Annuities could become the financial scandal of 2014, pensions campaigner and former government adviser Dr Ros Altmann has warned.
Ms Altmann says pressure is mounting on the Financial Conduct Authority (FCA) to regulate a booming market where retirees are paying a big slice of their pension fund to insurers and brokers in commissions that are not disclosed, despite not getting the advice they need.
She says the annuity scandal is a hidden symptom of the move from the safe environment of final-salary pensions to a "wild west world" of unregulated alternatives, and of the unintended consequences of the 'retail distribution review' (RDR).
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Despite the RDR clean-up of the industry which saw adviser commissions on investments and pensions replaced by a fee-based regime last January, commissions are still allowed on non-advised sales of products such as annuities.
"What RDR has done is create an unlevel playing-field and biased the market towards non-advised broking services," Ms Altmann said. "They are allowed to advertise themselves as 'free', then charge commission when you buy - something advisers can no longer do."
The Financial Services Consumer Panel, which monitors the FCA, recently published a report after a 12-month study into the annuity market. Investigating 15 online firms, and using a £49,950 pension pot example, minus a 25% lump sum, it found fees for the same service went from 0.75% to 3.35%, with costs ranging from £281 to £1255.
It warned around a dozen firms offered a "straight through" service online that led to an annuity purchase, while another layer of firms acted as "introducers", adding: "Their regulatory status and true identity is frequently unclear, as is their location (some are based offshore). Consumers often do not appreciate that an actual purchase would be with another firm with which they have had no contact. There is evidence of poor conduct, persistent unsolicited emails and telephone calls."
The panel observes market reform itself, the banning of commissions, is "leaving most customers with no choice but to use commission-based, non-advice services".
Advisers, meanwhile, were showing a "preference for non-advice" in annuities, with the twin attractions of earning commission whilst still enjoying "a lighter regulatory regime, under which advisers do not take responsibility for the suitability of sales".
The panel also confirmed Ms Altmann's research, published in August, showing that insurers' profits on "rollover" annuities "might be excessive". Ms Altmann said people who failed to shop around for an annuity on retirement risked settling for a lower income and might still hand over 3.5% of their fund as a commission without having received any advice.
She cited the 3.5% commission paid by Zurich and AXA customers when they accept an annuity without shopping around - a fee actually picked up by the provider Legal & General. She adds: "People are paying anyway for advice they don't get.
"When you buy an annuity, money is deducted whether it is pocketed by the insurance company or by the broker or signposter or by an adviser who works for you, in all three cases you pay the commission. You have to do the transaction before you find out, they don't really disclose these things, though advisers can negotiate on commission."
Four out of five annuity buyers fail to provide for their spouse, buying a standard 'single life' annuity covering themselves until death, whereas a final salary scheme covers partners automatically. "Insurers will often keep between three-quarters and half the pension fund," Ms Altmann said.
Five of the 20 providers shown when the Association of British Insurers launched its first "annuity window" this year offered rates which meant the buyer has to live 100 to do better than merely get their pension fund money back. The Prudential's rate is 23% lower than the best on offer.
Ms Altmann said: "People will think the Pru is a good company and they can't go wrong, but as it happens Prudential doesn't want to sell annuities so is offering the most awful rates."
Ms Altmann said a £100,000 investment in an Aviva corporate bond would yield 6%. "After 20 years you would have had 6% a year and still have your £100,000. If you buy an annuity from Aviva, you may get a return of under 6% and you have lost your £100,000 after one year, you have got nothing."
The FCA is due to publish its study of the annuity market early in the new year.
Ms Altmann said: "I hope they will be tough, but on past form one has to have a severe question mark over whether they will go far enough in the customer interest. "
She argued the current consultation by the Government over a cap on pension charges is a distraction. "We are being very careful about the money going into pensions at the front, but it is all leaking out at the back."
Ms Altmann was criticised by some for warning on Channel 4's 'Dispatches' that annuities would become "the new PPI". But Ian McKenna, director of the Finance & Technology Research Centre, said the industry is recognising "that non-advised annuities are the next mis-selling scandal waiting to happen".
The Association of British Insurers says the debate is currently generating "more heat than light" and said its members are "committed" to ensuring people get the most appropriate product at a competitive rate. It added: "But the pensions industry is only one part of the solution. We therefore welcome the important role of advisers and non-advice services is now also being considered."