Annuities for Pensioners

Alun Cairns Excerpts

Tuesday 7th January 2014 Westminster Hall

[Richard Graham (Gloucester) (Con)]

Today we are covering a subject that in many ways is both dull and important. “Annuity” is a difficult word, which lacks a simple definition, and it is not something that a man or woman under the age of 50 would wisely bring up in discussion with friends. However, 400,000 people this year will buy an annuity. That figure will grow substantially over the years, and anything that affects such a large percentage of our country’s population is therefore worthy of the first Westminster Hall debate in 2014. Annuities are dull, but important, and absolutely ripe for review and improvement. It is therefore timely that Mr Speaker has chosen the subject for the first Westminster Hall debate of the year, and it is a pleasure to participate in it under your chairmanship, Mr Dobbin.

I will first outline annuities and their market as it is at the moment, who buys them, for whom they are best and least suited, and whether we need them, before looking at specific issues raised by recent investigations and considering what more might be done to improve the world of annuities. Historically, pension structures have required individuals to bring certainty to our savings, effectively by exchanging whatever pool of savings we have for known income, by drawing an annuity or by having income draw-down—two technical terms already, which are perhaps better described as “income for life”. That is what an annuity was designed to deliver, and it is derived from a complex calculation that involves bond yields, longevity and charges. In due course, I will return to discuss the last especially.

The concept of an annuity is relatively simple: to provide older people with the certainty of knowing what their income will be in an otherwise uncertain world of costs and, perhaps, care. In a world of defined-benefit pensions, we had such certainty, but that world—outside the public sector—is going fast, so certainty of income is a bigger issue than it was, and in today’s world many people are searching for it. We might therefore imagine that an annuity is the product for today. As auto-enrolment expands, reaching about 8 million new pension savers, net of opt-outs, the number of new annuity customers will surely grow. It will be a slow burn, because most of those auto-enrolling over the next few years will not reach annuity-type age for some decades, but eventually the figure used in the media—the number of annuity customers doubling—will be reached. As a result, instead of more than 1,000 new customers a day in 2014, before long there will be 2,000 new buyers of annuities every day.

The annuities market will therefore soon have 500,000 customers a year, predominantly in their 60s and 70s, making what for most will be the second most important financial decision of their life—the first being their home. As Ros Altmann has pointed out, as things stand with an annuity, unlike buying a home, there is no going back: someone buys it and that’s it—no change, no transfer, no flexibility and no equivalent of renting out, moving on, selling or downsizing. An annuity therefore best suits customers who know exactly what they are looking for—because they are well versed in the language of annuities, such as open-market options, enhanced annuities or comparisons with income draw-downs—and perhaps already have a defined benefit pension and are looking to convert a smaller defined contribution pot, which is a modest percentage of their total savings.

Such customers use the comparison tables of the office of the Pensions Advisory Service, provided by the Money Advice Service. They shop around for alternatives offered by online and household-name providers. They know that they will keep the same wife, husband or partner for ever, that they will live long enough for the income draw-down to exceed the capital exchanged and the commission charges, and that, ideally, both partners will exceed the lifespan expectations of their current health and the geography of where they live—alternatively, perhaps they will buy their annuity in a poor city and thereafter move to an idyllic village where people live longer. Such a customer should do well in the current world of annuities. Unfortunately, he or she is as exotic and rare as a sacred ibis on the banks of the river Severn in my constituency.

[Alun Cairns (Vale of Glamorgan) (Con)]

I pay tribute to my hon. Friend for securing the debate and for the way in which he is presenting it. He rightly highlights the fact that the transaction is extremely complicated—that is exceptionally important—and he has used a range of phrases that are commonplace to financial advisers, but not necessarily understood by the clients. Does he accept that the retail distribution review, although perhaps painful in the short term, will deliver significant benefits over the longer term, but that the charging structure and the change in the culture might well put some people off seeking advice for annuities, thereby making this extremely complex transaction far more difficult for the average punter to decide on?

[Richard Graham]

My hon. Friend has spent a lot of time working in the sector and knows the issues well. He is absolutely right to highlight the unintended consequence of the retail distribution review, which in a sense is to put people off the idea of buying up-front advice on a complex product such as an annuity. For those who have a relatively small pot of savings, such as £20,000, £30,000 or £40,000—a lot of money for some people—the idea of paying £400 or £500 for advice is not attractive. My hon. Friend is right to highlight that, because it is one of the issues.

I drew attention to the perfect customer for an annuity; let me now give the other side of the coin. By contrast is the customer who is told by the provider of their direct contribution pension—his or her only modest source of savings—that they need an annuity, has no idea what an annuity is and asks the pensions provider what they can offer; who has no idea whether that offer is good, bad or indifferent, goes for the cheaper of the options available, probably leaving out any cover for his or her partner and certainly any provision for inflation, and forgets to mention perhaps a hereditary heart weakness; and who moves from a suburb to the inner city to be closer to shops and a hospital, lives for a few years and then dies, having drawn only a small percentage of income from a capital sum that has now disappeared, leaving their wife, husband or partner on the state pension. For what purpose did he or she save?

