In December 2014, as part of our Corporate Insurance Advent Calendar, we predicted that “life would return to the UK life sector” following an announcement in the 2014 UK Budget (the “Budget”) which was anticipated to have an impact on the sale of annuities.
Shortly before the festive break, the FCA published its provisional findings in relation to its study on the Retirement Income Market (the “Interim Report”), with a particular focus on annuities. This article assesses ongoing concerns around the UK life sector and highlights some key findings of the Interim Report.
Last year, the Chancellor announced that, from April 2015, retirees holding defined benefit pension pots will no longer be obliged to purchase annuities. The UK government is keen to see an increased choice of retirement income products and to give retirees greater freedom of use of the funds saved during their working lives. The FCA stated in the Interim Report that they will continue to work strategically with the relevant government departments to improve competition for customers in this market.
The Budget also introduced significant changes to how lump sums withdrawn at retirement age will be taxed going forwards. From April, retirees will no longer be subject to 55% tax rates if they withdraw their entire personal pension pot as a lump sum. Rather, at least 25% of any lump sum taken will remain tax free, with the remainder being subject to marginal rates of income tax. These changes are expected to have an impact on the amount of cash pensioners choose to take on retirement as a lump sum and, consequently, on the products chosen to provide a retirement income.
What concerns has the FCA identified?
Government figures estimate that three quarters of retiring participants in a defined benefit personal pension scheme purchase an annuity each year. This purchase typically represents a one-off irreversible decision, which results in a fixed yearly income being paid to that consumer, usually for the rest of their lives. The Interim Report found many customers were ill-informed of available options and underestimated their longevity and, therefore also, their income needs during retirement.
Further, there appeared to be legal (in the form of exit fees), and perceived, barriers to switching retirement income providers. The FCA has, therefore, identified a potential for the misselling of annuities as customers are reliant on appropriate information being made available before sale and on the fair pricing of products by life insurers.
The FCA has also identified potential issues with approximately 30 million “historic” policies which, in some cases, were sold as long ago as the 1970s. Policyholders may not be aware that they hold these “sleeping policies” and it is estimated that millions of pounds remain unclaimed in “zombie funds”. In other cases, the terms and conditions of historic policies, such as high exit fees, prevent customers from switching providers without incurring financial penalties. This is problematic as policyholders may now get a better deal on the open market.
The FCA’s indication that it will not now be conducting a review of the selling, or misselling, of historic products (as it did for PPI) will, no doubt, be a relief to the market. However, the FCA has identified certain improvements which it wishes to see adopted in relation to the sale of annuities going forwards.
One of the key recommendations of the Interim Report is the need for clearer communications with customers, both verbally and in writing, before the point of sale of annuities. Customers should be informed not only of their right to shop around, but also, more controversially, of how a product’s terms and conditions compare to a similar product’s terms and conditions sold by its competitors, including information on charges. The creation of an online “Pensions Dashboard” (similar to the system available in the Netherlands) has been suggested as a solution to provide a means of consolidating information on available products and a forum for customers to access such information. However, it is unclear where responsibility for such a scheme would lie and how it would be funded.
Currently, insurers are encouraged to send “wake-up packs” to customers who hold “sleeping policies” informing them of the existence of the policy, their rights under the policy and pertinent terms and conditions concerning exit options. The Interim Report criticises some of the wake-up packs reviewed for being too long and confusing customers with unnecessary jargon. The FCA would like insurers to reflect on historic charging structures which may no longer provide good value of money for customers, including exit fees.
April 2015 will see the introduction of significant changes to the UK life sector. These changes will give insurers the opportunity to innovate and offer new products to retirees. Such products are, however, likely to attract the keen eye of regulators. How customers will react to the greater choices potentially on offer is also uncertain. Given the importance of annuities to UK pensioners, it is likely that the life sector will remain a focus for further reviews by, and recommendations from, the FCA.
For now, the FCA has alleviated some of the concerns of life insurers by stating that it does not currently intend to conduct a review of the potential misselling of historic policies. Insurers now have some breathing space to digest the FCA’s interim findings, and to begin implementing some of its recommendations, ahead of the publication of the final report expected in the latter half of this year.