Could the mis-selling by insurers of annuities result in compensation on the scale of payment protection insurance mis-selling, with savers in line for payouts worth billions?
The financial watchdog has this morning fired the first salvo in what could result in a gargantuan process of reviewing the sales of annuities to millions of lifelong savers.
The eventual outcome could be compensation payments – which would have to reflect the fact that savers have lost out on an income payable over a lifetime – worth billions of pounds.
But just how big could this become?
Annuities are a form of insurance purchased by savers with the money they have built up over decades in their pensions. The annuity converts the lump sum of the pension pot into an income paid monthly for life.
Until recently, the purchase of annuity was all but compulsory, with around 400,000 savers buying such plans each year. Recent changes to pension rules have meant annuity sales have dropped.
But key to the annuity mis-selling scandal which the Financial Conduct Authority’s report today has begun to expose is the fact that insurance companies play a dual role in the pension process. They are typically the provider of the investment account where a saver’s pension pot is built up during their working life in the form of monthly contributions. They are also the firms which then sell the (often highly profitable) annuity to the same saver.
Once an annuity is bought there is no going back. The deal is irreversible, and so if a pension pot has been used to purchase a poor-value annuity, the saver will suffer a lower income for life.
In recent years a series of rules were introduced aiming to ensure that when savers made the crucial decision to swap their pension pot for an annuity, they did so with enough information at hand to guide their choice. Crucially this included information which could alert savers to the fact that by looking to another annuity provider they could possibly, if not probably, get a far higher income for life.
It is these rules which the FCA now says were flouted, on a major scale, by Britain’s biggest insurers.
That is no surprise to critics of the pension industry including Telegraph Money. Over many years we have highlighted systematic, if not intentional, failures by insurers to properly spell out savers’ choices. Only last month Telegraph Money broke the news that Britain’s biggest insurer, Aviva, is compensating 250 annuitants on the grounds that they had been mis-sold. This is believed to be the tip of the iceberg, resulting from an internal sales “spot check”.
Other leading commentators, such as respected pensions expert Ros Altmann, has said annuity mis-selling is indeed a scandal on the scale of PPI.
The following sets out the numbers potentially at stake:
– Approximately 400,000 people bought annuities each year since 2008, the period at which the FCA review begins.
– According to the FCA’s data, the proportion of savers who took their pension savings and bought an annuity elsewhere – rather than sticking with their firm – varies between 40pc and 60pc, depending on when in the past six years the surveys were undertaken.
– In its report published today the FCA says of those who bought a standard annuity from their existing pension provider, 79pc could have got a better deal. Of those who bought an “enhanced annuity” – typically because their health was poor, leading to a lower life expectancy – 92pc could have done better by switching.
– There is the additional issue of how many of those who bought standard annuities might have qualified for the higher-paying, enhanced type.
These damning figures indicate the scale of the redress that could be payable. The figures could be extrapolated to argue that if, on average, half of savers failed to take their money to another pension provider when buying their annuity, and that of these four in five thus failed to get the best deal, compensation could be owing to some 160,000 savers each year.
To go beyond that and try to calculate the actual sums payable to individuals means estimating the length of annuitants’ lifetime and also the size of their pension pot.
But as most annuities are bought by savers at age 65, it would be a fair assumption that income would be drawn for 20 years.Where £100,000 was spent on an annuity, the FCA’s report reckons the average annual loss to one of those savers mis-sold the policy would be just over £1,000. So their lifetime loss would be in the order of £20,000.
The FCA’s report leaves questions unanswered. What it has not said is how robustly it will pursue this matter – and quite how much pressure will be applied to firms to properly evaluate their past sales and pay up.
It’s record in this area is poor. Insurers’ failure to help savers find the best annuity deals (as opposed to the most profitable ones for the insurers themselves) has been a widely publicised scandal for many years. There is, as ever with the watchdog, a sense in which this problem is only now beginning to emerge.