Beat the postcode lottery
Putting a postcode on a letter or quoting it when calling a taxi is second nature for most of us. It’s been 50 years since plans to introduce postcodes in the UK were first announced in July 1959, with Norwich the chosen city to trial the initiative in October that same year.
Over the following decade, postcodes were rolled out to all addresses in the UK – and some beyond. For example, Santa Claus has his own special postcode - SAN TA1 - and receives 750,000 letters each year.
There are now more than 1.7 million postcodes across the UK, covering 27 million addresses. According to Royal Mail, the use of postcodes makes it 20 times faster to sort mail, although a surprising 20% of non-business letters, cards and packets still fail to bear a full or accurate postcode.
Over recent years, postcodes have started to take on more significance in the financial services sector as well, with banks and insurers using them to categorise applications and to ‘price’ products. This is because the first three digits of your postcode say a lot about you, your assumed lifestyle and the type of area you live in.
This could include crime levels, access to heathcare and even life expectancy. And all this information is used by many firms to make a decision about whether they want you as a customer, and how much you should have to pay.
While there isn’t a lot you can do to escape the postcode lottery (bar moving of course), it’s important to understand what areas are subject to this sort of pricing and what other steps you can take to get around the possible increase in cost.
What is postcode pricing?
Postcode pricing is mostly used for certain insurance products, although in the past few years insurers have started adopting this method for pricing their annuity (or pension income) products too.
With buildings and contents insurance, the benefits of postcode pricing are pretty straightforward. The area that you live in is effectively assessed for risk – this could be the crime rate or the threat of flooding or subsidence.
Darren Black, head of home at confused.com, says home insurance premiums reflect the perceived risk of your postcoded area. “Once the insurance provider knows the postcode of the property, it will be able to paint a picture of that house and the risks it could face,” Black adds.
“It will also apply risk analysis programmes based on previous claims data and crime statistics, among other things. This enables the insurer to provide a competitive quote for the customer, but reflective of the risk it is taking on.”
Car insurers use a similar method to price policies. Lee Griffin, business and research director at gocompare.com, explains: “Your postcode is the most important rating factor when it comes to car insurance, followed by your age and the car you drive. Insurers will look at loss ratios [which estimate how likely you are to claim] in your area and price your policy accordingly.”
Crime rate is key to postcode pricing for car insurance, as is the concentration of traffic on the local roads. This is why urban areas tend to be more expensive for car insurance than rural areas.
For annuities, the issue is a little more complex. Nigel Callahan, annuities expert at Hargreaves Lansdown, explains: “Insurers have learnt from their general insurance offerings that the information that can be gleaned from a postcode can be used to predict your life expectancy.”
This is important for annuity products as this type of pension income will pay you a pre-agreed income until you die. The longer you live, the more an annuity provider will have to pay out – the shorter your life expectancy, the ‘cheaper’ you are.
Callaghan adds: “As life expectancy increases, annuity providers need to protect their own risks – so, if you have a long life expectancy, they will pay you less each year on the grounds that you will live longer. If you have a shorter life expectancy you will get a larger annual income.”
By looking at your postcode, an annuity provider can judge how affluent you are. It will also make assumptions about your diet, your access to healthcare, and the physical aspect of your job or career. If you live in a less affluent area, it is assumed that you may have a poorer diet, bad access to heathcare and a more physically demanding job.
“Postcode pricing is bespoke – it is a proxy measure for understanding your lifestyle and life expectancy without subjecting you to a medical check,” says Callaghan.
So, what steps can you take to offset the impact of postcode pricing?
1. Cut the cost of car insurance
Generally speaking, there are two types of car insurance – third party or fully comprehensive. Third party is the legal minimum and will cover you for any personal injuries to other people and damage to other vehicles. So, if you crash into someone else’s car, the insurance will pay their costs but not your own.
Third party can be extended to include fire and theft.
If you want more protection, then fully comprehensive car insurance covers every party for damage or personal injury regardless of fault, as well as fire and theft. It can also be extended to include the theft or damage of your personal belongings within the car.
