July 2008

In this statement we set out the results of our thematic work on Open Market Options (OMOs).  Announced in October 2007, this review is part of our commitment to the Government's continuing work on the effectiveness of the OMO.

There were two parts to our review:

  • we looked at the quality of firms’ literature issued to pension customers as they approach retirement outlining the OMO; and
  • we examined alleged delays by some pension firms in transferring OMO funds to new annuity providers.

This review links to our work on ‘treating customers fairly’ (TCF) and the extent to which firms have implemented their TCF programmes and are delivering improved outcomes for consumers. It reveals some good practice, but also that many pension firms must make improvements to their OMO literature and processes. We have given individual detailed feedback to all firms involved in our review.

Where remedial work is required, we expect firms to complete this by December 2008, in line with deadlines on other wider TCF work. We will scrutinise how firms have responded and will consider further action where positive change is not evident (including enforcement action where appropriate).

The decision on whether to buy an annuity from a 'host' insurer or to purchase one on the open market is important, as it influences an individual’s lifetime income. In our Financial Risk Outlook 2008 we noted that despite the significant variation between annuity rates, only around 40% of policyholders exercise the option to buy their pension on the open market. We said that there was a risk that if insurers’ communications around selecting retirement options were insufficient or unclear, policyholders may make poor decisions or fail to take active steps to maximise their retirement income.

Our OMO rules can be found in COBS 19.41.   Principles 6 2and 7 3are also relevant.

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Summary of research findings 

Part 1 - Quality of OMO literature

We asked all insurance companies that write pension annuity business to provide examples of their wake-up packs (sent between four and six months before the retirement date) and the reminder packs (sent at least six weeks before retirement). We reviewed and scored around 80 packs from 55 firms or groups of firms4, against the OMO rules and Principles 6 and 7.

Overall we found some good examples of literature which clearly set out customers' options, including explaining the potential benefits of exercising the OMO. More than 60% of the firms give material to pension customers approaching retirement age that provides clear information to enable policyholders to make informed decisions about their retirement options. However, almost 40% of firms have material for one or more products that fails to meet our requirements.

The results are summarised in Table 1.1. In scoring firms' literature we distinguished between:

  • material that did not meet the OMO rules and Principles;
  • material which meets the minimum requirements of the rules and Principles; and
  • material which exceeds minimum regulatory requirements, clearly demonstrating best practice in OMO literature.

Table 1.1: Summary of review findings

 
  Material must be improved (does not meet OMO rules and Principles) Material meets minimum requirements Material exceeds minimum requirements (demonstrating best practice for OMO literature)
No. of firms
21
24
10
%
38
44
18

 

We did not find any link between the quality of a providers' OMO literature and the level of annuity rates it offered. Nor did we find any link between the quality of literature and the type of firm; for example there was no link to small/large, closed/open or mutual/proprietary types of firm. Good or poor material was equally likely to come from any type of firm, offering any level of annuity rate.

We found it difficult to draw simple conclusions about what is the 'right' level of OMO transfers. A significant proportion of firms have guaranteed annuity rates (GARs) applicable to a part of their legacy policies, and it is logical to assume that these older policies are the ones that are maturing now.  And customers may wish to avoid penalties on with‑profits policies incurred if they transfer away (market value reductions, or MVRs).  Others may take advantage of the option under the pensions tax regulations to commute benefits on grounds of triviality.  Only by looking at an individual firm, taking into account the type of policies, the quality of the communications, its customer profile and its in-house annuity rate is it possible to assess whether its OMO take-up rate is an indicator of TCF.

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What we found – areas for improvement

The following findings illustrate the areas of poor practice that we found.

  • Not explaining the advantages of exercising the OMO.

Several firms stopped short of actually explaining that exercising an OMO can result in a higher pension. Other firms explained the OMO as where 'you can get another firm to pay the pension' which in itself does not suggest any advantage to the customer. To comply with our rules, and with Principles 6 and 7, firms' literature should include a clear message that exercising the open market option might result in a higher pension and is therefore worth investigating. The wording firms use should also have regard to the realistic possibility of whether their customer base is likely to be able to shop around, for example most firms impose minimum fund sizes for taking OMO business of say £10,000 or £20,000.

