Annuities for Pensioners

David Mowat Excerpts

Tuesday 7th January 2014 Westminster Hall

[David Mowat (Warrington South) (Con)]

I congratulate my hon. Friend the Member for Gloucester (Richard Graham) on securing the debate and on his chairmanship of the all-party parliamentary group on pensions, which has aired these issues on a number of occasions.

Over the lifetime of this Parliament, we have discussed the pensions industry a number of times. To date, the discussion has mostly been of the accumulation part and not, to use the jargon, the decumulation part, which we will talk about today. However, the issues are similar. I am a little less sanguine than some hon. Members who have spoken about the fact that we have fixed the transparency problems in the accumulation part of the industry—I believe we have not started to do so yet. The same problems of market failure, asymmetric knowledge and lack of transparency exist in the industry. Whether hon. Members represent the party of the cost of living or the party of hard-working people—Conservatives seem to have won in terms of numbers, at least in today’s debate—the issue really matters.

The fact that annuities are talked about so little compared with, say, energy prices, is a function of the point my hon. Friend has made. People understand annuities so little—annuities take people outside their comfort zones. That is a terrible thing when 400,000 people a year sign up for such products. This morning, during the time of the debate, 250 people will have signed up for an annuity. By lunchtime, a constituent of every Member in the Chamber will have signed up for an annuity. Approximately a third of them will have bought the wrong product within the market, even by the terms of the market. In my opinion, the market is inappropriate and a great disincentive for people to be part of the pensions industry. It is one of the reasons why so many people who should be investing in pensions would rather bite their arm off than get involved in either the accumulation or decumulation part of the industry.

Let us step back and think about the structure of the industry, because my solution responds a bit to that. It is an artificial industry, fed by tax relief. We have made the decision in the UK to have a pensions industry that is predicated on the relatively low basic state pension—it is low compared with the rest of Europe—but one that is supplemented by tax relief and private sector provision, of which the annuity is one of the final products. The tax relief that we pump into the industry is about £30 billion a year, which clearly behoves the Government to get involved. With auto-enrolment, that urgency is becoming much greater. It is not acceptable for us to leave it as an industry that has failed, on any measure, at any time when it has been looked at. It is reasonable that the Government get involved.

There are two parts to the failure. The one that gets most attention is the failure of people to shop around—the open market option—notwithstanding the progress that the ABI has made with its code of conduct. It is in that context that one third of people are currently making the wrong choices. However, that is not the only aspect of the failure. The industry is not subject to the market pressures that would cause better performance. Within the context of the industry, one third of people are choosing wrongly, but the whole industry is failing to provide products that are competitively priced and transparent.

The industry has fairly viciously applied the term “caveat emptor”. It is playing it long, because it is only a matter of time before a Conservative Government or a Labour Government take the matter more seriously and start to fix things. In discussions of energy companies, in which I have also been involved, it has been said that they operate a cartel. I do not like to use words such as “cartel” lightly, but we have to look at the return on capital employed in industries and at transparency. Anybody who compares the pensions industry with the energy industry will know where the evidence of a cartel, such as it is, exists.

The National Association of Pension Funds and Cass business school report estimated that about £1 billion a year was being misappropriated, or at least was not going to the pension holder, because about one third of people buy the incorrect product. We could fix that through the application of the OMO—more attempts to make the market transparent—but the view I took as I was doing research for the debate is that that is not actually the solution for annuities market. The solution is that the Government should offer annuities. People will say, “You want to nationalise the industry.” I do not want to nationalise the industry—I am a free marketeer. I was about to say that I am as much of a free marketeer as anyone in the debate, but then I saw my hon. Friend the Member for Wycombe (Steve Baker), who possibly would challenge that. However, I really do believe in the free market. I believe that the free market is a panacea and a great mechanism for allocation of capital and all that goes with that, but the annuities market is not working. When a market does not work, particularly a market that is at the centre of Government policy on retirement and incomes in old age, and all that goes with that, it is reasonable that we look at what we might do about it.

Our national savings organisation in Glasgow offers interest rates as the Government sell gilts. I see no reason why an organisation like that cannot offer annuities in the same way. It is basically a very simple product. Because of the interest of the industry in developing the asymmetry and all that goes with it, the product has been overly complicated.