With either policy, the price you pay will depend on the type of vehicle you drive as well as your personal circumstances – including your gender, age, how long you’ve held your license, and your postcode.
Luckily, there are several ways to reduce the cost of your car insurance and offset any damage your postcode might do to your premium.
Urban areas tend to be more expensive than rural areas, because there is a higher risk of crime and vandalism. However, Griffin says that some insurers have an appetite for London postcodes, for example, so it’s worth shopping around.
“Car insurers look at their own loss ratios in an area, but as these will vary, so will the premiums quoted by different insurers for your postcode,” he adds. “Likewise, the loss ratio can change from one year to the next.”
You should also make sure you shop around for car insurance, rather than letting your policy roll-over from one year to the next. Ask your current insurer for a quote and then use a price comparison website to compare this – Moneywise offers this service in our Comapare & Buy section. It’s probably worth using more than one comparison website, as the results might vary, and also phoning insurers such as Direct Line and Aviva directly, as they don’t use third-party websites.
Beyond finding the best value car insurance for you, there are several other things you can do that might bring down your premium.
Keeping your car locked up in a garage, or even parked on a driveway, will reduce the risk of vandalism or theft, and make insurance cheaper. Equally, investing in an engine immobiliser or car alarm should help cut the cost marginally.
Adapting the type of insurance you take out will impact your premiums. For example, the higher the excess, the cheaper the premium.
Finally, when buying a new car, remember to check out the insurance group a vehicle is in, and bear in mind that fancier cars tend to attract higher premiums because they are more appealing to thieves.
2. Cut the cost of buildings insurance
There are two types of home insurance. The first, buildings insurance, covers your house from any accidental damage that requires building work to be carried out. For example, this might include damage from a fire or vandalism to subsidence or a flood. Homeowners with mortgages are required by banks and building societies to take out buildings insurance.
As with any insurance product, it’s important to shop around when buying buildings insurance, as not only do prices vary, but new customers are generally offered better deals than existing ones.
One of the most effective ways you can save on home insurance, after shopping around, is by making sure you don’t overestimate your re-build cost, also known as the ‘sum insured’. This is the total amount of money an insurer will pay out, and is the amount it would cost to rebuild your home from scratch rather than the market value.
You can find out your re-build cost by checking your original mortgage documents, or by using a special calculator powered by the Building Cost Information Service.
Many people mistakenly supply the market value of their home to the insurer when asked for the re-build cost – but Confused.com estimates that this could result in people paying 20% more for insurance. This is because the market value tends to be the higher of the two costs.
3. Cut the cost of content insurance
The second type of home insurance protects the contents of your home – this includes electrical equipment, furnishing and your actual possessions. Some policies will also protect portable items, such as laptops and cameras, away from the home although you’ll have to pay an additional premium.
You can choose whether to protect your possessions (from clothes to furniture and white goods) from accidental damage as well as theft. Covering your possessions for accidental damage is likely to increase your premium, as is extending the policy to include protection for items away from the home.
You will also need to consider whether to opt for a new-for-old policy that meets the replacement or repair cost of any items, or an indemnity policy that replaces exactly what was there before.
Other small measures that could make a price difference include making sure you are on the electoral register, as insurers tend to check your credit record before approving you for insurance, and fitting a burglar alarm. You could also join a Neighbourhood Watch scheme.
Also, check your locks to see if they have the British Standards Kitemark - this means they conform to the insurance industry’s standards and could afford you a discount.
When it comes to contents insurance, it may be cheaper to buy this separately from buildings insurance, so it’s worth doing a bit of research before you buy to see if this is the case for you.
4. Boost your pension income
Currently, only three annuity providers use postcode pricing – Aviva (formally Norwich Union), Legal & General and Prudential. However, between them they make up around 40% of the annuity market, and are considered the biggest players around.
It is likely that more annuity providers will follow their lead down the line. Callaghan says: “These three insurers are shaping the annuity market, which puts other providers at risk – if they fail to adopt postcode pricing, which is pretty sophisticated, then they risk offering great deals to people that have a high life expectancy.”
