18 November 2013
- Widows penniless while insurers pocket £1billion a year from husbands’ pension funds
- Companies make huge profits as customers buy wrong annuity because they don’t understand complex terms
- Focus just on ‘shopping around’ or ‘best rate’ is not enough, need right product first
- Channel 4 Dispatches reveals real life example of this failure and insurer agrees to change annuity terms
The UK annuity market is failing its customers. An annuity is a product sold by insurers who take a person’s pension fund money and then promise to pay a small part of it back to them, usually every month, until they die (and to keep on paying even if they outlive their assets). Every day, more than 1,000 people buy an annuity and the market is worth around £13billion a year. Unfortunately, annuities are not working well for customers and Channel 4 Dispatches tonight highlights some of these issues. Many annuity companies offer such poor rates that customers will need to live to their late nineties before they are paid anything other than their own pension fund (including a small 3% investment return) back. The insurer will keep the balance of the funds of anyone who dies before this age. Providers can get away with selling poor value products because there are no regulatory controls and no requirements for customers to be given advice to assess whether they are buying the right product or getting fair value. Insurers and annuity brokers are charging high fees to sell inadequate products to customers who do not understand the market.
Widows left penniless when husbands don’t buy right product: As annuities are complex and irreversible, people really need advice but they do not receive it. Often, the annuity rates offered are such poor value that buyers need to live to their late nineties before they receive anything other than their own pension fund back. This proves poor value for purchasers and one of the particular problems is that buyers do not realise how annuities work, which can lead to them buying the wrong product as well as obtaining a poor rate. In particular, many men buy an annuity which does not cover their partner. The Channel 4 programme shows what happened to Mr. Adams, who bought an annuity and sadly died of cancer aged just 73. He had always believed the annuity covered his wife too. However, he had in fact bought a single life annuity, which meant nothing would be paid to his widow. She has fought since he passed away to have his pension continue and, until the programme became involved, she had no success. But, happily, the insurer has now agreed to keep paying to her. Most widows are not that fortunate.
Insurers could be making extra £1billion a year by not paying widows’ pensions: One of the significant failings is that many men are buying annuities that cover only themselves and not their wife or partner. This is because most men do not understand how annuities work and often assume that their annuity will provide for their wife as well, but this is not the case. When they die, the insurer just keeps the balance of their fund rather than paying a pension to the widow. In general, wives tend to outlive their husbands by about 5 years, and I calculate that this could mean the insurers keeping an extra £201million a year for those five years, which is over £1bn from the £13bn of people’s pension funds annuitised annually. (See calculations in the notes below). Obviously, this will be very profitable for providers.
Hundreds of thousands of widows betrayed by the annuity market may fall back on means-testing, cost taxpayers more: Many annuity purchasers are married or have partners, but the vast majority buy an annuity that provides no partner’s pension. Of those who buy an annuity from their existing provider (around half of purchasers) more than 90% buy an annuity called a ‘single life annuity’ that leaves nothing for their widow or widower after they die. However the vast majority of men who receive financial advice buy a ‘joint life annuity’ to cover their widow too. Thus, the UK annuity market could betray hundreds of thousands of future widows or widowers every year, by failing to ensure customers buy the right product or at least warn of the risks. Most people do not understand how annuities work and, despite having saved for decades, they may leave their partner with nothing and possibly at risk of poverty or having to rely on means tested benefits instead. This will cost taxpayers more money, while the insurance companies keep the partners’ pensions.
Current older generation most at risk as women in their 50s or 60s were so disadvantaged by UK pension system in the past: This problem is particularly acute for the current cohort of older people. Female partners or wives of those men reaching retirement now are less likely than future retirees to have their own pension provision. Women currently in their 50s or 60s have been much more disadvantaged by the UK pension system than younger women. In the past, when today’s 50 and 60 somethings started work, it was still legal to exclude women from company pension schemes, women were paid far less than men and often stayed at home to look after their families, therefore having less chance to accrue their own pensions.
