Standard Life probe puts enhanced annuities in the spotlight

With the exception of final salary pensions, which as their name suggests pay retired employees a proportion of their final salary every month, all pension savings have traditionally been used to buy an annuity, which, according to Candid Financial Advice director Justin Modray, “is when you swap your pension fund for an income for life”.

The benefit, said Mr Modray, is that the person buying the annuity is “guaranteed to receive the income until they die” while the drawback is that “if you unexpectedly die sooner rather than later it could prove very poor value”.

Until last year, when pensions reforms brought in by former Chancellor George Osborne came into force, all non-final-salary pension pots had to be used to buy an annuity, with enhanced versions being designed for those whose life expectancy was reduced either through ill-health or lifestyle choices.

“Enhanced annuities mean the annuity provider pays you a higher rate of income if your health or lifestyle means you are likely to have a shorter than average life,” Mr Modray said.

“Put bluntly, if they expect you to die sooner rather than later they can afford to give you a higher than usual level of income and still expect to make a profit.”

The problem, as the FCA review uncovered, was that while most insurance companies made sure retiring customers were made aware of the existence of enhanced annuities and their eligibility for them, a minority did not.

As Megan Butler, director of supervision, investment, wholesale and specialist at the FCA, said when the regulator published its findings: “While we have found particularly poor behaviour at a small number of firms, there is no evidence that firms have systemically failed to provide customers with the information required by our rules.”

The FCA estimates that between 39 and 48 per cent of customers who were sold standard annuities should actually have had enhanced ones, with the total number mis-sold to thought to be in the region of 90,000.

Anyone who receives retirement income from Aviva or Legal & General is unlikely to be affected, with neither firm thought to be acting on the FCA review.

Although Aviva did previously identify a small number of customers who had been sold standard rather than enhanced annuities – and addressed the matter in 2013 – a spokesperson for the business said that it does not “anticipate having to take any significant retrospective action” following the FCA review.

Similarly, a Legal and General spokesperson said: “We have always aimed to provide customers with the best annuity for their needs and are pleased with the outcome of the review.”

However, insurance analyst Anasuya Iyer from investment bank Jefferies reckons that large swathes of Standard Life and Prudential customers could be affected because the bulk of those firms’ annuities were sold to customers who did not come via a financial adviser.

While Prudential declined to comment on whether, like Standard Life, it is carrying out its own internal review of annuity sales, Ms Iyer estimated that the business may well have to pay up to £200 million to compensate anyone it mis-sold to. For Standard Life the bill is likely to be in the region of £125m, she said.

For those whose ill-health has not already brought about the early death that enhanced annuities were supposed to make allowance for, that will be good news of sorts - so long as their annuity provider is reviewing its own practices and so long as they are identified as part of that review.

Not only will they be compensated to the tune of an estimated £120 to £240 for each year they had an incorrect policy, they are also expected to be offered cover to take care of the enhanced income they are entitled to.

This may well be a cruel irony for those in good health who have not made unhealthy lifestyle choices, given that one of the biggest complaints about the annuity market more generally is that it has offered poor value to all retirees.

Mr Osborne sought to remedy this situation with his 2014 pension reforms, but his planned secondary annuity market, which would have allowed pensioners to cash in poorly performing annuities, has been scrapped by the current government.

Although some in the industry have welcomed the move, with Aegon pensions director Steven Cameron branding the secondary market “a pension freedom too far”, it has been denounced by over-50s group Saga.

“There will be many pensioners who will be sorely disappointed – thousands of people who receive minimal income from annuities they were forced to buy would have benefitted from a way to sell their annuity,” said Saga spokesperson Paul Green.

“Indeed, research carried out by Saga found that 58 per cent of people who wanted to sell their annuity were receiving such a small income they could do nothing meaningful with it.

“It looks now that there will be no way for them to turn that meagre income back into a lump sum.”

For those yet to retire at least the freedoms have brought more choice, with pensioners no longer obliged to use their retirement savings to buy an annuity.

Mr Modray at Candid Financial Advice said this change could help people with shortened life expectancies in particular – as well as their beneficiaries.

“When you die an annuity dies with you unless you buy an option for a surviving spouse to receive some income, but under flexible drawdown your pension fund remains invested and you draw an income as required,” he said.

“Unlike an annuity there is a risk of income running dry during your lifetime if you draw too much, but on the plus side any money left over can be passed to a spouse or other beneficiaries when you die.

“In other words, if you live a fairly short life in retirement flexible drawdown allows you to potentially pass on any remaining pension fund and this is not usually subject to inheritance tax.”