Hargreaves Landsdown estimates that postcode pricing can make a difference of between 2% and 3% to your annuity income - however, it has seen examples of a 7% impact. While this doesn’t seem a lot, it’s worth bearing in mind that a 65-year-old man could live for a further 21 years. A 3% increase on his annual income adds up significantly over that time.
If you live in an affluent area, then you are likely to be penalised by postcode annuity pricing. There’s not a lot you can do about this - however, by taking steps to boost your annuity income, you could mitigate the impact.
According to an investigation by the Financial Services Authority (FSA), there is an average price difference of 20% between the best annuity income and the worst.
The easiest way to boost your annuity income is to shop around. Every retiree has the right to do this – it’s known as the Open Market Option (OMO) – yet around two-thirds of people still accept the first offer made to them by their pension provider.
Rather than take the annuity you’re offered by your pension provider, you should first compare the income with annuities from the wider market. You can either do this through an independent financial adviser, or by using a specialist comparison website. The FSA provides one on its website or you can use the annuity-bureau.co.uk.
Bear in mind that the FSA's annuity comparison tables exclude the likes of Prudential and Aviva, because both use postcode pricing.
Another way to boost your annuity income is to opt for a specialist product, known as an enhanced annuity. These are offered to people with shorter life expectancies and pay a higher income to reflect this. If you suffer from a medical condition or smoke then you should declare this information, as it could see your income increase.
Once you've selected an annuity, be it a standard one or an enhanced version, there are several factors that can impact the income you can expect to receive.
1. The amount of your pension you use to buy an annuity. You can take up to 25% as a tax-free lump and use the rest to buy a pension income, such as an annuity. However, you could choose to invest the full amount (or more than 75%) into an annuity. There are pros and cons to doing this, and your decision should be based on your own circumstances and your need for the money. But the more money you use to buy an annuity, the higher the income you can expect to receive.
2. When you buy an annuity, you can opt for a single life annuity, which pays you an income for as long as you live and stops paying out on your death, or a joint life annuity, which continues to pay your spouse or partner an income after you have died for the rest of their life. Again, the type of annuity you buy will depend on your circumstances and the circumstances of your partner, but bear in mind that a joint life annuity will pay out a lower income than a single life annuity.
3. Some annuities come with guaranteed terms of five and 10 years. Should you die within the guaranteed term, your income will be paid to your spouse, partner or estate until the end of the term. Opting for a guaranteed term will reduce your annuity income.
4. When you pick an annuity, you will normally be given the choice about whether you want a level product, which pays you the same amount for as long as you live, a 3% index-linked annuity, which sees your income increase by 3% each year to take into account inflation, or a Retail Prices (RPI) Index-linked annuity, which increases by the RPI rate of inflation each year. Both the inflation-linked annuity products will pay you a lower rate of income initially, but this income will increase with every year you live.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Open market option
People who have a money purchase or defined contribution pension, at retirement must use their fund (minus an optional 25% as tax-free cash) to purchase an annuity. As the annuity market is very competitive and rates differ vastly between annuity providers on a daily basis, the open market option is your right to shop around and buy the annuity from the company offering the highest rates at that time.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
This type of insurance covers the structure and fabric of your property – the bricks and mortar, not the contents (for which you need contents or home insurance). If you have a mortgage, the lender will insist you have a suitable buildings insurance policy in place. Many lenders offer their own building insurance policies, but you don’t have to buy it from your own lender but you have the option of shopping around. The insurance covers you for the rebuilding costs, not the market value of the property.
Does exactly what it says on the tin: covers the contents of your home for theft and damage and also may insure certain possessions (jewellery, cycles) outside of the home. Things to watch for include the excess and also the maximum payout on individual items. Another grey area is kitchen fittings, as some contents policies say these are not contents but part of the fabric of the property and covered by buildings insurance and some buildings policies don’t cover them because they regard them as contents.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.