Alan was becoming more and more confused, because the financial press seemed to be campaigning for changes to annuities and pointing out the poor value that they currently represented, just when he had been about to buy one.
He had read, with particular interest, about the idea of switchability of annuities and the possibility of enhanced rates due to health or other lifestyle factors.
Alan met with his financial adviser, Paul, and in preparation had sent him a list of the issues (as raised by one publication) for his comments.
Paul’s comments started with: “Well, Alan, I have looked at all these points and also your situation in the larger scheme of things and I am not sure that annuities are fit for purpose anymore. It is the background that has changed; when retirement lasted just a few years after age 65 an annuity was a good concept – it guaranteed you an income and even offered the possibility of a guarantee period.
“Now the statistics suggest that retirement can last for, on average, 19 years. If that is the case, the question is, why would you lock yourself into a fixed income rate early in that period when annuity rates are low and circumstances, personal and economic, might well change over that period?
“A lot of the points called for are self-explanatory and involve extra communication at the point of retirement, choice and more clarity around payments for what will be paid for ‘advice’ or ‘guidance’.
“As your adviser I will charge you for my time and implementation of any plan, but I can take into account all that we have gone through over the years and my knowledge of your family situation.
“Other websites might guide you in the right direction and that could be suitable, but what is not clear is the cost of commission paid by the providers to any third party.
“Anything that seeks to clarify the process and the terms offered has to be welcomed – there is something called the open market option which allows you to shop around for the best rate and a new directory to assist you in contacting companies that are in the market. In my view this is a difficult transaction to make without advice and understanding of the variables.
“The proposals that need a bit more work are the rules for small pots. Again this is a situation where circumstances have overtaken the rules.
“It would make sense to allow commutation of small pots, as many providers do not offer competitive terms for small pot values. If I remember correctly, the current commutation value is £18,000 and there is a strong argument to suggest increasing this amount to take even more uneconomical annuities out of the system.
“The idea of proving that an applicant has been offered a joint policy is as much to protect the annuity company as anything else, to cover up any misunderstanding in only setting up a single life policy. It will also show the difference in income levels between a single life income and a joint life income policy. Again, this is a decision that might need a wider consideration of family circumstances.
“The final point, namely underwriting each policy, is the one I have a bit of a problem with. There is a move towards enhanced annuity rates for individuals who have health or lifestyle factors and more and more enhanced rates are offered. The problem with this is that, ultimately, annuities are a pooled arrangement with a cross subsidy between those who die before their life expectancy and those who live longer. Underwriting takes out those with poor life expectancy and lessens the cross subsidy, such that the rate offered to those with fewer health issues will be lower.
“On the other side of the coin, is it right that standard annuity rates are offered to all - including those who would get enhanced rates but who do not understand the process?
“In effect, we either have pooling or we do not. If we move to individually underwritten terms then there will be winners and losers, as those with ‘healthy lives’ will get less than they would have under a pooled arrangement.
“So, in summary, some good points regarding communication but I am not sure that the switchability idea will get off the ground. There are some alternative options between annuities and income drawdown, such as fixed-term annuities and third way products using guarantees. However, the rates have not been particularly good and the costs of guarantees have historically been expensive.
“We do need some further work to make sure that the retirement income solutions we have are suitable for the changing face of retirement, and annuity purchase is one of them. We need to consider and improve both product and process!”
Mike Morrison
Head of Platform Technical
AJ Bell