The National Association of Pension Funds (NAPF) and the Pensions Institute (PI) at Cass Business School published a joint report early in 2012, suggesting that around half a million people retiring each year are being short-changed by up to £1bn from their total future pension income, because overwhelming obstacles stop them getting the best deal within the annuity market.
The report describes millions of private sector workers as saving for their retirement, whilst being stuck with a hugely unfair, opaque and bewildering annuity system. Worse still, it highlighted evidence of sharp practice and murky pricing in the annuity market putting unsuspecting consumers at a huge disadvantage. The £1bn loss could treble in size to £3bn over the next decade as the annuity market matures and as up to 8m people start being automatically enrolled into workplace pensions from 2012. Around 20% of these losses are passed on to the public in the form of lost taxes and higher means-tested retirement benefits.
When they retire, people in the private sector saving in a ‘defined contribution’ pension (now the most common form of company pension scheme) use their pension pot to buy a product called an annuity from an insurer. This gives them a regular income and is a one-off, irreversible decision that sets the size of their pension for the rest of their life. The process for choosing an annuity is a complex one and the majority still go for the ‘default’ option by sticking with their pension scheme provider. This failure to shop around for a better deal can wipe 30% off their annual pension income, and in some cases up to 50%.
The NAPF/PI report found that it is too difficult for savers to get the best deal when:
• 80% of savers have pots of less than £50,000, and most annuity advisers will not find it profitable enough to advise on pots of this size;
• Fewer than one in five people have the financial know-how needed to pick the right annuity at the best price;
• Those savvy enough to ‘shop around’ for the best rate struggle to do so because the best shops are not signposted;
• People get too little support from employers or providers when making a decision about their annuity.
The report, partly based on extensive interviews with companies that cover 80% of the annuity market, also discovered that in practice, annuity prices can be heavily manipulated:
• There is a severe lack of transparency and understanding about how annuities are priced, especially for those with medical conditions who could qualify for a much higher level of pension income;
• Annuity advisers say some insurers push rates downwards at certain pot sizes when they see a group of people approaching retirement, as they expect many will not look for a better deal and will accept the insurer’s first quote;
• Annuity rate bands can have ‘cliff-edges’ which mean that rates outside of the commonly quoted £50,000 and £100,000 benchmarks suddenly drop off and become much worse, penalising customers who could get a better rate by having as little as £1 more in their pot;
• Most savers pay commission when they buy an annuity. It is factored into the annuity rates of most providers – whether the saver gets advice on annuity choice or not!