The need for people to shop around for the best income in retirement must surely lie at the heart of the government's Big Society agenda, says Andrew Megson.
According to the Association of British Insurers (Q3 2009) over 80% of annuities were bought with funds of less than £30,000. However, the vast majority of those people are not shopping around for the best annuity rate at retirement. The difference between the best and worst annuity rates can be up to 30%, particularly for people with health conditions.
Partnership estimates that 70% of pension funds of £40,000 or less failed to take advantage of the open market option last year*. This means that last year out of the 270,000 people who purchased annuities with funds under £40,000, just 81,000 shopped around to find the best annuity rates. Instead these people defaulted into standard rates from their pension provider.
This inertia will result in those people missing out on £450m collectively for the rest of their lives. From this the 40% of people who would be eligible for an enhanced annuity because of a health condition would miss out on the equivalent to £311m for the rest of their lives, or 69% of the total pension income lost by people with small pension pots.
It is significant that it is the least well off pensioners and those with health conditions who are neglecting the chance to increase their incomes in retirement. It is a public policy scandal.
When considered along with this, research conducted by PICA (Pensions Income Choice Association) demonstrated that three elements contribute to poor take up of the open market option.
First, a fundamental barrier is the complexity of the annuity process. What insurers regard as requirements to process an annuity many consumers think of as barriers and is seen as a hurdle to fulfilling the transaction which ends up putting them off completely.
Second, PICA’s research suggests that the information provided by ‘ceding providers’ either failed to meet regulatory requirements or failed to highlight the prominence of key information. And third, PICA’s research conducted across the South East, London and Manchester among groups with retirement funds of between £5,000-£100,000, showed that the majority of participants demonstrated little knowledge of the open market option. Those with smaller funds felt that shopping around was only appropriate for those with funds of at least £50,000.
Another current key factor in failure to take up the open market option is the cost of participation by financial advisers in writing this business because of the high levels of cost involved in typical £30,000 pension funds. For a typical adviser the true cost of advising on a £30,000 fund we estimate is £720. Given typical commission rates of 1.5%, this would result in a loss of £270. By neglecting this business, advisers are failing to engage with a market, which on current figures, Partnership estimates could be worth £2-£3bn next year. According to Towers Watson, this retirement market is forecast to more than double in the next couple of years to £5bn.
Partnership would advocate ceding providers give a proper ‘wealth warning’ to potential annuitants. This would highlight the annual amount they will offer the potential annuitant and give a comparison to the best ‘open market rate’ that annuitant would be entitled to. The emphasis must be on the potential annuitant agreeing that they will accept responsibility for receiving less retirement income for life. They should also be notified that if they have a health condition they may be eligible for far more income.
In addition, Partnership would encourage take up of PICA’s proposed ‘Pension Passport’. This has been developed in response to feedback from the three step process set out in its Optimising Value in Retirement report which would improve the current process.
The three steps consist of a clear and easy to use form (a Pensions Passport), which focuses on the choices and decisions people face at retirement and the action they need to take; production of a personalised statement containing sufficient information for people to use to obtain quotations. It also includes a short communication requiring the member to inform the company/trustees how the fund should be applied. All communications sent in this process are to be written in a clear, unbiased manner with as little jargon as possible.
*Analysis based on ABI Providers’ returns, 2009 re 450,000 lives in September 2010
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