MPs debated annuities last week, an area that the MP initiating the debate, Richard Graham, described as “dull, but important, and absolutely ripe for review and improvement”.

Annuities are becoming an increasingly significant component of retirement income. They are the way in which most people saving in a defined contribution (DC) pension secure an income in retirement. (A DC pension is one that provides a pension based on factors including contributions made, investment returns, any charges applied and market conditions at retirement.)

The annuities market is growing. Already, some 400,000 people buy an annuity each year. And, according to the Financial Services Consumer Panel (FSCP), new business is expected to double by 2015 and then triple in subsequent years. This is due both to the growing maturity of the DC market and the impact of auto-enrolment, which is expected to increase DC scheme membership from around 4-5 million pre-auto-enrolment to more than 12 million by 2018.

Yet, according to the Centre for Policy Studies, 70 per cent of over 55s do not fully understand what an annuity is. In fact, it is a long-term insurance policy that provides a guaranteed level of income, usually for life. But buying one involves a number of important and complex decisions, such as the type of annuity to buy (single or joint life, fixed or escalating), when to buy it and who to buy it from.

All these decisions can have a significant impact on income in retirement. The Work and Pensions Select Committee found that people who purchased an annuity from a provider other than the one they had saved with could receive a substantially higher annuity income; in some cases as much as 20% more. People who suffered from ill-health (and were therefore eligible for enhanced or impaired-life annuities) could see an increase in annuity income of up to 40% from shopping around.

The industry has introduced a code of conduct with the aim of ensuring that customers have access to the information they need to enable them to make an informed decision about annuities, appropriate to their needs and lifestyle in retirement. However, some argue strongly that improved transparency will not be enough. The Opposition, for example, has pushed for a national annuity brokerage service to guide people through the process (see HC Deb 29 October 2013 c790-820). The FSCP, judging that the chances of “mass consumer detriment” were too high to trust to current market-driven solutions alone, recommended further regulatory and government-led structural reform.

The Government’s focus to date has been on ensuring the market works effectively but it has not ruled out further action in future. Its decisions will be taken in the light of the findings of a forthcoming Financial Conduct Authority report on the issue and an industry review of the code of conduct. This is just one part of a complex pension reform agenda, but one likely to increase in importance as more people in future depend on DC pensions for more of their retirement income.

For more on the background, see Library Note SN06552 Pensions: annuities.

Author: Djuna Thurley