"Your pension fund -
You can choose when and how to use it.
You won’t lose it - and you can’t abuse it."
Holistic Approach to
Pension Income Reform 2002
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"Your pension fund - |
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You can choose when and how to use it. |
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You won’t lose it - and you can’t abuse it." |
Stuart Bayliss, Annuity Direct
March 2002
Copyright © Stuart Bayliss, 2002
Stuart Bayliss asserts his right as the author of this work and the ideas contained within
Published by Annuity Direct, 2002
The author acknowledges the valuable help and copywriting of Paula Barron
Copywriter:
Paula Barron, PbCopyworks.com
Section 7 contains product ideas that have commercial value. We have already discussed these ideas with a number of annuity providers over the last 18 months so they have had a limited exposure in the public domain.
Holistic Approach to
Pension Income Reform 2002
Contents
Section Description Page
1 The bottom line
2 Summary of our proposals
3 Our assumptions about Government policy and regulation
4 How the market currently fails the consumer
5 Open Market Option reform
6 Legislative reform
7 Product reform
8 Bibliography
9 About Annuity Direct
From the tens of thousands of conversations we’ve had with people nearing retirement, it is clear that the retirement income market is significantly failing the vast majority of consumers.
Holistic change is required in order to create a framework that will enable consumers to have both:
In this document we expose the problems and propose reforms that, although simple in nature, will we believe:
1.1 A summary of the problems
Our proposed reforms are focussed on these main problem areas:
This valuable freedom goes unused by the bulk of retirees. There are three main reasons for this:
Because the OMO is not widely used (despite an increase in publicity), we estimate that over 70% of people retiring with private or company pensions end up on significantly less income in retirement than they could otherwise have secured via the OMO.
Those most affected are the ‘mass market’ of low to middle wage-earners who are most likely to become dependent on the State in their old age, if their pensions are insufficient for their basic needs.
The severely ill are most disadvantaged: Within this group, the most severely disadvantaged are those who, because of ill-health, have a shorter than normal life expectancy. If they were to use the OMO and go to the small number of specialist ‘impaired life’ annuity providers they could easily increase their yearly annuity income by 20% to 100% or in severe cases even more.
Primary legislation currently defines pension benefits in terms of income, along with some detailed rules based largely round tax. Yet during the 20-30 years while they are saving for retirement consumers think in terms of the size of the fund they’re building up. With temporary, partial and phased retirement becoming more the ‘norm’, the consumer emphasis has shifted even more firmly to focussing first on ‘pension fund’ then on ‘income’. A similar shift in primary legislation is needed in order to create a more flexible and pro-active framework for using pensions to deliver retirement benefits.
Not all pension savings plans or retirement income payment plans offer the same freedoms. The anomalies can create disincentives to save and confusion at retirement, as well as compelling or steering people to use their pension funds in a way which stops them from getting either best value or the type of value they need. This situation needs to be rectified – allowing all consumers, regardless of the type or size of their fund, to have the same freedoms and choices.
Most retirement income plans, particularly pension annuities, were designed in an age when interest rates were much higher than today. People stopped work completely at age 60 or 65 and looked forward to a retirement that would last on average 10 years or so. This situation has radically changed – interest rates are low, people’s retirement patterns are quite different and they are retiring earlier and living longer. Products need to change with the times. Simple changes in legislation could allow providers to quickly improve the flexibility and appropriateness of today’s products.
These problems, which are easily rectifiable, are at best disappointing for the retirees concerned, and at worst lead to:
1.2 Summary of what could be achieved by reform
The current market is failing consumers in every social group. Product development in the last decade has been aimed solely at those retiring with larger pension funds (ie £100,000+). As a result, the vast majority of consumers have not benefited at all.
More can and must to be done to assist people with private and/or company pensions to get the best retirement income and value from their pension funds ‘at retirement’.
Significant market improvements can be easily achieved, within the priorities set by the Government’s social and fiscal policies.
No radical change in legislation is required in order to create a more dynamic and beneficial market for the consumer. An appropriate, more flexible framework can be created by some relatively simple changes to primary and secondary legislation, and regulations.
