Pensions - Annuities
 
Making the best of it
 
Investors choosing an annuity continue to bury their heads in the sand when it comes to shopping around. Joe McGrath looks at the benefits of opting for an enhanced product
 
Despite much industry lobbying, the man (or woman) on the street remains lost when it comes to retirement options and it’s hardly surprising.
Until last month, government rules dictated that pension investors had to purchase an annuity by the age of 77 or opt for the Alternative Secured Pension option (ASP). The government has since confirmed that these rules may now be revised again in 2011, meaning that the compulsory annuity purchase rule is likely to be lifted.
However, for those still wanting to buy an annuity contract or those entering retirement ahead of the rule changes, there is still much to consider.
Currently, for those that don’t want to buy an annuity, investors can opt for ASP, which allows individuals to continue investing their pension savings while drawing some income within set limits.
 
Why choose an annuity?
An annuity is where an insurance company buys the pension pot in exchange for an immediate lump sum or regular payments.
Annuities have developed in sophistication and style over the years and, with the amount of choice now in the pensions market, it is important, perhaps more than ever, to do your homework before piling in.
One of the many options within the annuity market is the enhanced product on which this feature is focused.
The insurer that manages your pension fund should write to you before you get to the compulsory annuity age with what the industry calls a ‘wake-up’ pack. This tells you your choices under the Open Market Option – essentially a call to action to shop around before you pass the deadline.
Unbelievable as it sounds, most people don’t read these documents or flick straight to the signature page at the back of the book and most end up with a standard annuity and lose out on hundreds of pounds a year.
Table 1 shows the percentage of enhanced annuity sales as a percentage of overall annuity sales. While awareness of these products has certainly increased in recent years, there is remains widespread ignorance.
Research teams at Oxford Economics conducted a survey at the end of 2009 among eight annuity providers. 
The investigation team found that a 65-year-old male with a pension fund of £100,000 could have lost out on income of £1,118 a year if he accidentally chose the cheapest annuity on offer.
Similarly, a 65-year-old female with the same £100,000 pension pot could have lost £1,160 every year by choosing the wrong option. And yet, the figures in Table 1 show that less than 17 per cent of all annuities sold are enhanced annuities.
The killer figure, though, is from the Association of British Insurers (ABI), which shows that, of those people that didn’t shop around (or didn’t take the ‘Open Market Option’) only 0.5 per cent got an enhancement. 0.5 per cent! That’s thousands of free money that the insurers are earning from your pension funds.
 
Shopping around
It surprises many to learn that they may qualify for an enhancement to their annuity simply because of where they live, their career, or because they have an ‘unhealthy’ lifestyle.
Traditionally, enhanced annuity customers were those who fell into the unhealthy lifestyle bracket: smokers, the obese or those with high blood pressure. 
Those with serious medical conditions would have traditionally been better served by an ‘impaired annuity’. In addition to these, there were also specialist products for smokers and manual workers.
However, the market has moved on considerably from when these specialist products first emerged and the traditional ‘standard’ annuity market is fast blurring into what was the traditional enhanced market – with marginally higher rates on offer based on simple tick-box choices like postcode.
But the real value is to be found by going through the pain of filling out the medical questionnaires are surveying the market. It is a long and laborious process, but if it earns you over a grand a year, it’s probably worth half an hour of your time.
Yes, your existing pension provider may write to you offering you a slight enhancement, but the odds are that you’re unlikely to get the best deal if you say yes without doing your research.
If you’ve decided that an annuity is for you, give some thought to your current state of health – niggles or questionable lifestyle choices may actually help you earn more money in your annuity.
If you have time, it does no harm whatsoever to look around online at the various comparative tables. 
Those available on the Financial Services Authority’s website are heavily criticised for their lack of accuracy, but they will give you a starting point for where to hunt next. The Pensions Advisory Service also has an online selector tool that will give you some additional detail on what might be available.
 