Single ‘life annuity’ or ‘single life’ annuity – it’s confusing: Unlike final salary-type pensions, which must all provide partners’ pensions, defined contribution schemes require individuals to select the kind of pension they will buy. As most people do not understand how annuities work, they choose the annuity that pays them the highest rate on retirement, i.e. the highest initial income, which is called a ‘single life annuity’ and does not cover their partner. This kind of annuity also has no inflation protection either. The term ‘single’ life annuity means nothing to customers. They may not realise this is a ‘single life’ annuity, rather than a single ‘life annuity’! Thus, as they are buying only one product, they may think the word ‘single’ refers to the fact that they are not buying as part of a group of people, such as a company pension fund and have no idea their widow or widower will receive nothing.
All purchasers pay for advice, even though they don’t receive it: People need advice to ensure they buy the right product. They do not realise this. They also do not realise that, in fact, they pay for advice whether they receive it or not! An average of 2-3.5% of their fund will be automatically paid to someone when they buy their annuity, but whoever receives the money is not required to ensure the customer understands the risks of this decision or buys the right product at a good price.
Urgent reform is required as auto-enrolment proceeds: Before millions more people are brought into the defined contribution pension system, it is vital that the failings of the annuity market are urgently addressed. The market needs to work for the customer, not just the providers or brokers who sell the products. Many people may not need to buy an annuity at age 65 at all, but will not know this. Many will be misled into trying to find the ‘best rate’ rather than first finding the ‘best product’. The reform of annuities is long overdue.
Calculations showing how £1billion is being kept by insurers rather than paid to widows
Insurance companies take over £13billion of people’s pension savings each year from around 425,000 annuity purchasers, with an average value about £30,000 per purchase.
The insurance industry is very secretive about annuities and does not publish much information, so I have had to make a number of assumptions. However I believe this figure can be justified. Until we have more information, this is the best we can do.
Assume 75% of all annuity buyers buy single life annuity = 318,750 people: Let’s assume that 75% of the 425,000 people who buy an annuity each year buy a single life annuity, that is 318,750 people. (Those who have an adviser or shop around will be more likely to buy a joint life product, but those who do not move from their existing provider almost all buy single life annuities).
If 75% of these have a partner = 240,000 partners not covered: If we assume about 75% of these people who buy a single life annuity do actually have a partner, that means 240,000 people with partners who are not covered by their pension (75% of 318,750).
Assume 80% of partners outlive spouse = 191,250 people lose out: If we assume that, say 20% of these people have a partner who dies before they do, this will be 191,250 widows or widowers who will have no private pension provision from their partners’ pension savings after their partner dies (80% of 240,000).
Current annuity rates would give average joint life annuity of £1590pa, with two thirds widow/widower pension of £1050pa: At current annuity rates, we can assume that the £30,000 average pension fund has bought a single life annuity at an annuity rate of 5.6%, then the income they receive will be £1680 a year, while the average joint life rate is around 5.3%. So those who bought a joint life annuity would initially receive an income of £1590 a year. But after they die, that income would then carry on paying out for five more years but usually the widow or widower will get a reduced pension. If the joint life annuity would pay two thirds of the partners’ pension, then each widow or widower could have had an extra £1050 a year (two thirds of £1590) on average from a joint life annuity, but as their partner bought a single life product, they lose out on that income.
So partners lose potential extra £201m a year across all 191,250 people: If we take that across the 191,250 people who bought single life annuities and who we assume die before their partner, then this amounts to £201million a year that the insurers will not need to pay (191,250 x £1050). With a joint life annuity, they would have paid this income, but with a single life product the insurers just keep that money.
Insurers will therefore pocket over £1billion extra if spouses live average five years longer: Assuming that the spouse lives an extra 5 years longer than their partner (female partners are usually younger than their husbands and then also live longer) the insurance companies will save a total of over £1billion over those 5 years (£201m x 5). So partners will be losing out on more than £1billion of pension money, which goes to the insurance company, not to their families.