Making the simple changes we propose would enable retirement income providers to better meet the needs of all consumers.
In particular, it would help the vast group of lower to middle wage-earners – where the need to encourage private pensions is greatest and where the biggest savings in the future cost of pensioner support can be made by the Government.
We constructed our proposals against the benchmarks of wanting to:
At the heart of our proposals for holistic pension income reform is the desire to give freedom of choice and better value to consumers, while at the same time protecting them from ‘mis-using’ their pension fund. This is summed up by the phrase:
"Your pension fund -
You can choose when and how to use it.
You won’t lose it - and you can’t abuse it."
Details of our proposals are given in Sections 5 to 7. Here is a summary of the main recommendations with cross references to the pages where you can find more details.
Reform of the pension providers’ vesting process gives us the unique opportunity to ensure that consumers are presented with structured decision making and, potentially, universal provision of the OMO.
The creation of a central inter-active annuity rates information platform that can fully integrate with providers’ systems, and also be accessed direct via the Web - by IFAs, other advisers, trustees, employers, journalists and of course consumers.
This service would enable fully personalised, comparative illustrations to be instantly provided either on demand or to a bulk audience as part of a provider’s pensions vesting process. The service could also be used to facilitate and streamline the OMO process.
Despite years of publicity and attempts to inform about the OMO, uptake remains low and the time associated with providing advice is disproportionately high compared to the relatively low rewards. Structured reforms are therefore essential if universal use of the OMO and lower costs of provision are to be achieved.
To allow consumers to choose ‘not to use their pension fund’ if they don’t need the income from it. For example, allow them to:
The criteria for allowing this must protect against the future likelihood of these pensioners needing additional State benefits.
The current legislative inflexibility about how pension funds can be used
‘at retirement’ acts as a barrier to people wanting to save into a private pension. However, creating more freedom would not just provide an incentive to save – it would also give everyone the freedom to strike a balance between taking income and preserving capital, with the result that they achieve flexible income that is right for their individual and changing circumstances in retirement.
For example:
For example:
3 Our assumptions about Government policy and regulation
Our proposals take into account the social and fiscal objectives of the Government. To this end we have assumed that the following objectives will continue to be priorities:
As more people opt for redundancy and early retirement but then continue to work say on an ad-hoc/freelance, partial or temporary basis – the ability to ‘stop and start’ pension income is becoming as important as ‘phasing’ the use of the fund.
4 How the current market fails the consumer
Below is a summary of the main market failures which our proposals seek to address.
4.1 Low consumer knowledge and awareness
Although retirement income issues are now frequently covered in the quality national press, the majority of consumers (especially those on lower incomes) have little or no knowledge about their rights and options ‘at retirement’.
The problem: Around three-quarters of people entering full or partial retirement fail to take advantage of the OMO. (The OMO is a facility which allows people to ‘shop around’ for the best pension income.)
The result: Because the OMO is largely unused, the bulk of today’s pensioners are living on lower incomes than necessary.
New FSA proposals will require pension providers to raise awareness about this Option. But more radical reform is required to make the process of shopping around simple and quick to do.
4.1.2 Impaired lives
The problem: Many people with ‘life-shortening’ medical conditions do not know that they could be eligible for an ‘impaired life’ pension annuity that will pay them a significantly higher income.
The result: Again, these pensioners are living on much lower incomes than necessary. A higher proportion of this group are likely to come from the lower socio-economic groups which currently depend more heavily on means-tested State benefits.
4.1.3 People with smaller pension funds
The problem: The low commission on annuity products means that it is not cost-effective for advisers to service people with small pension funds (say under £30,000). However, putting up commission rates is not the answer. This would simply result in less income from the annuity which in turn further disadvantages the consumer.
In addition, many providers have an investment minimum for pension fund transfers – this may be £10,000, £20,000 or in some cases £30,000. This too acts as a barrier to the OMO.
The result: People with small pension funds are effectively prohibited from taking advantage of the OMO because it is difficult, if not impossible, for them to find advisers willing to help them, or providers willing to accept them. So they have no choice but to ‘stay put’, and accept what might well be a poor value annuity.
