable way then why aren't they going out there and advertising for it? It's only when an adviser goes out and does that that I'll believe they are truly serious about transacting that kind of business."
What can be done?
So while the options for those with small pots remain limited what can be done to increase the efficacy of the open market option going forward? Is there a role for generic services such as Money Guidance to play a role in helping everyone to get a better deal?
"I think that any service that worked to give customers extra information should be welcomed," said Gosden. "It could help to boost awareness of products such as impaired annuities which still only have a small market penetration."
Callaghan agreed that such generic services have a role to play but believes that the only way to gain real momentum is to make the OMO compulsory.
"I think schemes such as Money Guidance should be championed," said Callaghan. "Anything that explains people's options in a simple way should be applauded but I don't think any one initiative can do this on its own though. I think the real way forward would be to make the open market option compulsory and then we would have a more competitive marketplace."
So it would seem that the open market option will remain a real issue for some time yet. Making OMO compulsory could be one way of boosting take-up but more work needs to be done in offering guidance to consumers before people really start to get value for money.
- FSA comparison tables - www.fsa.gov.uk/tables.
Duo start roles on 1 October
Where true value lies
Economy to thrive despite global risks
Behaviours, animals or something else?