The burden of making consumers aware of the risks of selling on their annuity will fall squarely on the industry’s shoulders, despite a £960 million government windfall
The government knows that selling on an annuity will be the wrong decision for the vast majority of people. Indeed, the FCA has said as much in all its consultation documents ahead of the new rules coming into force in April 2017.
The latest document reads: “We believe that there is a significant risk of poor outcomes for consumers in the secondary annuity market. Annuities are inherently difficult for consumers to value, and consumers who will be able to participate in this market will include a higher proportion of older, more vulnerable consumers.”
As a result of these changes, the government has estimated that it will gain £960million in revenue over the next two years. While a revenue loss is also expected in the following two years that still leaves a net gain to the Chancellor of £665million throughout the remaining term of this government.
This is potentially a double win for the government”
Tom McPhail, head of retirement policy at Hargreaves Lansdown, commented: “This is potentially a double win for the government, giving annuity holders the chance to exercise more control over their savings, and raising extra revenue in the process.
“There are still unanswered questions around the regulation of the market and how consumer protection could work; we need to make sure investors don’t end up getting ripped off by their insurance company, for some of them possibly not for the first time.”
A risky business
The risks facing consumers are many and varied, but FCA highlights seven main areas of concern:
1) Longevity risk– a consumer selling an annuity income is giving up some or all of their income and insurance against longevity risk, depending on the other income (including other annuities) they have. They may therefore face an increased risk of running out of money in retirement
2) Value for money– some consumers may struggle to value their annuity incomes in respect of the benefits being forgone. Consumers will need to be helped in making an informed choice about whether to sell, and at what price
3) Consumer inertia– if consumers do not shop around they may not find the best price for their annuity income
4) Vulnerability– there is a higher incidence of reduced mental capacity among potential annuity income sellers. Individuals who have debts may come under pressure to sell their annuity income in order to pay off those debts, although this may not be in their best interests. Sellers who are, or may become, reliant on means tested benefits may also be vulnerable
5) Potential conflicts of interest– conflicts of interest exist that have the potential to cause detriment to sellers. For example, in respect of relationships between brokers and buyers
6) Potential risk of investment scams and fraud
7) Market depth– it is impossible to know in advance how many buyers will seek to participate in the secondary annuity market. If insufficient buyers participate, this may reduce the price offered to consumers for their annuity income
The document also highlights the risk that consumers could face a hefty tax bill if they cash an annuity in for a lump sum.
To try and mitigate these risks, the FCA has proposed that any firm interacting with someone wishing to sell their annuity must provide risk warnings.
It will be incumbent on companies that wish to buy a second-hand annuity to ensure risk warnings have been provided and advice has been taken (where the annuity value is over a threshold yet to be determined).
The industry is going to have to handle the majority of the administration”
Meanwhile, the FCA is proposing a rule requiring annuity providers to make reasonable efforts to receive consent from contingent beneficiaries who could have an entitlement under the annuity contract before they facilitate assignment or buy back.
The industry will also need to come up with a reliable way of knowing when the annuitant dies and annuity payments should stop, which at present doesn’t exist.
Costly for consumers
And while the industry is going to have to handle the majority of the administration involved, consumers seem likely to bear the associated costs.
Any brokers will need to follow a similar system to advisers in a post-RDR world where costs are incurred from the individual not the buyer. Consumers may also have to face significant costs associated with medical evaluations, transactions and more.
Consumers will be made aware of this as all quotes made for a seller’s annuity income will have to be presented net of the estimated forthcoming costs where possible. The FCA is proposing that this will be accompanied by a quote of the replacement cost of the annuity income were it to be bought new on the open market.
Consumers seem likely to bear the associated costs”
Again – the responsibility for ensuring that consumers will have this information will fall on the industry’s shoulders.
And all of this to provide freedom - that the consumer pays for; choice – that the industry administers; and an entirely coincidental new source of revenue for the government.
Admittedly, the government has agreed that Pension Wise will be extended to cover annuity resale for both proposed sellers and their contingent beneficiaries. Although with the FCA recently announcing that Pension Wise’s budget is likely to be cut by 27% and the proposed merger of TPAS, MAS and Pension Wise it is not clear how successful this operation will be.
An optimist might argue that the government’s decision to carry on with a second-hand annuity market, regardless of the risks and the administrative headaches, is all part of the ongoing ‘freedom and choice’ agenda. And they might be right.
However, it’s hard for a cynic to overlook the £665million flowing into the Treasury’s coffers over the next four years. Hopefully the price for consumers and the industry won’t be nearly as steep.