4.1.4 Investment-linked income options
The problem: Although the number of advisers who are familiar with guaranteed annuities is rising, there is a severe lack of specialist advisers in investment-linked annuities and income drawdown.
The result: Product innovation in this area is slow to gain acceptance and uptake within the adviser community; with the knock-on effect that not all consumers for whom it may be relevant will be offered investment-linked retirement income as a solution to their needs.
4.2 Annuity product shortfalls – what consumers "don’t like!"
Annuity products could easily offer more flexibility – yet this may require changes to primary or secondary legislation. In our experience, these are consumers’ main concerns:
"I won’t get my money’s worth if I die soon after buying my annuity"
Consumers want to get their money’s worth. They believe that the annuity company will pocket what’s left of their pension fund when they die. In fact this is not true – as any remaining fund is used to support the incomes of annuity holders who live longer than expected. In this way everyone is guaranteed an income for life – however long that may be.
However, more could be done to give better value for consumers who are concerned about dying early in their retirement.
"Annuity rates are too low at the moment – I think I’d better wait"
Consumers who don’t want investment risk, also don’t want to get stuck for life with what they perceive as a rotten annuity rate!
Currently there is no half-way house between a guaranteed annuity and a with-profits annuity (the lowest risk of the investment-linked annuities). This gap needs to be addressed.
"Why do I have to do this with my pension fund …? "
Some high-income consumers build up bigger pension funds than they actually need (quite often because their contributions were based on tax planning rather than retirement planning).
Currently there is no way to get this surplus money out of a pension fund – either during their lifetime or on death. This situation could be fairly addressed in a tax-neutral way.
4.3 Legislative framework
Key to our recommendations is that primary legislation should be substantially less prescriptive, leaving secondary legislation and regulation to reflect the detailed needs of the market place.
This would provide a more flexible structure for implementing ongoing reform, and enable the market to be more responsive to the changing needs of society and the consumer.
Many of our proposals for reform could be implemented relatively quickly and easily through simple changes in the design of pension income products and the information, advice and purchasing processes that surround them.
The small but important changes we recommend to primary and secondary legislation will enable radical change, aimed at:
The Open Market Option (OMO) is an important entitlement, yet few people use it. The Government’s consultation paper ‘Modernising Annuities’ is a clarion call to increase uptake.
However, simply promoting its availability more widely is not enough. We believe structural alterations to the marketplace are essential if the OMO is to become the norm.
12 years ago we wrote a report entitled ‘Open Market Option – a moral obligation or a marketing necessity?’.
Since then, the topic of annuities has gone from being rarely discussed in the national press to being a headline issue virtually week in and week out. As a result three times as many people are currently using the OMO than the number 10 years ago.
5.1.1 Low uptake of OMOs
Despite the above progress, the take-up of OMO annuities and the provision of advice at retirement still barely affects 25% of people retiring with private pensions.
The FSA’s recent research shows that:
5.1.2 Lack of advice for low value pension funds
Given the small size of their pension funds, it is currently impossible for these consumers to receive advice on the OMO. This is because the commission and/or fees generated would not be sufficient to cover the adviser’s costs.
Another way to use the much needed OMO must to be found if the vast majority of consumers are to be helped.
5.1.3 Impaired life – lack of awareness
Every eligible consumer should be able to benefit from the considerably higher rates offered by impaired life annuities. Yet we believe that, currently, less than 20% of those who could benefit actually use the OMO to buy one.
5.1.4 No common vesting process
Many people now have more than one type of pension, with more than one provider, and the numbers of people with both money purchase (defined contribution) company pensions and private pensions is growing.