Who offers what?
Table 2 shows the 11 providers of enhanced annuities active in the UK market at the moment. 
Readers should note that it does not include companies that offer enhanced annuities under their own brands via affinity deals like Saga’s offering with Legal & General or the Standard Life offering through Partnership.
One of the better-known brands in the enhanced market is Aviva – known largely for the recent television advertisements starring comedian Paul Whitehouse.
The company’s annuity pricing manager, Scott Brown, is among the many predicting a harmonisation enhanced and standard annuities over the coming two years.
He explains, ‘The integration of the two product types has yet to be done but you will see the end of “enhanced” annuities over the next two years. There is already a grey area between the enhanced annuity market and a standard annuity.
‘Our questionnaire doesn’t ask you whether you want an enhanced annuity or a standard one.’
This alignment of the two markets has been widely expected for quite a number of years but two years’ ago experts were predicting a full integration of the market by 2010. While there have been improvements, the market is not yet fully intertwined. 
Tom McPhail, head of pensions research at Hargreaves Lansdown, explains that 25 per cent of his company’s business currently can be labeled as ‘enhanced’.
However, he believes that, as awareness improves and competitiveness increases, this figure is likely to grow.
He explains, ‘I think there is more to come. Increasingly, you are going to see this trend of moving away from standard annuity rates. The logical conclusion of this trend is that everyone will eventually get some degree of enhancement underwritten. The challenge for the industry is to come up with the right questions.’
As it stands, there are still ways for pensioners to get some uplift in their rate without going through the lengthy medical questionnaire process – through ‘Annuity Plus’ style products offered by providers such as Legal & General as well as the many providers that offer an uplift by postcode or occupation.
McPhail explains that you are almost always better off taking the time to go through the manual underwriting process, but there are some less-complex products that will also be suitable for a small proportion of customers.
He explains, ‘Offering enhancement by profession is using a crude solution, which, if you have enough numbers will work. It is a simple question to ask.
‘If you look at a prison guard for example, they will normally have a poor life expectancy and you can offer them some enhancement. But, if they allowed themselves to go through manual underwriting, they could get much better terms.’
Reliance Mutual is among the providers that are currently developing their enhanced product range. The mutual society is has been selling its smoker annuity through financial advisers for around nine years, but it is about to offer an enhanced alternative.
Philip Bowden, head of strategy implementation at Reliance Mutual, says the organisation is embracing the fact that enhanced annuities are becoming more popular.
He notes, ‘The market is growing and we are in the midst of developing our wider proposition. We want to try and keep the application process simple and we are not going to develop a fully impaired underwritten annuity.
‘We cover smoking, but we will also cover another four or five key sets of conditions on the basis that it can be arranged on a fully automated process rather than individually underwritten.
‘It would include things like body mass index, hypertension and some of the cardio-vascular conditions, so it will be reasonably wide ranging.’
 
When to annuitise
If you are considering taking some enhancement, retiring investors should also consider when they want to buy their annuity.
Insurers are agreed that most pensioners will lose out if they delay buying there annuity and their health remains the same. 
However, if you are one of life’s pessimists or have reason to believe that your health may deteriorate, you may benefit from increase enhancement if your situation worsens. 
As a rule of thumb, the worse your condition, the better your pay out as the insurer will not expect you to live that long!
Aston Goody, sales and marketing manager at MGM Advantage explains that it can be detrimental to defer annuitisation, although there are instances where that is not the case.
He says, ‘One of the things about deferring is that you may become impaired. If you are a 65 year old in drawdown and at 75 you are severely impaired, buy your annuity then, but what are the chances of you becoming impaired if you are not impaired already.
‘That is where advice at retirement becomes so complicated. You are dealing with so many uncertainties. My point was, some people think it is a free lunch by not annuitising but you have to consider the mortality drag.’
Mortality drag describes the investment return an investor would have to make in order to be better off from not annuitising his/her pension fund. Between the age of 65 and 75, Goody estimates that most people will find themselves worse off by 2 per cent per annum by not annuitising ten years earlier.
 
Making a decision
Once you have an idea of the types of products that are on the market, it can be worth talking to a retirement specialist. 
While many investors are skeptical about using financial advisers for investment advice, the pensions arena can be a lot more complicated and it can be worth considering seeing a pensions specialist.
These firms tend to do pensions and nothing else and they will be able to talk you through all of the options available to you.