The trm Report - May 2004

Trustee Risk Management
Trustee Implications of Annuity Purchase
Paul Clifton

When purchasing an annuity on behalf of a scheme member there are several issues that Trustees should consider. These can be broadly categorised into two areas: The Moral Obligations and The Legal Implications.

I shall start by looking at The Moral Obligations:

Put simply, why would trustees not want to purchase the most competitive and suitable annuity for a retiring member of your scheme? The difference between the most competitive open market rate and the rate offered from a pension provider can be considerable, as the example below demonstrates:

Mr Taylor had a money purchase pension fund worth £88,210. He decided to retire aged 60 and was offered an annual income of £4,873 by his pension provider. However, it was found that a provider on the open market was offering £5,840 per annum for exactly the same type of annuity. If he lives until the age of 80 (about average these days), Mr Taylor will receive an additional £19,340 of pre tax income. (Example based on a male non - smoker, age 60, setting up a single life, level annuity, guaranteed for 5 years and paid monthly in advance. Rates correct as at 14.10.2003. Source: HL Annuity Supermarket).

The figures used in the example are standard annuity rates, i.e. rates for those in good health who are non-smokers. If the annuitant does smoke or is in ill health, the income could be significantly higher. In our experience many schemes do not identify members that could qualify for enhanced rates.

This brings me on to the final piece of the jigsaw, suitability. There are many options available when purchasing an annuity. These include guaranteed periods, spouse's benefit and escalation. The most suitable choice for one member is very rarely the most suitable for the next. Many schemes do not even consult members before sourcing an annuity.

Now for the Legal Implications:

Seeking appropriate advice and implementing the right procedures could also be a valuable risk management tool for Trustees of occupational pension schemes. The following is a legal opinion which was given on the role of Trustees in relation to the open market and the purchase of annuities:

Where a scheme does not offer an open market option, it should treat the purchase of an annuity as though it were any other form of investment and seek appropriate financial advice in order to comply with the provisions of the Financial Services and Markets Act 2000 and the Pensions Act 1995.

If a pension scheme offers an open market option for its members, there is a fiduciary obligation to choose the most appropriate annuity available in the market; it is reasonable to conclude that unless the trustees are themselves qualified to consider the market, they should appoint duly regulated persons to advise on the most appropriate annuity for the member, or comply with the member's request making it clear that it is execution only. Such an obligation needs to cover the full range of annuities available in the market, not merely a limited selection, although the trustees may accept advice that certain annuities are not appropriate for good reason.

Where a scheme does not offer an open market option to its members, it may have a fiduciary obligation to ensure the purchase of the annuity is appropriate for the membership. In most cases the trustees will be unlikely to possess the requisite skills to complete the purchase without advice and should therefore retain appropriate advice to purchase the right annuities in the market.

Any failure to comply with the requirements would amount to a breach of both statutory requirements and fiduciary obligations. The penalties for breach of the statutory requirements are under the Pensions Act 1995 up to a £50,000 fine, and disqualification as a trustee.

It is therefore appropriate for trustees, when purchasing annuities as an investment, or in pursuit of an open market option right, to retain suitable advice from appropriately qualified persons to avoid liability for breach of statutory duty or for breach of fiduciary obligation.

As you can see, ensuring that the Trustees purchase the most competitive and suitable annuity for a retiring scheme member could have significant benefits for both parties.

Paul Clifton
Hargreaves Lansdown Corporate Solutions
(Authorised and regulated by the Financial Services Authority)
0117 317 1606

paul_clifton@hargreaveslansdown.co.uk