Yet there is no common process for using the OMO, whether that be
moving from:
It would be very beneficial to consumers if these different processes could be more closely aligned – ideally into a core process which is common or similar to all. This is less about prescribed timescales and wordings for illustrations or small print; and more about the key processes for:
5.1.4 How the OMO can currently be accessed
Information about OMOs is, as we have already seen, low key. At best consumers are reminded of its existence. Promoting its use and explaining how to access it is rare. For consumers who ask to use the OMO, there are a number of ways the service could currently be offered:
In-house IFAs: A ‘best rate’ OMO service may be offered with the pension provider using an in-house IFA. (However it is still a time consuming and cumbersome process for IFAs to accumulate the comparative information themselves). Only one provider has historically offered this service.
Tied agents: Annuities already have an exemption in relation to the current polarisation rules, which allows a tied agent to introduce a client requesting an OMO to any IFA (ie without using the normal IFA rotating-panel process). Not all providers are aware of this.
IFAs: Some customers are pro-active and, having sought out an IFA, will then tell their provider they are going to use the service if a better annuity rate is found elsewhere.
5.1.5 Impact of de-polarisation
Proposed changes in polarisation rules would allow pension providers to multi-tie to all the top annuity providers.
Although this would enable them to provide an OMO service more directly than before – say by researching individual cases or creating their own rates monitoring systems or accessing top rates via an Annuity Exchange – the end result would not be as ‘transparent’ or ‘streamlined’ as using a common OMO service via an Annuity Exchange (as described below).
5.2 Proposals for reform
The vesting process offers a unique opportunity to provide guidance on pension income choices and illustrate the value of the OMO. Pension vesting should be reformed to assist with two levels of decision. Firstly, what type of pension income is appropriate and therefore whether financial advice will be required. Secondly, if the annuity route is chosen, then the choice of annuity type and benefit structure can be delivered through a standard illustration for comparative purposes, alongside decision trees and "What if?" scenarios provided through TÆ.
Proposals have been drawn up with leading annuity providers over the last couple of years, for the creation of the ‘Annuity Exchange’.
The services it offers could be fully operational within 6 to 9 months. Being part of an ‘official’ reform could accelerate this timescale.
The Annuity Exchange would enable:
5.2.1 Annuity Exchange – comparative rates information service
The Annuity Exchange would provide this information via a web-based information service - independent of the consumer’s pension provider.
It would supply accurate annuity rates for:
5.2.2 Annuity Exchange – pension vesting service
The Annuity Exchange would enable all providers to provide a ‘best rate’ OMO service for their pension holders if they chose to do so. In particular, this would benefit:
From our discussions with the industry we also know of at least five other insurers that would rather offer this service, but they believe the current rules are unclear as to whether or not this would be an approved route. They are reticent to clarify this situation directly with the FSA.
The main benefits of an Annuity Exchange
- new annuity providers
- smaller specialist companies such as impaired life providers
- providers wanting to introduce innovative new products.
This part of the service fits well with the current DWP/Institute of Actuaries proposals relating to ‘Statutory illustration of money purchase benefits’, where the stated aim is to "Assist individuals to assess in broad terms the adequacy of their pension arrangements, the extent to which they need to make further provision and to understand the significant uncertainties involved in using illustrations of benefits".
5.3 The actions required to achieve real change
5.3.1 Universal right to the OMO
The simplest and most accessible route to universal provision of the OMO would be to establish in a publicly recognised way that it is a right that everyone has, and that it is made available by the pension plan/scheme provider.
In many cases, the OMO is a condition written into the pension plan document. When the OMO was first introduced, many insurers issued endorsements to their existing plans. Therefore, the OMO is part of the contractual relationship between the pension provider and the pension planholder.
5.3.2 Clarification from the regulators about this universal right
Regulators need to publicly confirm that they allow pension providers to offer an OMO directly through their pension vesting process. This change need not be introduced as a ‘requirement’ but as a ‘voluntary’ activity. Market pressure would do the rest.
The vesting process itself, which currently must contain illustrations of a company’s own annuity rates would then be changed to illustrate the ‘best rate’ OMO. (Note that the vesting process is offered by the provider itself, not its marketing group.)
Pension providers should be free to provide a comparative illustration using their own annuity rates if they wish, so the consumer can quantify the ‘income gap’. This is important because the difference may only be a matter of pence, in which case it will not be worth moving unless there are other reasons to do so.
