Stephen Hunt goes through the pros and cons of making the open market option compulsory
One of the main objections put forward for making the open market option (OMO) the default, is that there are insufficient resources to advise another third of a million people each year. This is especially true, as the average fund size is only £25,000. However, is having insufficient resource to do something any justification for not doing it correctly? The facts of the matter are that this should not be a problem as there are enough large specialist retirement income brokers to absorb this increase.
Another consideration must be whether people are getting the best advice. The whole area of retirement income is becoming increasingly complex, and although most IFAs feel comfortable with guaranteed rate annuities, they are often not familiar with some of the more complex products available to their clients.
In a survey of 50 IFAs (by Watson Wyatt) earlier this year, two out of five IFAs admitted to knowing little or nothing about variable annuities. It will take some time for them to retrain to handle this new wave of products, so at present, 'best advice' should be sought from an IFA who has specialist retirement income product knowledge. So as long as people are directed to the correct source to broker their pension fund, this should not be an obstacle to getting the best product possible.
Another objection is that funds are too small to motivate IFAs to write the business. So, why is it not viable for an IFA to give advice on a £20,000 fund? Because it will take forever for the business to complete, as ceding schemes take so long to pay funds. So, we have a situation where the companies who say that there are insufficient resources for the OMO to be the default, are the same companies whose delays in processing are one of the main reasons why the resources are not there.
No valid reason
I cannot think of a single valid reason against the OMO becoming the default. I considered guaranteed annuity rates (GAR), but provided that the annuity is brokered properly, this will be picked up, and if it is not, then the process is at fault, not the principle.
There is one area where a loss to the client is possible. If the default annuity had been an RPI linked annuity and the customer, through OMO, goes for a level annuity, and RPI subsequently goes through the roof. Or, if the default annuity is joint life and through OMO they opt for a single life, and they then die. Again, these issues would only be issues if poor information is provided and is likely to affect only a minute number of the retiring population. Not helping half a million people because a few of them may possibly be disadvantaged, is folly.
So, after hours of thinking of possible cons, what are the pros? Now that is easy:
More than 60% of people still do NOT exercise their OMO. This may cost over a billion pounds a year. Most people do not know or understand about shopping around for a better retirement income, and forcing them to do this is probably the only option.
The current position beggars belief. We have a situation where someone may have been saving diligently for 20, 30 or 40 years and then when they retire, they put their entire pension savings into a product on which they have had no advice and which could be unsuitable. You also need to take into account that once made, the decision to buy an annuity is irrevocable.
So, how should the OMO default option be managed? That is possibly the real problem, as the ceding schemes have to take responsibility. They cannot and should not be allowed to just say: 'There's your £40,000, now go and get your annuity'. The current OMO process is about as un-TCF as you can get.
What is likely to be the single largest benefit of making the OMO compulsory, is forcing the public to understand what the issues are regarding retirement income. Remember, an increasing number of these annuities will be paid for 30 plus years, and inflation needs to be taken into account. To discount high inflation coming back in the next 30 years would in my view be extremely foolhardy.
If I were cynical, there is one down side to making the OMO compulsory. Currently, most of the 60% of annuities that do not go down the OMO route are invested in gilts. Based on the ABI figures for 2007, a total of 433,000 annuities were sold in 2007, with an average fund size of £25,500. If 60% of this figure is invested in gilts, that amounts to nearly £7 billion. The annuity market or the 60% non-OMO annuity market is a major contributor to government borrowing.
Yet another benefit of making the OMO compulsory is that 1-1.5% of the pension pot is usually paid as commission, even if there is no adviser. With the 1-1.5%, at least some basic advice could be given to address the vital questions that people must consider and help them get the best rate. E.g. do I have a health problem? Do I want to cover a partner? Do I want inflation protection?
Another potential advantage of the OMO being made compulsory is to limit potential mis-selling claims against insurance companies or IFAs. Where someone goes from accumulation into an annuity that is a 'new sale'. So when an annuity is automatically taken out an actual 'regulated sale' has taken place and very often commission has been paid, or kept by the insurance company. I can remember very clearly the insurance industry being very complacent about personal pension mis-selling in the mid 90s and we all know where that went!
It would seem that the default OMO is a 'win-win' solution to the current problem. The travesty is that everyone knows what is happening with the OMO is wrong - the government, the Insurance industry and the regulators. It is like a doctor who knows a patient has a serious disease and deliberately does not them. Is it any wonder that the public do not trust the financial services industry?
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