Is this the next pension mis-selling scandal?
Annuities could be the next pension mis-selling scandal because insurance companies are pushing their deals onto people without fully highlighting their right to shop around, experts have warned.
Despite every retiree having the right to shop around for an annuity product – known as the Open Market Option (OMO) - around two-thirds of people still accept the first offer made to them by their insurance company.
Regulator, the Financial Services Authority (FSA), recently hit out at insurance companies claiming that 40% of letters sent to retirees explaining their options do not sufficiently highlight their right to use the OMO.
However, by not shopping around, retirees could be diminishing their retirement income by over 50%. Laith Khalaf, pensions analyst at Hargreaves Lansdown, says his firm managed to get one client a 60% increase on his annuity rate because a medical condition made him eligible to enhanced or impaired life annuity.
This type of product pays a higher-than-normal income to people that smoke or suffer from health problems that threaten to reduce their lifespan.
Khalaf says: “The difference between the annuity your insurance company offers you and the one you could get by shopping around is significant – around 20%. And this is especially true if you have a health problem.
"Smokers could be 15% better off in retirement by opting for an enhanced annuity, while those with a medical condition could be 30% better off.”
According to MGM Advantage, which recently launched into the enhanced annuity market, around 40% of people could be eligible for an enhanced annuity.
Craig Fazzini-Jones, a director at the firm, says: “Unlike life insurance, where health problems can push up the cost, enhanced annuities offer better returns for smokers or people with medical complaints. Shopping around or getting independent advice really is crucial as you could be missing out on potentially better retirement income.”
And you only get one change to get it right. “The majority of annuity products are for life, so you can’t learn from your mistakes,” says Khalaf. “Buying an annuity is the most important decision you make with your retirement savings and it’s a one-off decision so it’s vital to get it right.”
Who’s to blame?
Experts agree that the reason the majority of people fail to shop around is because they simply do not know that they are entitled to. Currently, life insurance companies are required to inform customers about the OMO, but many bury this important information in the small print and instead highlight their own offering.
Following the FSA’s criticism of insurance companies, a deadline of December 2008 has been set for the industry to clean up its act. If it fails to do so, then companies are likely to be hit with fines.
Independent Financial Advisers are also often blamed for the number of people who fail to exercise their right to shop around. “IFAs get commission on your pension policy if you take out an annuity with that provider,” explains Khalaf. “It’s important, therefore, to see an adviser that offers the OMO.”
As well as commission, the complexity of arranging an annuity can often put financial advisers off – especially as the amounts of money involved do not necessarily make it worth their while. But consumers are able to compare annuity products on the FSA’s website, whch clearly highlights the best products for them at any given time.
According to Dr Ros Altmann, an investment and pensions expert, insurance companies and the government are complicit in the lack of people shopping around.
“Every year, hundreds of thousands of people buy an annuity with their private pension savings. The insurance company who sells the annuity to them will deduct between 1% and 2% of their pension savings in commission even if they have no advice. The government knows this is going on, but has not stopped it,” she says
For Altman, the reason this has been allowed to continue is clear: “I presume because the insurance companies would lose a profitable bit of business […] Many insurers simply don't want people to buy the right annuity.”
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.
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
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.
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.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).