5.3.3 Common OMO process
Introducing the OMO for all fund-based pensions would enable consumers to experience a ‘common process’ which they will be able to identify with, and relate to all their personal and/or company pensions. This is important because many people are now reaching retirement with multiple and varied pension provision.
Under the Pensions Act 1995, trustees have an obligation to ensure that members of defined contribution schemes get the best income. This group would also benefit from the kind of OMO services to be provided by the Annuity Exchange. (There is considerable evidence that at the current time this market is an unsatisfactory one with many pension scheme members retiring with less than optimal benefits).
Although the requirement for change is not a legislative issue, we have made the above points to demonstrate how the objectives of the FSA’s consultative document could be most rationally fulfilled.
5.4 Summary
The overall benefits of our OMO proposals are to:
The Annuity Exchange (TAE) would also be highly complementary to the Government’s portal ‘UK Online’. As the scope of UK Online increases, working in partnership with TAE it should be possible to present retirees with a total picture of their retirement income –integrating data about the State retirement pension as well as the various company and personal pensions the individual may hold.
"Your pension fund -
You can choose when and how to use it.
You won’t lose it - and you can’t abuse it."
Our proposals in this section are designed primarily to ensure that all pension savers have the same flexibility of use for their pension funds, that the benefits and options are available to meet their real needs – and that nothing discourages any one group from making private pension provision.
The proposals also take into account foreseeable changes in the pension savings market over the next decade or so. For example:
6.1 Legislation based on the pension fund rather than pension income
We believe primary legislation should aim to provide a framework solely for the pension fund itself - determining when and how the money can be used, and so preventing any ‘misuse’ or ‘abuse’ of the tax privileges already granted.
Currently, with the exception of tax-free cash, the only option the consumer has is to use their pension fund to provide an income, and at age 75 this becomes compulsory.
The problem
Within the current legislative framework, the ability to provide the flexibility needed by today’s consumers is only partially possible – and then with complex advice and product design.
Many advisers balk at providing such advice and consumers run out of the patience, time and sometimes the capacity/ability to understand the complexity.
What’s required is a legislative framework that facilitates partial retirement (often referred to as the ‘decade of retirement’) as well as meets the needs of those taking temporary, early or late retirement and those who, for these or other reasons, need a flexible income during retirement.
For certain, smaller groups of people, the current rules are too restrictive and don’t allow them to get the value they need from their pension savings at all. For example:
We believe there should be a tax-neutral way for such people to access surplus capital during their lifetime and/or to pass it on after their death.
We believe the compulsion to act by age 75 should be removed. Obviously safeguards (ie secondary legislation/regulations) need to be in place to ensure that any surplus is real, and that the consumer already has an adequate income.
Proposal for reform
We propose that the compulsion to use any or all of a pension fund for income by age 75 (or any other age) be removed - unless not to do so would mean the consumer became dependent on the State.
As a result of exercising this option, any remaining pension fund (this could be the whole fund or the unused part of it) would:
A way of providing additional flexibility could be, for those ‘who can afford it’, to allow access to surplus capital in pension funds, subject to the payment of appropriate taxes. (If this concession is used and tax-free cash has not yet been taken, then the tax-free cash must be taken before the surplus is calculated).
If the consumer’s pension income is:
- in the ‘higher rate tax band’ - allow the surplus to be accessed before or after death, or
- in the ‘basic rate tax’ band – allow the surplus to be accessed only after death.
With these ‘access to surplus capital’ concessions, any money paid out from the pension fund would be subject to tax at an appropriate rate (in order for the Treasury to recoup previous tax benefits).
The Budget would be used as the platform to declare any yearly changes in the guidelines/tests/thresholds that would relate to these concessions.
Vesting guidelines for the ‘majority’ of consumers should recommend using the pension fund by age 75 as this will still provide the best value to small and medium-sized pension fund holders. The pros and cons of ‘not vesting’ the fund should be fully explained to the consumer within the context of a full financial review.
Those choosing ‘not to vest’ by the State’s recommended age of 75
should sign a form of declaration to indicate they have agreed to this.
