FCA launches competition review into ‘disorderly’ annuity market

The watchdog says the current annuity system isn’t working, so will launch a market study into the sector that will put providers as well as retirement income under the spotlight.

The Financial Conduct Authority (FCA) has launched a competition study into the UK annuity market.

The move is a result of the watchdog’s year-long review into the sector, which found too few people were switching providers and not enough being done to support those with smaller pension savings.

According to the FCA, the review is the first in-depth, industry-wide study of the annuities market. It gathered information from 25 firms which represent 98% of the sector.

Based on its findings the FCA said the UK annuity market was ‘not working’ and described its current state as ‘disorderly.’

The body has now ordered a competition review that will investigate retirement income products (like annuities and income drawdown) as well as take a closer look at the sales practices of pension providers.

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Shopping around and small pots

Around 400,000 annuities are sold every year and that number is set to increase as more savers join pension schemes under auto-enrolment.

An annuity is a product which converts your pension savings into a guaranteed income that will last as long as you live after retirement (and sometimes beyond depending on the type you go for).

Generally once you pick an annuity your decision is irreversible – so it’s important to get the best deal you can as the impact of making the wrong choice will last the rest of your life. It has become even more crucial as annuity rates have fallen sharply.

But the FCA review found too many people are buying an annuity from their existing pension provider without looking at their options on the open market.

In 2012 60% of annuities were purchased from existing pension providers.

The FCA found that eight out of 10 of the people who don’t switch could have got a better retirement income by shopping around and switching to another provider.

On a typical pension pot of £17,000, sticking with the provider you saved with would on average provide an annual income of £1,000 on  a standard annuity.

But by shopping around and switching the annual income had the potential to be £67 higher, or 6.7% more generous, giving a yearly income of £1,067.

For those eligible for an enhanced annuity (in terms of the FCA review because they smoked) the figures are even higher. With an average pot of £26,800 an average income of £1,630 could be found with an existing provider, but shopping around added £135 to that total, an increase of 8.3%.

The review also found that people with smaller pension pots weren’t being served fairly by the industry.

Those with less than £5,000 saved up were found to have less choice when shopping around as there are only a few firms that will offer annuities and rates were found to be typically lower than those offered to people with larger funds. 

Trivial Commutation rules exist that allow small pots to be taken as a lump sum, but these are complex.

Martin Wheatley, chief executive of the FCA said "There is virtually no market whatsoever for people with smaller pension pots. This means that for those people who need to make every penny of their pension count, the market has closed the door on them."

The low levels of switching - despite the clear benefit in doing so - and lack of options for people with smaller pots are both key factors in the FCA commissioning a market study.

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The next stage

The next stage of the FCA’s work will be to try to figure out why people aren’t shopping around and switching and how to fix it.

It’s a troubling issue that has plagued the industry for years, though recent improvements like the new ABI code which includes issuing a 'wake-up' pack to people about to retire explaining their options, have helped increase awareness.

According to the FCA nine out of ten are aware they can shop around for their annuity. However, awareness doesn’t equate to consumers actually shopping around and switching.

The FCA believes behavioural issues like inertia could be at play, as well as a lack of confidence, but the complexity of annuities seems to be the number one concern.

The Financial Ombudsman Service (FOS), which handles complaints for financial products like pensions, regularly deals with consumers baffled by annuities. It suggests a ‘plain English’ approach is needed.

How pension providers deal with smaller pension pots will also be under the spotlight, as will sales practices.

The market study will include a ‘supervisory element’ which will look into providers' current sales practices and strategies when selling annuities to their existing pension customers.

The further supervisory work will look at how pension provider sales teams conduct themselves when selling to existing customers- this will include specialist retention teams tasked with convincing customers to stay.

Of the 25 companies looked at in the FCA review, 13 only sold annuities to their existing customers, nine sold to both existing and the open market and three only sold on the open market.

Annuities sold to existing customers were found to be more profitable than those sold on the open market. The FCA believes there is a risk that providers may be unfairly trying to keep customers to maximise profits. The FCA says if poor practice is uncovered here, immediate action will be taken.

The next steps will determine whether the FCA needs to make any changes to the rules in the market or consult other bodies like the Office of Fair Trading or Prudential Regulatory Authority to step in.

The findings will be published in 12 months.

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Industry response

Many in the pensions industry have welcomed the FCA’s findings, but have pointed out these issues have been apparent for a while. A few are critical of how much longer reform will take and what that means for those that have to make decisions about their retirement income now.

Andrew Tully, Pensions Technical Director at MGM Advantage said: "The FCA review doesn’t go far enough, or act quickly enough…Although the review puts the spotlight firmly on issues that need to be addressed, another year or two of customers sleepwalking into retirement is simply not good enough."

Tom McPhail from Hargreaves Lansdown echoed this sentiment: "We have been lobbying for reform for years now; recent developments suggest that we are finally making some headway.... We can wait another year for the FCA to complete its review, however there is much that can be done today to help the hundreds of thousands of investors reaching retirement every year.”

If you are about to retire and want some help read How to buy an annuity.

Meanwhile the Association of British Insurers (ABI), which represents many of the pension firms that supply annuities, accepted its role in the process. Director General, Otto Thoresen, said:  ‘We recognise that our industry can do more to make the market work effectively for customers which is why we are finalising a new package of measures to enable people to engage and to shop around for better deals.

"This would include ensuring customers have the right to a conversation to help them understand the difficult decisions at retirement; and how all customers can get a comparison of rates."

While Dean Mirfin, Group Director at Key Retirement Solutions emphasised that the onus should be put on insurance companies. He said: “The industry must work hard to deliver the best consumer outcomes. Some insurers have taken, and continue to take, further steps to achieve this but too many are still taking advantage of consumer apathy and their customers trust in them to do the right thing."

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