[Sheila Gilmore (Edinburgh East) (Lab)]

I apologise for missing the initial part of the debate because I was in a Select Committee.

The market is not completely free. The Government have already intervened to say that people should be contributing to pensions. People do not have a choice or increasingly will not have a choice not to take part. The Government have a responsibility to the people they have placed in that position.

[David Mowat]

That is absolutely the point that I am making. It is not a free market, and it behoves Government to do more than they have done so far to get it right.

One approach is to try to make the market work better—that was the subject of some of the points that have been made already. The other way of dealing with it is more dramatic. I believe it is reasonable that the Government think very hard and seriously about providing products that would compete in the market with the industry guys, because, in any event, the principal thing that annuity providers do is match Government bonds. One reason why QE has been an issue is that the industry is buying Government bonds in order to match income and liability. It is a classic middleman thing. It is entirely reasonable for the Government—a Government of either complexion—to look long and hard at that suggestion. I believe that will happen, because we cannot continue with the market abuse that has occurred over the past two decades.

[Richard Graham]

My hon. Friend makes an interesting point on which we will no doubt hear more from the Opposition spokesman, the hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East (Gregg McClymont). Does my hon. Friend really believe that nationalisation of the annuities sector is in the overall interest of large numbers of taxpayers, who will in effect see the risk for their product transferred to them?

[David Mowat]

The point that has been made, I think, is that that risk is currently with the annuity providers; that seems to be the implications of that point. If that is my hon. Friend’s belief, it would be reasonable to say that their profits should be transparent, understood and not abusive.

[Richard Graham]

Does my hon. Friend not see that that is precisely the argument for reform? The case I have made is that the opportunity is there. The initial research by the consumer panel provides enough light to justify a more detailed investigation, which is happening. The Government can then make decisions to reform the industry. The mortgage sector was reformed, but the Government are not providing the country’s mortgages.

[David Mowat]

My hon. Friend is right that the Government do not provide mortgages, but they do provide people with interest rate products. There is an analogy with annuities, which are an extremely important transaction. In any event, the industry is an artificial one, because it is driven, as I have said, by tax relief. Annuities are not optional—we can draw down, but, broadly speaking, until very recently, everybody has had to buy an annuity.

By the way, I did not advocate nationalisation. I am advocating that the Government offer a product. They can compete with the existing market, rather like the National Employment Savings Trust competes with the existing market. That is not nationalisation. If the existing market is pricing things in a certain way and making very clever decisions on longevity and actuarial things and so on, it will win, and so be it; good luck to it. However, I suspect that that may not be the case. We must bring trust back. I agree that it is important to make the market work. I floated the point about national insurance because I think that that proposal will have to happen, but I also think that there are a number of things we could do to make the market work better.

[Mr Hoban]

One objective of the FCA is to promote competition. It is currently undertaking a thematic review of the annuities market. That would be a very good starting point for it to undertake a market study to look at the economics of the annuity industry, to see whether it is making excessive profits, and to understand the charging structures in order to help to inform what the next stage of the reforms of the annuity market should be.

[David Mowat]

I have absolutely no problem with any of that. In fact, the next point in my notes is on the Office of Fair Trading. We should try to make the annuities market work better, in the same way as we should make the accumulation market work better. The fact that NEST has been introduced is not a reason not to have that happen. My proposal on the Government offering annuities alongside the market is not a reason not to make the market work better.

The point was made earlier on education in the market, the retail distribution review and all the rest of it. I do not agree that the charging structure is a disincentive, if that was the point made by my hon. Friend the Member for Vale of Glamorgan (Alun Cairns), who has left the Chamber. It might be a disincentive, but it is no worse than a charging structure that pays people to recommend products based on commission and all that that means. That is not a solution in its own right, but I agree that we should try to make the market work better. We should hold the ABI to account on the application of the OMO.

We could try other things. If one third of people continue to stay with their existing supplier and buy inappropriate products as a consequence, there is a case for enforced separation, meaning that people buy the decumulation product from a different provider from the one from which they buy the accumulation product. That is entirely reasonable if the OMO code of conduct does not work better—it is currently rather patchy.