These concessions would benefit all consumers – the less well off as well as the rich. For example, if a low income pensioner wishes to live more frugally so they preserve some of their pension capital to pass on to the next generation – they are free to do so without being eligible for additional State benefits.
One possible extension to the use of pension funds would be to allow unused funds to pay for long-term care and/or long-term care protection – without being taxed, or being taxed at a reduced rate.
6.2 Income drawdown
It is implicit within the above proposals that income drawdown rules should also be significantly simplified.
Proposal for reform
all/part of the existing pension fund to be put into ‘draw mode’.
6.3 Pension income tax
There is currently a hidden tax subsidy within pension income – the tax received by the Treasury from pension income is just over half the value of the tax allowance given on pension savings – because of lower incomes in retirement. The reforms outlined above would enable the Treasury to make such a tax subsidy overt rather than hidden.
The majority of these proposals deal with changes in the design of products, practises or processes that would be simple, cheap and relatively quick to introduce.
7.1 Annuities: Payment guarantee option
This option allows an annuity income to continue for a guaranteed period if the consumer dies early in retirement – this applies regardless of whether or not they have a spouse or other dependant.
The problem
Current primary legislation restricts the maximum guarantee period to 10 years. This dates from a time when 10 years was the average life expectancy in retirement.
In 1956: A 65 year old man was expected to live for 11 years.
Today, people are retiring earlier and living longer - so a 10 year maximum is no longer appropriate.
In 2001, a 65 year old man was expected to live for 20 years (and a 65 woman for 24 years).
This ‘longevity’ problem is further compounded by today’s low annuity rates. Many consumers react badly to the 10 year restriction, believing that they have every chance of surviving it and will fail ‘to get their money’s worth’ if they die during this relatively short guarantee period.
Proposal for reform
nb: Various actuarial proposals for change in this area have been made, but they would all result in increased complexity for the consumer which we believe makes them undesirable compared to this simple solution.
7.2 Annuities: Joint-life option
Another way to help consumers get better value from their pension funds once they have been ‘vested’, is to allow alternative ways of providing a pension income for a surviving spouse, partner or other financial dependant.
The problem
Currently the only option is to buy a joint-life annuity which will pay an income to any surviving dependant, based on all or a proportion of the annuitant’s income at the time they die.
Currently, a joint-life annuity (depending on the level of spouse’s pension they choose) could pay 10% to 25% less income than a single life-annuity.
Joint-life annuity holders who outlive their nominated dependant are then stuck with a low income for life, and rightly feel they are not getting the best value from their pension fund.
As people’s life expectancies have gone up, term insurance rates for those aged between 50 and 70 have substantially reduced. So today, many joint-life benefits could be more cost-effectively provided using term insurance – particularly during the early retirement years or during partial retirement. However, current legislation does not offer the flexibility to do this.
Proposal for reform
7.3 Levelling the playing field for Section 226 Retirement Annuity Contracts
These are the ‘old style’ pension savings plans that preceded personal pensions, and were sold before 1986/87.
As they were written as annuity contracts at the outset, they do not have a built-in OMO facility that allows consumers to shop around for the best annuity deal. This is because at the time they were sold it was assumed that the pension plan provider would automatically provide the pension income at retirement.
The problem
In today’s market, many of the companies that sold S226 plans originally have no desire to be in the annuity market, mainly because they cannot afford to offer competitive annuity rates.
However, their hands are tied because legislation requires them to offer their own annuity. As a result, their customers are likely either:
Aside from seriously disadvantaging the consumer, this situation also creates anti-competition:
Proposal for reform
This simple change would also:
*Because many consumers are unaware of the OMO, they simply take the annuity offered to them by their pension provider without shopping around for a better deal).
7.4 Vesting of personal pensions and S226 plans
In the mid-1970s the Inland Revenue issued guidance that S226 pension policies could not be partially vested at retirement – consumers must use the whole pension fund in one go.
Some companies reacted to this by selling plans that were segmented into a number of identical mini-policies which could be used separately at retirement.
