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The trm Report - November 2006 In May 2004, I wrote about the implications for trustees when purchasing annuities. The corporate annuity market has moved on considerably since then; this article reflects on our experiences to date whilst looking forward to future developments. When establishing our service, we sought legal advice on the position of trustees, and were told: “It is 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.” What surprised us at the time was that many schemes did not seem to understand these issues and that some defined contribution schemes had been established without a great deal of consideration being given to actually securing member benefits. Having checked with their own legal advisers, many trustees became aware of these issues, but unfortunately only after the schemes had been established. Times have changed, and it is rare today that we meet trustees who do not already have a good grasp of their legal and moral obligations. However, a recent search showed a difference of 13% between the top and bottom annuity providers (see chart below). It’s clearly important that trustees make members aware of these differences in annuity rates. A few hundred or thousand pounds a year can add up to a great deal of extra income for an individual over a 20-year plus retirement.
The 13% difference between the first two rates is based on a comparison between the best rate from our panel of leading providers and the lowest rate on the FSA annuity tables. The rates compared were for open-market annuities only. The difference across the market as a whole could be considerably more as we did not include rates from closed life offices, or from providers who offer annuities to existing pension policy holders (not through the open market). Those who smoke or suffer from certain medical conditions could increase their income by nearly that much again, as shown in the chart. Looking forward, we increasingly feel that the choice of annuity options (in terms of escalation, spouses’ pension, guaranteed period, etc) is as important, if not more so, than the choice of provider. It would seem that a disproportionate percentage of the population are choosing single-life level annuities, which produce the most income in the first year but then decline in value in real terms. This trend could be a mini ‘pensions crisis’ in the making, as either inflation erodes the value of these benefits, or spouses are left to rely on state pension provision once the annuitant dies. It is obviously important that the pros and cons of each annuity option are explained properly to the retiree. AIG and Aegon have recently launched annuity products which are designed as ‘halfway houses’ between unsecured pension arrangements and conventional annuities. Although suitable for some, the risks and charges mean that the majority of retirees, with funds under £100,000, will still be more suited to conventional annuities in most cases. Unsecured pensions offer flexibility and potential for growth, but are only generally viewed as suitable for those with larger retirement funds. Retirees can benefit from this option up to the age of 75. Generally speaking, we believe that people should take full individual advice when considering both of the above products, as they can involve higher levels of risk and expense than conventional annuities. In conclusion, the good news is that trustees in 2006 seem much more aware of their obligations to retiring DC members; most occupational (and many contract-based) schemes appoint an annuity adviser as a matter of course. There is undoubtedly, however, room for improvement in communicating the increasing range of annuity options to retiring members. The ‘one size fits all’ approach is a thing of the past; trustees should look across the whole market, and try to help the retiree to choose a suitable annuity. Paul Clifton
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