The great annuity scandal

September 22, 2009

stevehunt- Steve Hunt is Managing Director of independent annuities broker Rockingham Retirement. The opinions expressed are his own. -

The concept of an annuity has not changed in hundreds of years. In fact the first annuities sold were probably during Roman times where ‘annua’ were sold for a fixed period or for life; but today’s mortality is unprecedented in history. An annuity was never designed to be paid over 30 years, or even 20 years for that matter.

What concerns me a great deal is the number of people who are going to be living in poverty in 10 years’ time because they have bought an annuity. Or the number of widows forced into poverty because their husband had bought a single life annuity.

Let me explain why. Inflation may not be a problem now, and who knows when it will return, but return it will – that is a given. The vast majority of annuity sales are level (and a great many single life). At just 3% inflation an annuity paying £500 a month in 10 years will reduce to £370 a month and at 5% inflation to just over £300 a month. And God forbid we get back to good old 1975 when it hit 24%. Mind you, 24% inflation would significantly help the government’s debt problem! Now there’s a thought.

With so many final salary schemes now closing, the de-accumulation risk of retirement is also being passed to the members themselves who are ill equipped to make the right or indeed informed decisions; in fact, I am not sure many Trustees themselves are.

Decisions made on de-accumulation may be the most important decisions in someone’s entire life and once made are usually totally irrevocable if a whole of life annuity is purchased. It’s like taking out a 30 year mortgage which can not be changed in any way for the entire 30 year term!

The current retirement income process is scandalous and needs to be changed – and quickly; what is currently allowed to happen really beggars belief.

Imagine a high street bank, let’s say Barclays, has a customer, Mr Harris, who has had a savings account with them for 30 years. Now Mr Harris has just had his 65th Birthday and Barclays told Mr Harris that he needs to take his money out and buy an income but Mr Harris does not reply to Barclays for one reason or another so Barclays buys one of their own products, which they know is poor value, and what’s more Mr Harris is stuck with for the rest of his life. Oh and Barclays pay themselves a commission as well for selling themselves the business.

Believe it or not this is currently happening in the Life Insurance industry. Someone can save their entire working life with an insurance company and when they retire, if they do not shop around their company will buy one of their own products for them; one which may be totally unsuitable – and then pay themselves a commission!

This should not be allowed to happen and because it does, millions of people are going to be worse off in retirement. Fact.

The alternative is something called an Open Market Option or OMO. The OMO should be compulsory. An insurance company should NOT be allowed to sell someone their own inferior product. The OMO should become the default option, period.

This is a disaster waiting to happen. It is only a matter of time before someone stands up and says ‘I have been mis-sold this product’. Insurance providers do not believe they have been mis-selling annuities; but then they did not think they mis-sold personal pensions in the 1990’s either.

Let’s consider a hypothetical Mr Smith who worked all his life as a factory worker; who made sacrifices and enforced sacrifices on his wife and family to save for his pension with Winstones Life Insurance Company. He is sent his options at age 65 and, not really knowing what to do, defaults into their standard level single life annuity.

Mr Smith is not in good health – he smoked all his life and had a good social life at the club and had high blood pressure and mild diabetes.

Seven years after Mr Smith retired he unfortunately died aged 72. His pension fund when he retired was £50,000.00. He received back £28,000 in annuity payments. Did the remaining £22,000 go to his 65 year old widow? No, Winstones Life Insurance Company keeps it.

The worse thing is that Winstones Life knew he would be much better off financially if he shopped around and exercised his OMO; not only did they do nothing about it, they sold Mr Smith one of their own plans as well, knowing it was an inferior policy!

Remembering insurance law is governed by the maxim Uberrima Fides, of the Utmost Good Faith and NOT Caveat emptor.

Comments

My understanding is that once you retire you can:

1. have 25% in cash without tax
2. the rest does not have to be put into an annuity but can be invested in other vehicles
3. leaving the remainder to the old girl when he dies, as he will before her, because she’s driven him to an early grave.

Posted by adams | Report as abusive
 

The FSA is pushing hard for advisers to adopt Treating Customers Fairly principles (many of us have been doing this for years) – this does not seem to apply to Life Assurance companies never has, probably never will.

cave canem
Beware of the dog

Posted by Nigel Saunders | Report as abusive
 

100% agreement – he could have got a LOT more for his bad health!

Within each council area (for example) there should be a panel of registered IFAs to which such cases should devolve automatically (round robin?) for a fixed fee.

The insurance co should have NO say in the matter.

Posted by A L miller | Report as abusive
 

Excellent piece from Steve Hunt to highlight the ‘rip-off’ Britain saga dealt by the financial industry !!