However, there are still many maturing S226 policies which are constrained by this Inland Revenue rule. In particular, this has affected pension maturities with Equitable Life.
The problem
This IR restriction does not fit in a world of partial and phased retirement where financial planners and the world of work are encouraging consumers to take pension benefits on a phased basis. In a modern world, this disadvantages people who have the misfortune simply to have bought ‘old fashioned’ plans.
7.5 New temporary annuities – giving more choice about investment risk
The current annuity range falls into two camps, those paying:
As you know, once an annuity has been bought it is for life. Yet, today’s annuity designs offer little or no scope for adapting an annuity as investment conditions or income needs change in the future.
For example, if you initially buy an investment-linked annuity you must stay with the same company all your life, even if their investment performance is abysmal. Also, within that one company, you might not be able to alter the amount or type of income you take, or switch from a with-profits or unitised investment to a conventional guaranteed annuity. (However, some of the most recent products are beginning to introduce more flexibility in these areas).
The problem
At this end of the market the only annuity choice is either:
- a conventional fixed lifetime rate with the mortality risk borne by the provider (no risk of the income falling), or
- a with-profits annuity where the mortality risk is borne by the consumer* (this is the lowest risk investment-linked annuity, and it offers a medium risk of the income falling from year to year, as a result of changes in the providers’ investment performance and death claims experience).
*except for one provider
Because many people fail to make enough provision for retirement, their incomes reduce considerably when they stop work and their standard of living drops as a result. Therefore, most people need to maximise their income – but cannot afford to take the risk associated with the current range of investment-linked annuities (even though in the longer term they might get a higher income and some protection from inflation).
Proposal for reform
A need clearly exists for a low-risk investment annuity to bridge that gap and meet consumer needs. Indeed the Government’s recent consultation document called ‘Modernising Annuities’ includes proposals for one type of temporary annuity.
In our view this does not sufficiently address the problem of investment risk, and here we propose a lower risk product – as an addition to the range:
- Pay a guaranteed income for a chosen term say 5 years. (Different terms of up to 10 years could easily be offered.) The initial income would normally be slightly higher (say 5%+) than the top conventional guaranteed lifetime annuity.
- At the time of the initial purchase, include an option that gave the following choices at the end of each fixed rate term (this would enable the consumer to react to market conditions and any changes in their needs at that time):
- Incorporate a fixed mortality risk within the original purchase price based on the consumer’s life expectancy at the time of purchase.
7.6 Flexibility for those who expect to suffer ill health in early retirement
The problem
There is a growing sector of the market that is:
Currently these people have no choice but to buy a standard rate annuity and hope for the best – or delay vesting their pension on the off-chance that the worst may happen.
Proposal for reform
7.7 Transferable annuities
In theory, having the right to switch providers seems like a good idea – say if investment performance or customer service has been poor.
Indeed, the Government’s consultation document ‘Modernising Annuities’ suggests that consumers may be more likely to encounter poor service when they buy a ‘for life’ product as there is no incentive for the provider once the sale has been made.
However, in the many providers we deal with we have found no evidence at all of a reduction in post-sale service quality. On the contrary, because the vesting process is so fraught with difficulties, the quality of post-sale service is very often superior!
How might the annuity market be affected by transferable annuities?
If transferable annuities were introduced in legislation, we can envisage a number of detrimental scenarios but few benefits for the majority of consumers – unless the transfer is for a book of business (such as Equitable Life’s with-profits annuitants).
For example, if the right to transfer came into force the following downsides could potentially happen:
How could the need to transfer be minimised?
Given such scenarios, it would be vital to minimise the risk of a transfer being desirable. To help avoid the need to transfer we believe that:
However, to encourage multiple investments and make them easier to effect, improvements to the pension vesting and annuity purchasing process would be desirable. Currently, it is extremely time-consuming and difficult when making transfer arrangements to just one provider or one product. (See Section 5 for our proposals re a common vesting process.)
Below we list the reading material that we have drawn from in establishing some of our background information.
However, by far the largest source of influence on our thinking has been the tens of thousands of private pension holders we have spoken to about their retirement income prospects.
