I sometimes find it hard to understand why everybody of retirement age does not know about the open market option because I have been talking about this in the national media for over 25 years. Then I realise I have lived in an ‘annuity bubble’ and have been communicating with a self-selecting group of people who take their retirement income options seriously.
The bubble was hugely inflated from 2010 onwards when a lot of hot air was blown in as a result of new media marketing and an increase in non-advised brokers.
The bubble had to burst at some time but it took the then chancellor George Osbourne and his infamous 2014 budget speech ‘no one will have to buy an annuity’ to deflate the bloated bubble and boy did the hot air come rushing out. The annuity market is a shadow of its former self with sales falling by over 50 per cent compared to pre-pension freedoms volumes.
But just because the bubble has burst and pension drawdown is quickly becoming the option of choice rather than annuities for those converting pension pots into income, it does not mean that those people who buy an annuity now should not shop around.
Open market option annuities are back on the agenda following a FCA’s retirement income market study which recommended an “annuity comparator”.
What is an ‘annuity comparator’ you might ask? According the FCA’s press release it ‘will be required to deliver information in a personalised form in a format set out by the FCA. This prompt will have to show the difference between the provider’s own quote and the highest quote available to the consumer from all other providers on the open market. There will also be a prompt to help the customers access the best quote – this will be a link contained in the information prompt’.
Not only will firms have to compare rates they will also have to give details about joint life options and guarantee periods. Although there is no mention of it, presumably details about escalation options should be discussed as well, especially as in the Brexit and Trump era it seems inflationary pressures are set to return.
The FCA has carried out behavioural testing and found that when shown the annual increase in income that a consumer could gain from purchasing an annuity on the open market, there was a 27 percentage point increase in the number of participants who went on to compare products from different providers.
The FCA has proposed that the new rules will come into force in September 2017. Surely this is a good thing?
Of course it is a good thing if people are encouraged to shop around for the best annuity because who would not want free money? The table below compares the best buys from the top annuity providers and the difference between the providers that actually publish their rates is significant, but if we were able to get the rates from those company who do not publish rates we would see that the difference between best and worst could be as much as 40 per cent.
Company
| Ages 55 / 50 | Ages 60 / 55 | Ages 65 / 60 | Ages 70 / 65 | Ages 75 / 70 |
Canada Life | £3,633 | £3,958 | £4,368 | £4,907 | £5,654 |
Hodge Life | £3,426 | £3,830 | £4,296 | £4,852 | £5,649 |
Aviva | £3,518 | £3,861 | £4,289 | £4,864 | £5,651 |
Retirement Advantage | £3,410 | £3,745 | £4,169 | £4,593 | £5,115 |
L&G | £3,338 | £3,575 | £4,117 | £4,633 | £5,541 |
(Gross annual income, £100,000, joint life 2/3rds, guaranteed 5 years and level payments.)
It is important to remember the published best buy tables normally only quote good health annuities for a standard postcode, but many annuities are arranged on enhanced terms and it is difficult to provide generic tables for these annuities because the rates are based on personalised information.
Before you go shopping you need to know what you are shopping for. I am like a record and have been repeating this message long before pension freedoms and it is even more relevant today.
My latest words of wisdom on the annuity market is that for most people there are two forces at work when they weigh up their options at retirement. First of all there are some technical factors including: the income from annuities, attitude to risk and value for money.
Secondly, there are a number of behavioral factors and these include: short term gratification or longer term prudence and income certainty or pension flexibility.
The best decisions are made when both behavioral and technical factors are taken into account in a balanced way. Poor decisions are made when there is an imbalance.
In the context of the annuities and the open market option, behaviorally people may think they are getting the best deal by shopping around, but technically they may be buying the wrong policy at the wrong time. It is obviously better if people shop around for the best annuity; someone can get the best annuity rate possible but this is of little use if the annuity is the wrong policy in the first place.
I can already hear some people with a vested interest saying ‘research shows that most people want guaranteed income and annuities are the only policy that can pay a guaranteed income for life’.
I do not disagree with this but I ask whether at current rates annuities are good value for money and if it is good long term planning to lock into guarantee annuities when the underlying interest rate is close to negative.
I can keep this simple. If we think of an annuity being like a mortgage in reverse in that the money used to purchase an annuity is paid back with interest over the lifetime of the annuitant. If the annuitant lives longer than expected they will benefit from the mortality cross subsidy but if they die before expected they will not have benefited.
The underlying interest is set at the outset and reflects the yield on long-term fixed interest investments. In September 2016 the yield on one of the benchmark gilts (15 years) fell to just over 1 per cent. This means that allowing for expenses, the underlying interest on annuities was at the lowest levels ever recorded in modern times.
Therefore, although I agree that it is important that risk averse investors should consider annuities they should also be told about the historically low annuity rates. Especially in the context that in 2017 it is likely that yields will rise if as expected, inflation will increase in the UK following the Brexit decision.
Again, keep it simple; there are three key decisions before an annuity purchased:
When is the right time to take income?
What is the most suitable option?
Which company is offering the best deal?
In my analysis, shopping around for the best annuity is the last step, but some firms promote this as the first step.
Without doubt, it is only right and proper that the FCA, and the industry does all it can to promote and increase awareness of the open market option. However, it is also important that more is done to make sure that people know what they are shopping for in the first place.
Annuities will continue to play an important part in retirement income planning but there must be more sophisticated approach as to how annuities are explained and used.
Billy Burrows is director of Retirement Intelligence
Key Points
George Osborne's 2014 speech on pension freedoms took a lot of hot air out of annuities
The FCA recommended a retirement income 'comparator'
The Open Mark Option should be the last thing people look at, not the first when selecting an annuity