Another thing we could do to make the market work better is enforce the simplification of annuities, exactly as we have done in the energy industry, with bands to allow the comparison of products from different providers. The case for that is even stronger in the pensions industry than in the energy industry. I want recognition that draw-down might be used on smaller pots than at present, so that it receives wider application. When I speak to anybody who is about to make a decision on whether to use an annuity or a draw-down, I recommend that they think long and hard before they go down the annuity route. We could do more on that.

We need to make the market work better. The point I made about national insurance also applies to accumulation. NEST is working quite well, and it will be an incentive for reform in the industry. We could do the same with the decumulation part of the industry.

I have a couple of final points. It is interesting that a Treasury Minister is replying to the debate and a pensions spokesman is speaking for the Opposition. In a way, the issue has suffered because it has not wholly been owned by either Department and has tended to fall between the two. I hope that that does not continue. I also hope that people in the industry listen to the debate—I see that a couple of them are in the Public Gallery—because it is not right for the current situation to continue. It is not right that the industry response is to play it long. In the time I have been speaking, 40 people will have signed up for annuities, 15 of whom will have bought the wrong ones. We owe it to all our constituents to get that fixed.

--- Later in debate ---

[David Mowat]

Since we are discussing the point I made, I feel I should chip in. Of course it was about participation. Two of my hon. Friends have made points about risk. The state already carries risk of inadequate pension provision, which is manifested daily. To talk about further risk in that context is disingenuous.

[Gregg McClymont]

That is clearly a matter for Conservative Members to debate among themselves after we leave the Chamber.

We face a broken market; the question is what to do about it. It seems to the Opposition that the way forward is increasingly to involve pension schemes in—I am wary about using this term, as I try not to use the jargon—“decumulation”. Pension schemes are involved in building up savings pots for members. They should also be involved in turning those savings pots into retirement income, which is what the process is all about, after all. Moving to a system in which pension schemes ensured that their members got decent, well regulated brokerage advice would mean bigger pension schemes, because many very small pension schemes do not now have the ability.

We have mentioned NEST. What does it do about annuities? It has sealed panel bids from annuity providers for each cohort coming to retirement. That is not the whole of the market, because NEST must annuitise for people with very small pots, as part of its public service objective, but that is the road we must go down. The Royal Mail pension scheme is another one that recently announced that it would provide an in-house brokerage service for its members.

The hon. Member for Gloucester was absolutely right in his analysis of the market. The problem—it is not his problem; he is an august Back Bencher, but not on the ministerial team—is that so far the pensions Minister and, I assume, the Treasury have not come up with anything concrete. Until they do, the hundreds of people who are annuitising as we speak and the 400,000 people who annuitise every year will surely look at the Government and ask when they will end the rip-off and the excess profits. If the pensions Minister says that insurance companies are profiting excessively from annuities, when will the Government act? Surely it must be sooner rather than later.

I make this point again to the Government, in the hope that they might listen. Any solution that depends solely on increasing individual consumers’ engagement in the process of buying an annuity will not succeed. The whole thrust of Government pensions policy since Turner, which this Government have continued, is that inertia is a reality that we must make work in the public interest, rather than in the interests of pension company shareholders. That has been the thrust of pensions policy for a decade now. Any solution to the annuities market dysfunction must start from that assumption. In the spirit of the Turner consensus and co-operation on auto-enrolment, I urge the Government to take heed of that reality in the annuities market.

--- Later in debate ---

[Mr Gauke]

The hon. Gentleman raises an important point. It must be right that we should do all that we can to ensure as much transparency for consumers as possible. That includes a number of aspects, some of which I have mentioned. Let me go further.

The code and other measures will only be as successful as the outcomes that they prompt. We want clear evidence that more people are making active, better choices about their retirement income as a result of the changes. If we do not, we will not hesitate to consider further action. In addition to the ongoing work to help consumers make better choices, the FCA is currently conducting a thematic review of the annuities market and how well it is working to serve consumers’ interests, a pricing survey of all annuity providers and a comparison of the rates available to consumers through a range of distribution channels. The review will consider whether firms create barriers that can restrict consumers from shopping around, and what risks and potential for detriment those barriers may present for consumers. I look forward to the report’s initial findings, which will be published next month.