Available on the Web
Modernising Annuities
Department of Work and Pensions
Reforming Polarisation
Financial Services Authority
Statutory illustrations of money purchase benefits
Institute of Actuaries
Annuities and Taxation
By the Retirement Income Reform Campaign, Nov 2001
Extending Retirement Income Choices : Retirement Income Options for Modern Needs, June 2001
By Retirement Choices Working Party, Pensions Board, F&I of Actuaries
www.actuaries.org.uk/index2.html
Reinventing Annuities
By M Wadsworth, A Findlater, T Boardman
For Staple Inn Actuarial Society
Others
Income in retirement – are annuities the answer?
Oonagh MacDonald, AUTIF, April 1999
The finances of older people: past present and future
Richard Disney, University of Nottingham, 1999
Mortality and the next millennium
Richard Willets FFA, SIAS Paper 7 Dec 1999
Annuities markets in comparative perspective: Do consumers get their money’s worth?
James and Vittas, World Bank 1999
Selection effects in the market for individual annuities: new evidence from the UK
A Finkelstein MIT, J Poterba MIT, NBER
UK annuitants
Banks and Emmerson, Institute For Fiscal Studies, Dec 1999
The value for money annuities; theory, experience and policy
Murthi, Orszag; Birkbeck College.
Portfolio choice and annuitisation during retirement
S Kapur, M Orszag; Birkbeck College, Dec 1999
Annuities: the problems
Michael Orszag, NAPF Annual Conference 2000
Choices – an independent report to encourage the debate on retirement income
Oonagh MacDonald et al, Retirement Income Working Party, March 2000
Annuities; the case for change
Donald McCarthy, Social Market Foundation
Annuity and insurance products for impaired lives
Ross Ainsilie, FIA. SIAS Paper, 9 May 2000
How should we insure longevity risk in pensions and social security?
J R Brown, Harvard University Centre for Retirement Research, Aug 2000
Is there an ‘annuity problem’?
Julie Stark and Chris Curry, in ABI Insurance Trends, April 2001
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Annuity Direct
Annuity Direct are retirement income specialists, providing advice through an information and arrangement process that happens mainly by telephone and post.
We are the UK’s leading source of annuity statistics via the national newspapers and the BBC Ceefax service.
We also provide advice and information about pension income, product development and annuities to pension scheme trustees, investment companies, insurers, the national press and of course direct to the public.
Alongside providing services directly to the public, we work with groups such as Express Newspaper Financial Services, the British Diabetic Association and the International Myeloma Foundation, as well as various trustees and actuaries. In addition, Marks & Spencer Financial Services and Virgin Direct refer business to Annuity Direct.
Since our formation ten years ago we have assisted over 50,000 people to assess their pension income options ‘at retirement’.
The value of pension funds advised by us in the year 2000 exceeded £130 million - net of tax-free cash.
Stuart Bayliss
Stuart Bayliss’s interest in annuities dates back to 1988-89 when a consultancy project led him to devise and launch The Annuity Bureau as its managing director for two years, subsequently starting Annuity Direct as a direct retail IFA.
His management consultancy – The City Partnership – is retained to provide advice on strategic planning and product design through to implementation of customer services and sales processes. Clients include Barclays, The Leeds (Halifax), Marks & Spencer FS, J P Morgan, Prudential, Rabobank and Scottish Widows.
During the last four years he has been continuously involved with Equitable Life, through initiating and co-ordinating the voice of the guaranteed annuity policyholders to proposing the compromise arrangement immediately the company closed for new business in December 2000.
Aside from this, he established a portfolio career with the creation and growth of a number of financial services related companies, both brokerages and support services, undertaking temporary senior management roles, for example Managing Director of Jersey General Investment Trust during merger/reconstruction.
Prior to setting up his own companies in 1988, Stuart was a director of Oyez IBC and Deputy Chief Executive of Ætna. He has been a director of a number of charities, including the Youth Enterprise Scheme (the Prince’s Trust) and currently Parentline Plus, and makes frequent appearances in all forms of current affairs and financial media.