With longevity the way it is, we might argue that such a customer scarcely exists, as we would all hope, but the reality is that some of his or her characteristics are a reality—as the Pensions Advisory Service has confirmed—especially in the understanding of what they are buying. Ros Altmann has estimated that insurers will often keep between half and three quarters of a pension fund they take over and convert it into an annuity.

I did a quick reality check on the word “annuity” in a Gloucester pub last weekend. Of the 22 people I asked, six said it was a financial thing like a pension, one of those said it gave income and most of the rest said they had no idea. I accept that it was a bad weekend for Gloucester rugby, and trying to discuss annuities in a pub was pushing my luck, but I do not believe that the people of Britain know what an annuity is or that the average response would be any different. Why is an annuity useful? Do people have to have one? The answer is no. How do they go about getting one? An annuity is potentially the second biggest financial purchase of our lives, so the current state of information about them is worrying.

In any market that size—£12 billion a year is big—if a customer feels that he or she has to buy something but does not really know what it is, the definition of good value is elusive. Customers need a lot of knowledge to pick the right product and the market is dominated by a handful of big names, so there is a danger of high charges, a lack of transparency and inadequate protection. The annuities market more than lives up to all those risks. I rang the Pensions Advisory Service yesterday to get some initial advice—just one man in his 50s ringing in to ask questions about annuities. I got good general advice on a whole number of issues, but when I asked about charges, I was told confidently, “You will never be able to work out what the charges are.” I asked the helpful adviser whether he thought that was right. “Not for me to say,” he replied, which was fair enough. However, it is right for hon. Members to raise and challenge the situation on behalf of our constituents, who ought to know what they are being charged for a product as important as an annuity.

Almost 20,000 of my constituents in Gloucester are between 50 and 64. For all of those people, some understanding of annuities would be useful. It is not good enough to have a product for which people will simply never know the charges. The situation for annuities sits oddly beside that for their stepbrother or sister, the pension. Huge efforts are being made to clarify, and make as simple as possible, all the costs and charges for pensions; to estimate a management fee that is neither rapacious nor drives investment managers to the lowest common denominator; and, above all, to make charges transparent to the client. The status quo is tantamount to an insurance firm—everyone is under the same roof, in the same organisation—saying, “Right, over here is a team of investment managers managing pensions: you need to be squeaky clean, work out all the costs and charges and report them completely. Your margins will be tight. Over here, in this corner, we have the annuities guys: your pricing is roughly what you want it to be, and there is no need to explain or declare anything.” That has to be wrong. When such efforts are being made to ensure transparency about money coming into a pension, it is especially strange that, at the moment, the system does so little for moneys coming out of a pension and into an annuity.

For today’s debate, we have the benefit of the detailed investigations by the Financial Conduct Authority’s consumer panel and The Daily Telegraph. The latter found that differences between annuities offered amounted to as much as £1,444 a year on a pot of £100,000. The FCA’s consumer panel found that commission charges vary by up to £1,000, which might, for the cynical, explain why the industry is so shy when it comes to explaining what the charges are.

The FCA found in general that the industry was “very dysfunctional”, with “possible exploitative pricing”—up to 6% of a customer’s pot could go in commission. In a rebuke to any of us who thought that the answer might simply be to provide more information, the consumer panel found that customers are put off by the mountain of jargon and “information overload”. Frankly, I am irresistibly reminded of the endowment mortgage I was obliged to buy in the 1980s: however it was explained, it was absolute gobbledegook, and there were high commissions, often from one insurer to another. The consumer panel found that 3.5% commission for an introduction from Zurich to Legal & General seemed to be the going rate for annuities today. In the 1980s, if someone wanted to buy a house, they had to have an endowment mortgage. Later on, of course, the fabulous projected investment returns did not materialise, the mis-selling was investigated, fines were levied, the product was binned and the financial sector moved on. Will we see a repeat of that?

I chaired a seminar recently on annuities and asked the Association of British Insurers whether there was a danger of any of its members being sued for mis-selling. There was a long pause before the answer came: “Not yet.” It is therefore not surprising that the FCA consumer panel has recommended urgent regulatory and Government-led reforms to protect and benefit millions of our constituents.

I will turn now to what changes have already been made, and then move on to what could or perhaps should be done next. I start by recognising what the Government have already done. Some of the changes made by the Treasury should have been made a decade ago. For example, it has removed the default retirement age and the effective requirement to purchase an annuity by the age of 75. That is a vital change: it means people no longer have to buy an annuity, and, if they do not, they can take 25% of their savings tax-free and draw an income from the rest. That is a serious option for many people. The starting point of a debate on annuities for every individual should always be whether an annuity will be useful and helpful to them, and what the alternatives are.

There have also been changes to the capped draw-down rules—more jargon, I am afraid, but those rules have been reformed, and that matters within the sector. The Treasury has also encouraged the ABI’s new code of conduct for retirement choices, which has come into play and has made modest steps forward on explanations and general advice, but I do not believe that that is enough. At the same time, the Department for Work and Pensions has promoted open market options and obliged DC schemes to provide what it calls a “wake-up pack” of information, pre-retirement.