This is why the annuity system is broken
There are two important reasons within the Financial Conduct Authority (FCA) study on the annuity market which explain why it is ‘not working’ for consumers.
Both have to do with money.
The first reason is that annuities sold to existing customers are more profitable to insurance companies than annuities sold to new customers; those who are exercising their open market option.
Call me a cynic, but this single fact explains why insurance companies lack the necessary motivation to fix a broken system.
Why would your pension provider properly encourage you to shop around for a better annuity rate when they will (all of them) make a lot more money from your inertia?
The second reason is that annuities sold to people at ordinary rates are more profitable to insurance companies than enhanced annuities sold to people with health problems.
This explains why people with health and medical conditions are still being sold unsuitable annuity products, missing out on enhanced rates that would give them a higher income in retirement.
As a result of these two factors, the FCA found that 80% of people who buy an annuity from their existing pension provider would be better off in retirement if they shopped around, exercised their open market option and obtained a better rate.
However, as we have explained many times before, making decisions about your retirement income is about so much more than simply shopping around.
Shopping around is one important step. It does not replace the need to consider the whole range of retirement income options, choosing the one most suitable for your personal goals and objectives.
This requires advice. Encouraging insurers to better encourage consumers to shop around is an important step, and will no doubt be an outcome from this FCA report, but what the regulator really needs to conclude is that advice is an essential part of the annuity process.
Without a bold step like this, consumers will continue making bad choices at retirement, hitting them directly in their wallets in later life.
Critics of the need for advice in the annuity market – typically the ‘stack em high, sell em cheap for loads of commission, online broker brigade’ – will claim that there is insufficient capacity to provide advice to people with smaller pension pots.
In which case, make advice the gold standard, the route that is strongly encouraged for all reaching retirement and needing to make lifelong decisions about their pension income options.
Any size pension fund is important when it comes to funding your lifestyle in retirement. Making the most of what you have worked so hard to build is something we should all aspire to.