Posted by Eric Harrison | Report as abusive
 

Its already a disgrace bordering on criminality. I can understand the useless FSA doing nothing as it’s really an arm if the financial industry and staffed by ex financial advisers. And I can understand Labour ignoring private annuitants as they have no interest beyond their own public sector tribe. But the Conservatives have been suicidal, and lost my vote, by their cavalier disregard for protecting their natural voters at annuity time. You save for a lifetime, then when maturity comes you have to chose whether to go open market without first receiving a firm contractual quote from your savings company. Likewise your open market annuity provider does not give you a firm quote, and reserves the right to alter the annuity rate after you accept it. And this happens frequently – it did to me several times. This practice has given rise to a whole industry that buys up dead life offices as they can milk a bit more during the maturity process the more unethical they behave. Tories have taken leave of their senses to connive at this abolition of the law of contract at annuity time. Open Market does not work as you have to buy a pig in a poke – no proper offer and acceptance or even turn round times specified by the FSA. Eevn having rules was recently turned down by the FSA. I am disgusted with the lot of them. I don’t think any parties understand the real world at all.

Posted by Peter | Report as abusive
 

I agree the whole pensions racket is ‘a disgrace bordering on criminality’.

Why can we not have ALL of OUR money, when we reach a certain age or retire, to do what we like with?

I am not familiar with MPs pension arrangements but I suspect that they understand the real world very well and have the best defined benefits scheme that OUR money can buy for them – so why would they care about the rest of us?

So, I would like to know what to do – so that, by the time I retire, I can spend MY money as I choose and not how a bunch of spivs and con-men dictate.

Posted by David Edwards | Report as abusive
 

A fascinating article. Every ten years there is a financial scandal from current account charges to pensions mis-selling, and endownments failures. At least if you are hit by one when younger in life you have some years left to correct the mistake, but not when you are retired and locked into an annuity as in this case.

Beyond annuities completely I am going down the self invested pension route and will have no intention of buying an annuity at the end of my working life!

Posted by John Scott | Report as abusive
 

A good, well natured article, however a couple of criticisms…

Where Steve talks about the effect of inflation on the buying power of level annuity, he should really have included by way of comparison an indexed annuity, as whilst these provide an increasing income they start at a MUCH lower level.

The next step is to calculate the “cross over” period, i.e. the time at which the indexed annuity will finally equal the level annuity in monetary terms, this could be anything from 8 to 15 years depending on the client’s age etc.

The final step is to calculate the “value” period, i.e. the point of time when an equal amount, in monetary terms, will have been paid out by both the level and indexed annuity as it is not until this point that the client has received the same return on their annuity. Again, this can be anything from 17 to 30 years depending upon the client’s age etc.

On this basis, many clients will find that an indexed annuity is not the utopia indicated above!

Undoubtedly, clients need advice regarding the oprions available to them, which include phased retirement and income drawdown as well as “third way annuities” and the adviser needs to take into account health status etc. and more should be done to ensure that this is the default option at retirement…

Posted by Ian J | Report as abusive
 

As an erstwhile Rockingam customer I applaud the sentiment of this piece but regret its narrow focus. The financial services industry globally, but particularly in the UK, is “front end loaded” without clawback to a such a degree that it ensures that any real return to the customer is exceptional and not the norm: this has been the subject of many research papers. It is also not attributable to inadequate market returns.

Th graft and “rinky dinks” run from the scandal of the 9 Billion “Inherited estate” retained by Prudential, to the scandal of the negative value added exit charges levied by all the snouts feeding at the trough of a managed investment, to the ridiculous charges for operating the register of members (a statutory requirement) (Santander/Equiniti) if a member wishes to use his or her independent broking facilities, to the foul obscenity of the publicy rescued banks and their compensation structures, to the captive insurers used by large organisations to avoid paying third party motor claims…. the list is endless and will remain so until we have a system of regulation which is accountable to the customers of the industry rather than the industry participants who pay for its existence.

To those of you who would point up the financial ombudsman service, I would simply direct you to inquire of its paymaster – the FSA.

Posted by David | Report as abusive
 

Another good example:

The direct result of the ego seeking to maximize its pleasure by making material gains at the expense of others. It is indeed sad that one who works and saves in the hopes of having a means of support in their elder years, should be cheated out of the comfort and support they worked for in their youth.

Once again it shows how much we need each other. The worker, not skilled in finance trusts the financial “specialists” to conduct business in good faith. Thus earning a profit by benefiting the client. But when people of low conscience control money that is not theirs, there is but one outcome. And that outcome is the subject of this article.

So by nature we need to work together, but by ego we destroy each other and consequently, ourselves. This is not a systemic problem of the financial industry. It’s a systemic problem of the human mind and heart.

One who cannot feel the suffering of his fellow is condemned to live in suffering as well. We each disregard the needs of our brothers and sisters in this place. And we do all we can to take care of ourselves. Unfortunately all of your “friends” are doing and thinking the same things. So even though you are in need of help it won’t come from your friends because they value themselves and their concerns over yours.

But when we begin to value each other we no longer have to worry about ourselves because others are taking care of that for us.

 

In response to Benny Acosta’s comment……

Thank you for such an eloquent and thoughtful statement. I’m sadly in complete agreement. It seems to me that over time our collective standard of living must decline as our economic system eventually balances excesses of the past. As a retired economist and business man I’ve always felt that inflation is the path of least resistance for societies that develop serious economic imbalances.

Since our society today places virtually all it’s emphasis on consumption, it seems that we are unfortunately a very long way from “taking care of each other”. It truely is more like caveat emptor or more to the point “every man for himself”. Sad……

Posted by Barton Poran | Report as abusive
 
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