Very few firms mentioned the advantages of shopping around for customers with health problems, who could be better off buying an annuity from providers offering impaired life or enhanced rate annuities.

  • Prominence of information

Generally, the OMO itself was given sufficient prominence in firms’ material, but in some cases it was hardly mentioned or left until late in the wake‑up letter, with the main focus on the firm’s own annuity products.  Care needs to be exercised to ensure that the OMO is given proper prominence and that there is an appropriate balance between the information provided on the OMO and on the firm's own annuity products.

Some firms failed to give sufficient prominence to important information and key decisions. Although there is no set order in which issues or options should be explained, firms should tailor their communications to the circumstances of their policyholders and policy terms and conditions and not rely on standard industry templates. For example, if the average fund is less than £10,000 then the explanation of triviality commutation might appear sooner in the letter than where the average fund is £25,000. Where there is a GAR (which is significantly higher than market rates) this should be prominent, making clear when it applies and in which circumstances it could be lost, such as exercising the OMO or deferring retirement.

  • Illustration of GARs

Not all firms are using their guaranteed rates in their default annuity illustrations, even though they would result in significantly higher incomes for policyholders.   This results in the policyholder getting a misleading view of the in-house pension and could lead them to underestimate the value of the GAR and choose an option where it would be lost. 

  • Relevance of information

Some firms tried to explain technical points when they were unlikely to be relevant to most of their customers. For example, some firms took a whole page of the wake-up letter to explain the lifetime tax allowance and the tax penalty that would be imposed for providing misleading data – while separately indicating to us that most of their policyholders had funds of less than £10,000. In some cases this meant that much more important information such as GARs or penalties for deferring retirement were therefore less prominent as a result.

  • Relevant information not grouped together.

In several examples the retirement options were not linked with the relevant consequences. For example the option of deferring retirement appeared on the first page but information explaining the implications of this decision (in terms of incurring an MVR) appeared separately and much later on in the pack. Similarly, the interaction between MVR free-dates, GARs and the OMO was not always clearly explained.

  • Mixing up the best type of annuity with the best rate.

Too many companies blurred these issues into one, to make statements such as 'no one insurance company can provide all different types of annuity and there is no best type that suits all'. Another firm said 'there is no such thing as the best rate'.  Both these statements are misleading. There are different types of annuity and while no one type will suit all, once a policyholder has decided on the right 'type' for them, there are different rates available. Firms' literature should make it clear that policyholders have the option of shopping around and that by doing so they could get a better rate. 

  • The weak flagging of advice.

Several firms did not make clear the value of seeking advice in making a decision. Sometimes the reference to seeking advice was weak, and was not linked to exploring the OMO.

  • Using the FSA factsheet on buying a lifetime annuity: 'Your pension – it's time to choose'.

If firms choose not to use our factsheet, it is particularly important that their own communication covers all of the relevant issues in a way which enables the customer to make an informed decision; some firms failed to do this. Where the factsheet is used, firms are still required to provide a written summary of the customer’s OMO which is sufficient for the customer to be able to make an informed decision. Some firms failed to do this and simply referred the customer to read the FSA factsheet.

We also found some firms using the wrong FSA factsheet – the correct one can be found on our Moneymadeclear website and is entitled 'Your pension – it’s time to choose'.

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What we found – examples of best practice

Some firms achieved excellent communications covering all of the key points in a two- or three-page letter with clear headings. There is no standard format that constitutes a good wake-up pack – it should be tailored to the specific situation of the group of policyholders taking into account such things as the average fund size, the existence of GARs and MVR free-dates and the firm’s competitive position of their own annuity rates. The best examples contained concise details of the following points in a covering letter and enclosed the FSA factsheet:

  • Scene‑setting and timetable.
  • Option of drawing benefits now or deferring them.
  • Option of drawing some benefits as tax free cash; taking the rest as regular income, either as an annuity or using income withdrawals.
  • Option of buying an annuity from the existing provider or shopping around using the OMO for a higher income, making it clear that other firms may offer better annuity rates.
  • Impact of any GARs and/or MVRs and their relevance to using the OMO as well as deferring taking benefits.
  • Where relevant, information about commutation on grounds of triviality.
  •  A short summary of the tax allowance limits.
  • Where to get help, including the advantages of taking professional advice.