Although it is imperative that the annuity market works in the consumer’s interests as an effective option for retirement income, it is important to consider the retirement income market as a whole to ensure that consumers have income flexibility in retirement. To increase flexibility, the Government have removed both the default retirement age and the effective requirement to purchase an annuity by age 75. Whether they annuitise or not, individuals are permitted to take 25% of their accumulated pension savings as a tax-free lump sum before going on to secure an income with the remaining savings. To ensure that that income can best serve retirees’ needs, the Government have reformed the capped draw-down rules and raised the annual withdrawal limit from 100% to 120% of the value of an equivalent annuity. That can help to raise the retirement incomes of individuals in draw-down arrangements who may recently have experienced reductions in income due to wider economic conditions.

There is additional flexibility for those with a guaranteed income of at least £20,000 a year. With income already secured, they have the option of a flexible draw-down arrangement, in which they can withdraw any amount from their pension pot. Those coming to retirement will benefit from having more flexibility in deciding how to provide an income for themselves in retirement, and for those with small pension pots, the Government have taken steps to reform the trivial commutation pensions tax rules. An individual who is aged 60 or over with total pension savings of less than £18,000 can withdraw the entirety of their savings as a lump sum. The first 25% of that lump sum is normally tax-free, with the remainder taxable as income. In addition, small occupational pension pots under £2,000, and up to two small personal pension pots under £2,000, can be taken as a lump sum for those aged 60 or over, even when people have savings in excess of the aggregate limit. All those options add flexibility.

Having a decent retirement income is driven by two factors: saving enough for retirement through working life, and making good choices at retirement to secure a reliable and maintainable income throughout retirement. It is important to remember that the biggest determinant of how much income someone receives in retirement is how much they have saved during their working life. With the introduction of auto-enrolment, the Government have taken a huge step forward towards ensuring that consumers start to save for their retirement and carry on saving throughout their working life. Auto-enrolment is the most important pensions change for a century—around 6 million to 9 million people will make new savings and increase savings for their retirement. It is estimated that that will generate around £11 billion in extra pension saving by 2020, which will mean an extra £11 billion coming to the retirement income market within the next six years and a new wave of retirees with robust defined contribution pension pots, making it all the more important that we ensure that the retirement income market is working effectively.

The Government are also acting to protect those valuable savings. We recently consulted on proposals to cap pension charges and introduce a range of transparency measures as a means of ensuring that savings are not eroded by charges. We are currently assessing the responses to the consultation and an announcement will be made when that work is completed.

[David Mowat]

The Minister is right that the Government are consulting on pension charges. I have two questions for him. First, have the Government given any thought to annuity charges and to capping them? Secondly, approximately what level of charge does he believe is reasonable on an annuity of £100,000 during the lifetime of that annuity?

[Mr Gauke]

I suspect that my hon. Friend will not be surprised to learn that I am not inclined to be drawn into specifying what I believe is a reasonable charge for an annuity. What I will say to him—I will expand on this in a moment—is that we want to ensure that the annuities market works. We want to ensure that there are competitive pressures in that market. In the light of the consultation that we have undertaken on pension charges, the work undertaken by the FCA and the analysis of the evidence that has already emerged on the ABI code of conduct and so on, we want to ensure that the spotlight remains on the market, so that we do everything we can to ensure that it works effectively for consumers.

We are committed to ensuring that consumers have access to retirement income options that provide a reliable and decent income throughout retirement. That is an agenda to which ministerial colleagues in the Treasury and the Department for Work and Pensions and I are committed. We are working together to ensure that consumers have appropriate options, value for money and support when they come to turn their hard-earned pension savings into a retirement income. As the Minister of State, Department for Work and Pensions, my hon. Friend the Member for Thornbury and Yate (Steve Webb), who has responsibility for pensions, has recently suggested,reforms will be considered in the context of that work. That is why the Treasury and the DWP are currently considering the broad range of research and evidence on decumulation and how the market is working—to explore the impacts and interactions between market and consumer behaviour and Government policy.

I thank my hon. Friend the Member for Gloucester for securing and opening this debate. It has allowed us to discuss important annuities issues that are crucial for consumers if they are to secure the best from their savings at retirement.