PensionsFeb 14 2014

FCA exposes profit disparity in ‘disorderly’ annuity market

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The Financial Conduct Authority is to launch an extensive 12-month competition probe into annuities after uncovering profit imbalances at the heart of a market in which more than 130,000 a year at least are receiving a significantly lower rate by staying with their existing provider.

Following a year-long investigation launched January 2013, the regulator concluded that the annuities market is “disorderly” and “not working well for consumers”.

The investigation found that of around 420,000 people that cash in their pension pots for an annuity every year - spending a total of £1.2bn in premiums in 2012 - 168,000 buy from their existing pension provider.

Of these, the FCA found that as many as 80 per cent of people - about 134,400 - secured a lower income than they could have by shopping around. On average, shopping around could gain a customer £70 more per year of income, equivalent to about £1,500 more in savings.

Crucially, the FCA also exposed that providers make more profit from selling annuities to existing pension customers than they do from business sold through the open market option.

The FCA warned that, given that internal business is more profitable than open-market business, providers could potentially be incentivised to prevent switching in increase their profitability. It said it would not comment further on these findings until it had completed its competition study.

The regulator’s review looked at information from 25 of the 31 firms which sell pension annuities and data covering 330,000 annuity sales in 2012, representing 78 per cent of all sales.

Although the average increase in income from shopping around would be £71 per year - an increase of 6.8 per cent - five per cent of consumers could secure an increase in annual income of up to £200.

The watchdog specifically found that 10 of the 25 firms surveyed do not offer an enhanced rate to their existing customers, meaning anyone with a health or lifestyle impairment that would qualify them for a higher rate would lose out unless they surveyed the wider market.

Things are even worse for people with very small pots of less than about £5,000, as they have less choice when shopping around because just three of the providers actually offer annuities for such clients.

For some clients these factors combine: 10 out of the 12 companies which offer enhanced rates to their existing customers do not offer them to those with small pension funds.

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

“There should be competition across the entire market, not just for those with the most money.”

The market study will take up to 12 months to complete, although the FCA will publish an interim report in the summer.

The study will look at ways to improve customer engagement and encourage shopping around; examine the market to understand high levels of concentration found in some areas; and try to predict how these markets will develop in the future.

It will look at the effects and extent of customer inertia when it comes to buying an annuity, as well as the growth in enhanced annuities and the relative decline in the standard annuity market. It will also look at the effects of auto-enrolment.

It could include instructing firms to make immediate changes if the FCA finds poor sales practice among annuity providers.

The Financial Ombudsman Service receives around 40 to 50 complaints about annuities each month, and upholds about one in three.

A spokesperson for the Fos said: “When we get to the crux of the matter, it becomes apparent that if the pension firm had made more of an effort to explain in plain English how the annuity works and what it is, many of the complaints could have been avoided.”

Nick Flynn, divisional director for longevity at LEBC, said: “Without a clear steer the industry will continue to stumble along with consumers paying the price. Consumers should be directed to whole of market advisers.

“Limited annuity provider panels and commission payments should be banned and brought in line with the Retail Distribution Review.”

The FCA has shared its findings with the Treasury and Department for Work and Pensions.