Individual feedback

We have given individual feedback to all firms involved in this part of our review, setting out our views on their OMO literature.  Where remedial action is required, firms are expected to complete this by December 2008, in line with other wider TCF deadlines.

 Part 2 – Alleged delays in transferring OMO funds

Introduction

Allegations have been made that some pension firms consistently take a long time to process OMO requests and delay the payment of OMO funds.   Several stakeholders gave us anecdotal and other evidence in confidence, including the names of those pension firms most likely to delay payments.  In contrast, pension firms have defended their positions and generally rejected those allegations. To examine this issue we selected for thematic investigation the 14 firms whose names cropped up most often in external submissions.

We reviewed files for 238 cases, selected at random, from lists supplied by the 14 firms included in this part of our work.  This represents around 10% of the cases processed by these firms during January 2008.  For the purposes of our review, no distinction was made between ‘true’ OMOs and full transfers.

We focused on the time taken by the transferring firm to pay OMO funds once it had received all the necessary documents and information, but inevitably took account of other parts of the overall process. We did not measure the time taken by transferring firms to respond to requests for annuity illustrations. Most cases were initiated by pension firms as part of the ‘wake-up’ automatic process as customers approach retirement age, with annuity illustrations being provided as part of that process. We used a period of ten business days5 as a minimum standard for transferring funds by pension firms once all documentation was complete.

We also looked at the stages before final payment of the OMO funds and examined the time taken by receiving scheme operators, customers and their advisers to respond to requests from transferring firms for documents or other information. And we used the same standard of ten business days to decide whether the time taken by other parties (including intermediaries and customers) in submitting documents and information to the transferring pension firm was reasonable.

We also obtained and reviewed firms’ management information in this area.

Results of our review

We found delays in 147 (a little over 60%) of the 238 cases reviewed. Of these 147 cases, unacceptable delays were caused by transferring pension firms not paying the OMO funds within ten business days of receipt of all documents in 62 cases (26% of the total reviewed).

Delays were caused by other parties in 85 cases (36% of the total reviewed). This means that customers, their advisers or receiving scheme operators took longer than ten business days to supply a document or other information to the transferring firm.

On a more positive note, the remaining 91 cases were completed without undue delay by any party involved (and in fact all were paid by the transferring firm within five business days of receiving all documents).

We found that there is room for improvement on all sides – transferring pension firms, receiving pension firms, intermediaries and their customers.   Delays can arise at any time during the overall OMO process and have many causes.   One of the main reasons for delays in the OMO process is the sheer multiplicity and variety of pension firms’ requirements and documentation.  Inevitably, this leads to confusion and lack of understanding on the part of customers and their advisers, which in turn results in delays.   We believe that there would be significant improvements if processes and documents were rationalised and standardised across the OMO market.

We found significant shortcomings in the depth and quality of management information (MI) maintained by transferring pension firms about OMO processing times.  Only three firms submitted MI in the format requested.  These firms’ data showed comprehensive information on processing times for paying OMO funds enabling them to measure performance against internal and external standards over various periods of time.  The remaining 11 firms submitted MI below an acceptable standard of depth and scope – for example, failing to show trends, just recording the time for the overall OMO process or using legacy computer systems that do not provide adequate MI.

Next steps

Individual feedback has already been given to all 14 pension firms involved in this part of our thematic work, giving our view of the firm’s performance and indicating where any remedial action is required.   Firms are expected to complete any remedial action by December 2008, in line with other TCF deadlines.

We note that the ABI has set up a working group of pension members which is looking at the issue of improving and standardising OMO transfer procedures. We intend to liaise closely with the ABI and other stakeholders to ensure that this work reaches a successful conclusion. We welcome the ABI’s initiative and urge all provider firms to join in this process and adopt the new improved transfer procedures.

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1COBS is part of the FSA’s Handbook of rules and guidance, dealing with retail investment products, including personal pensions.

2A firm must pay due regard to the interests of its customers and treat them fairly.

3A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.

4 The review did not include material from scheme operators other than insurance companies. Customers of these other operators must exercise the OMO to purchase an annuity.

5We adopted 10 business days, in line with the periods quoted in the relevant ABI statements of good practice in force at the time (10 business days for pension transfers and 14 calendar days for pension maturities).