Treat the open market option cause, not the symptom

The open market option is not fit for purpose says Tom McPhail, chairman of the Pensions Income Choice Association and head of pensions research at Hargreaves Lansdown

TOM.jpg

The ABI has just announced various process improvements to the open market option, but the fact is these incremental improvements to the OMO are focusing on the wrong problem.

The the real issue is that shopping around should be the automatic choice, not simply an option; the pensions industry should be devoting its energy towards making shopping around the simplest possible solution for as many investors as possible.

Investors are missing out because the system is flawed. After years of trying to get investors to use the OMO, more than half still don’t.

Improving the OMO won’t solve the problem because the OMO is the problem. Shopping around should be the default for all investors rather than simply an option added on as an afterthought.

Here are two reasons why shopping around isn’t simply about finding the best rate, though that is important, but is also about buying the right type of annuity.

Firstly, according to the ABI’s own research, only 10 per cent of eligible investors purchase an enhanced annuity. By buying a standard terms annuity a considerable proportion of them are losing out on a possible increase to their retirement income.

Then there is also the issue that between a half and two thirds of annuities are bought on a single life basis. This means when they annuitant dies the income stops.

Yet most annuities are bought by men and on average their wives will outlive them, with nothing to live on.

The disparity between pension incomes for men and women is stark. In 2008-09, single men received £81 a week on average from occupational pensions, compared with £54 for single women. The disparity for personal pension incomes was even greater, with men receiving £13 per week compared to women’s considerably lower £4.

As occupational pensions decline and individual pensions such as personal pensions, Sipps and Nest, which largely rely on annuitisation at the point of retirement, increase in importance, so the decisions which men make with their pension funds will become more and more influential on older women’s financial security.

Investors are missing out because the system is flawed. After years of trying to get investors to use the OMO, more than half still don’t

The majority of women are married at the point of retirement. But for those who reach their 80s and beyond, widowhood is increasingly likely.
Last month Nest published research on the problems with pensions jargon. The story is covered in detail elsewhere in this issue, but two statistics from that research serve to underline the importance of not relying on the OMO.

Nest’s research shows that just 10 per cent of those surveyed ’completely understand’ the term ’Open Market Option’ and just 23 per cent of respondents understood the term ’Annuity’.

The Pensions Income Choice Association has campaigned over the past 18 months to make shopping around the default option for investors.

Our proposals include making shopping around at retirement the default for all retiring (money purchase) pension investors, developing a three step process, including the Pensions Passport, to make shopping around easy for investors and introducing a stand alone £5,000 limit for money purchase pensions to pay out benefits as a lump sum at retirement, ie trivial commutation.

We also want to see the development of a network of shopping around providers which can help investors decide how best to draw their retirement income.

Everyone has the option to choose the right product to provide their retirement income and on the most advantageous terms, but those who most need to do this are failing to do so. We have the opportunity to help improve their finances during retirement. We can achieve this without any substantial direct cost to government, without any significant burden on industry and without any major sacrifice from individuals. We must take this opportunity.