Pensions World

Will annuities be the next mis-selling scandal? asks Paul Evans, Capita Hartshead

There is concern that the current retirement arrangements of many defined contribution (DC) pension schemes conceal a ticking time bomb. When it explodes it could lead to a huge number of compensation claims being submitted.

The concern centres on members who are not being offered the opportunity to shop around to obtain the best retirement income based on their circumstances – known as the open market option (OMO). Although the number of claims being submitted to the Ombudsman is currently small, the indications are that those legal firms that specialise in mis-selling claims are starting to turn their attention to the retirement world.

Schemes at risk are those which are not providing a sufficient level of assistance to their members when arranging the purchase of an annuity on retirement. Currently the Pensions Regulator’s (TPR’s) regulations require that members, and their dependants, must be made aware of the OMO.

In addition, TPR’s good practice guidance states that a scheme should recognise and emphasise the advantages of obtaining financial advice; consider providing a service that offers members a competitive annuity and offer a process that takes account of different member situations.

When this was last assessed, TPR found that one third of schemes were in breach of retirement disclosure regulations and over half had some scope for improvement in the standards of retirement information sent to members. From a claim perspective, it has been argued that providing an explanation of the OMO but burying it in “small print” would not be sufficient. Many similar claims in other financial arenas have been upheld.

However, it is not all about pleasing TPR. There is a body of opinion that any claims which do not directly contravene TPR stipulations will, instead, be directed against the integral obligation for trustees to act in the best interests of the member.

Members must be clear

Annuities are not static; the market is constantly evolving. Specialist annuity providers have been at the forefront of developing more advanced underwriting systems which now allow individuals to obtain enhanced rates for over 1,500 medical conditions (including relatively minor conditions such as high blood pressure or high cholesterol).

Figures published by one such company show that over half of individuals of retirement age may now qualify for an increased income. For example, a ten a day smoker is likely to receive an extra 20% income over the best standard rates, while serious conditions which are likely to halve the member’s life expectancy could increase income by 60%!

Recent figures suggest that less than 10% of annuities currently being arranged include any such enhancements. It is imperative that trustees ensure that their members are clear on the potential benefits provided by this alternative.

Schemes have adopted a wide range of solutions in response to requirements. The use of the default pension provider’s offering or agreeing to arrange all annuities through a tied arrangement with one company still prevails. It can be argued that these members are not being offered a competitive pension. The rates offered by the main annuity providers on the open market currently vary by around 10% whereas pension providers’ in house rates are often a further 10–20% below these. In addition, most pension providers do not offer any form of increased rates for medical conditions or smokers. Where non-specialist providers do offer enhanced annuities, they can set stricter qualifying terms and consequently lower enhancements.

What can schemes do?

An increasing number of pension schemes are finding that using annuity brokers is the most effective way of meeting their requirements. This enables their members to be offered a full open market service, including access to specialist impaired providers in an efficient and cost effective manner.

Brokers often offer a range of services to match the varying requirements across schemes. These can include flexible payment terms, low cost service offering access to a panel of competitive providers, arranging annuities for funds of less than £5,000 and access to full financial advice for members with larger funds or suitable risk profiles.

Many brokers are also able to provide a range of supplementary services. This can include retirement seminars for members, telephone helplines for members purchasing annuities, consultancy services for retirement literature or regular retirement market updates for trustees. Such services can provide real benefits to both members and to trustees. As a result, members receive the opportunity to make the best choice for them and the trustees meet their regulatory requirements and can feel confident their members are receiving the help they need.
Many brokers work closely with both annuity providers and schemes to improve the annuity purchase process. Technical advances are being incorporated into the process to allow secure electronic transferral of information and payment of funds. These are leading to faster turnaround of information as well as leading to a greater range of cost effective options for trustees.

Regular review

As mentioned earlier, the retirement market is constantly evolving. Consequently it is essential that the selected retirement process is reviewed regularly to guarantee that any new market or regulatory developments are incorporated into current practices.

• It is also essential that the administrative processes employed by the scheme at retirement cover all the essentials, but do not confuse members or delay receipt of income. The scheme should consider such points as:

• Are the members expected to provide unnecessary/excessive information?
• At what stage should disinvestment of the underlying investments take place?
• Are the necessary communication channels in place between the scheme administrators/brokers/providers?
• Have all the necessary checks been made prior to payment (eg triviality, lifetime allowance etc.)?
• If the scheme pays tax free lump sums in advance, how will the scheme ensure members respond?
• Are default options in place if members do not respond?

Such assessment will ensure that the retirement process is smooth and efficient and will encourage members to feel positive about their pension.

Unintentional outcomes

Apathy and ignorance can easily derail a quality retirement process. Even if good practices are in place, if the member is not prepared for what will happen at retirement then unintentional outcomes may occur or essential points may fail to be considered. For the average member, even the most straightforward process can be confusing. There are more than 60 options to consider when choosing the pension basis alone. When you add on the possibility of medical/lifestyle enhancements, the decision on whether to take tax free cash or the need to think about how certain statutory requirements will effect what options are available, this can appear daunting.

Schemes are required to incorporate a “wake up” process to enable members to consider their retirement options in advance of arrangement. However, many trustees are not sure when this process should start and how best to engage members.

Most people start to think about what they will do after retirement many years in advance of the date they actually retire. Ideally it would be at this point that the member should be made aware that:

• they are entitled to use their pension to purchase an annuity on the open market
• there are potential tax benefits of taking tax free cash
• more income can be received by declaring their health/lifestyle situation
• alternatives are available if income will not be required at retirement.

The use of retirement seminars or literature specifically aimed at people thinking of retiring promotes consideration of the above issues, as well as encouraging them to consider any dependants, all retirement income sources (including any other pensions) and other important issues.

By following this approach members are prepared for when the retirement process commences and are more likely to make sound decisions. Consequently they will feel much happier about the final outcome.

Hopefully schemes will feel that they can assess their own potential liability. Trustees can act now to ensure that they protect themselves from any future compensation claims through a combination of diligence and taking advantage of the expertise that is available from the wide range of specialist assistance that is available.

Help is out there!

Paul Evans is an annuity consultant at Capita Hartshead Actuarial and Consultancy Services; paul.evans@capita.co.uk