FSA to launch pension annuity probe

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An investigation into the £11bn annuity market will be launched today by the City watchdog amid concerns British pensioners are getting a poor deal in exchange for their retirement savings.

The Financial Services Authority (FSA) will launch an inquiry into the varying rates offered to pensioners when they sign up to an annuity, which provides them with a stable income in return for their retirement fund.

Politicians and regulators have raised fears that many Britons of retirement age may be losing out by not shopping around for an annuity and simply accepting the offer tabled by their current provider.

Under what is called the “open market option”, people reaching retirement age are allowed to take their pension pot and shop around other providers for the most favourable annuity deal.

There can be a difference of as much as 20 per cent in the rates offered by different providers, which means some pensioners could be missing out on a substantial boost to their incomes.

The FSA investigation will examine both the pricing of annuities and how they are advertised to savers, according to reports.

>> Pension tools: Annuity calculator

Experts have long warned that too few people shop around when they look to buy a stream of retirement income.

Regulators have intensified the focus on the pensions industry following the launch last year of auto-enrolment, which will see all workers automatically enrolled into savings schemes by 2017. Confidence (BSE: ZCONFIDE.BO - news) in the pensions system is seen as key to making the scheme a success.

Earlier this month, the Office of Fair Trading launched an investigation into whether employees are being unfairly hit with high charges on existing workplace pension schemes.

Tom McPhail, head of pensions research at financial services company Hargreaves Lansdown (LSE: HL.L - news) , said: “The open market option (OMO) agenda has always been about improving investor’s incomes and the FSA is right to scrutinise this area of market failure.

"With auto-enrolment under way it is essential that investors get the best possible value from all stages of their retirement saving. Important steps are already being taken to improve the OMO market. However this announcement from the FSA serves notice to any insurance companies which aren’t looking after their customers that the regulator has its eye on them.”

The open marjet option was introduced in 1988 but with take up low the FSA compelledl pension providers to disclose to customers that they have the right to shop around. Yet still only around 40 per cent of pension customers use it.

To compound the problems for those reaching retirement, the cost to buy an income has soared in recent years due to measures deployed by the Bank of England to fight the financial crisis.

Keeping the UK Bank Rate low at 0.5 per cent for nearly four years and injecting £375bn of created money money, via a programme of quantitative easing, has depressed the yield on gilts, government bonds: it reduces borrowing costs for the Treasury. But because annuities are linked to the yield on 15-year gilts, it means savers get far less for their money.

Research by the Prudential (LSE: PRU.L - news) earlier this month showed people who retire this year can expect an annual income of £15,300, compared with £18,700 in 2008 - a decline of £3,400 or 18 per cent.

Experts, however, have suggested that annuities may mount a recovery, with some suggesting a recovery in the economy could push gilt yields up and improve annuity prices by as much as 25 per cent over the next year or two.

How annuity rates have fallen in the past year

>> Pension tools: Annuity calculator