1 December 2014
A leading newspaper asked me last week to calculate some estimates of the possible or potential losses suffered by pensioners over the past 10 years as a result of buying unsuitable annuity products. They wanted an estimate of a potential base for mis-selling claims, following revelations that Aviva has already compensated some customers who were found to have been sold inappropriate annuities.
Over the years, customers reaching their scheme pension age have received an annuity offer with a communication from their pension company, or been sent to a tied annuity company which offered them this product. The annuity quote provided was for the standard ‘single life, level annuity’.
The calculation is obviously a rough estimate, since we do not know exactly how many people have bought unsuitable annuities over the past 10 years. I have tried to make assumptions about the numbers of annuities purchased, size of the fund, how many were unwell and how many would have a partner that could have benefited. Inevitably, this is a rough approximation but it gives a starting point to assess the possible scale of losses and consumer detriment.
I assume the average number of people buying annuities in the past 10 years is 300,000 a year, so this means 3 million people. All of these people might have been at risk of buying potentially unsuitable annuities, but I have then made assumptions about people receiving advice (which means they are likely to have had the right annuity), people who were healthy, people who had no partner and so on.
Summary of findings:
Potential loss to those who bought standard annuity but could have had enhanced rate £5.4bn
Potential loss to those who bought single life but would have needed joint life £2.65bn
Potential loss to those who could have trivially commuted £0.45bn
TOTAL POSSIBLE LOSS/COMPENSATION £8.5bn
Assume 300,000 annuities sold on average each year = 3million people bought single life, level annuity in the past 10 years
Assume 60% of these sales were non-advised and did not have guaranteed annuity rates = 1.8million. These customers are more likely to have bought an unsuitable product. Those customers who had advice or guaranteed rates are likely to have less case for compensation. So I have assumed that 1.8million of the 3million people are at risk of having bought (or been sold) the wrong annuity.
We now need to look at the basis on which an unsuitable sale may have been made and compensation that might be claimed:
1. IMPAIRED LIFE: Assume 60% of these 1.8million people would have some kind of impaired life = 1.08m who should have had enhanced rate
This is easiest to estimate: If we assume an average uplift of 20% on their annuity rate and a standard £25,000 average pension fund, the value of their detriment would be 20% of £25,000 = £5,000 each on average
For 1.08m people that amounts to about £5.4billion (1.08m x £5000 = £5.4bn)
2. SINGLE LIFE/JOINT LIFE: Assume three quarters are married or have a partner = 1.35million of the 1.8 million people
If we assume two thirds of these people have a partner who would have liked a pension to keep on paying if their husband died sooner, this means 900,000 people may have bought the wrong product – should have bought a joint-life annuity, not single life.
We then have to assume how many of these people will die before their partner and, as most purchasers are men, this is likely to be a relatively high proportion – let’s say two thirds. That is 600,000 widows/widowers who will not get a pension from their partner who passes away before they do.
If we assume that these widows/widowers on average live 5 years longer than their partners, they are losing out on 5 years of income.
If we assume that they could have had an average income of an extra £900 a year for those 5 years, that means 600,000 widows or widowers lost out on £540m a year, which is £2.7billion over 5 years. So the ‘mis-selling’ of single life rather than joint life annuities may have resulted in a loss of £2.7billion in pensioner income over the last ten years.
(PLEASE NOTE: To do this properly one would need to estimate the extra income that the household originally received from a single life annuity, but this is more difficult since some of those affected may have had or been entitled to enhanced rates, so the mis-selling could apply on that basis too. I have therefore assumed the relative positives and negatives from this source cancel out).
3. TRIVIAL COMMUTATION: Assume 5% could have trivially commuted = 90,000 out of the 1.8million
If we assume 5% of those who bought an annuity could have taken the cash instead, then that means 90,000 people may have been able to trivially commute and bought an annuity unnecessarily.
If we assume the average size of the pension that could have been commuted was £5000 then that means £450million of annuity purchases may have been unsuitable (90,000 people x £5,000 pension = £450million)
Therefore the total potential amount of mis-sold annuities over the past ten years is estimated to be around £8.5billion.