 By Kim Durniat, Partner, Barnett Waddingham
The Budget delivered one of the biggest reforms to pension taxation since 1921. Something most were not expecting! At present retirees are all but forced into purchasing an annuity, with the alternative being a hefty tax bill. Once the new rules come into effect pensioners can do whatever they want with their money from the moment they turn 55, and pay tax on the income they draw down at the marginal rate.
There will be no requirement to turn any savings into regular income via an annuity. The change is drastic, but what inspired it?
The FCA’s Thematic Review
Annuities tend to be the second biggest purchase in an average person’s life, after their house. But despite numerous initiatives to encourage consumers to shop around, a large proportion of retirees fail to do so. Realising this, the FCA set out to research just how much consumers were missing out on, and why.
Published in February, the FCA’s thematic review highlighted that 60% of retirees purchase an annuity from their existing provider or through a third-party arrangement; of whom 80% could have got a better deal from elsewhere, increasing their income by £67 a year. Whilst that may not seem like much on an individual level, annuitants across the UK are missing out on up to a total of up to £11m each year.
These figures, and a number of other key findings about insurer behaviour, confirmed the FCA’s opinion: the annuity market is not working well for consumers. It is easy to see how these damning findings prompted the recent shake-up of pensions taxation. The thematic review characterised the market as ‘disorderly’, a word echoed in George Osbourne’s Budget speech. Published alongside the Budget, the Treasury’s consultation document Freedom and choice in pensions comprehensively sets out the proposed changes. It points to the FCA’s findings as evidence that the annuity market lacks competition and consumers are disengaged with their savings even at the point of retirement. In this document the government also calls for views on its proposed changes to reforming the tax framework and supporting consumers in making retirement choices.
Impact on the annuity market
Pensions Minister Steve Webb said the state wouldn’t care how people used their pension pot, even if they blew it all on a silver consumer splurge: perhaps in the future an Italian sports car will be the second biggest purchase in an average person’s life.
There will certainly be some retirees who will enjoy spending fast, just as there will be those who value the security offered by an annuity. But there is a whole spectrum of potential in between, and by offering alternatives the government has ensured that fewer people will purchase annuities. This new realm of choice can only be a good thing for consumers, but it carries with it a degree of selection risk as insurers may find that those purchasing annuities in the future are those with the longest life expectancies, and be forced to increase premiums as a result. The most prudent of retirees may therefore be facing a hit in retirement income.
What about the insurers?
In the few hours following the Budget speech around £4.4bn was wiped from the value of the UK’s largest life insurers as the markets realised that a major business line had suddenly been pared down. Those affected include a number offering medically underwritten annuities whereby those in ill-health may be considered for an increased annuity income on the grounds that they will not be receiving it for as long. These companies now face the stark reality that their main customers – those who have shorter life expectancies – are those least likely to want an annuity. Those focusing primarily, or indeed wholly, on medical underwriting still have the advantage of many years of mortality data for impaired lives, and may be reassured that some ill-health retirees would value the security an annuity provides against the “risk” of them getting healthier.
In the wake of these changes the government expects that a number of new products will be created, allowing consumers to “mix and match” those products that work for them, rather than be forced into a one-size-fits-all annuity. Whilst the naysayers are of the opinion changes will damage the annuity market irreparably, this offers a chance for real competition and innovation as insurers now have to provide consumers with something they want instead of something they are forced to buy.
What next for the FCA?
For the rest of 2014 the FCA has a considerable amount of thematic work and market studies planned which relate to the insurance market, including the fair treatment of long-standing customers in life insurance (which has already received a lot of media attention recently), a post-implementation review of the Retail Distribution Review, and numerous general insurance studies on insurance add-ons, motor legal expenses insurance, and mobile phone insurance. The thematic review of annuities is one of the first carried out by the FCA and if we are to take the governments reaction to it as an indication of the FCA’s influence there may be some more surprises in store.
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