Facing the future

New rules are now in play forcing life offices to inform customers of their right to use the open market option (OMO) when buying annuities. This is so people look at providers other than where they have their pension to find the best deal.

Ultimately, this should lead to more people seeking advice from IFAs. Currently, around 60% of retired people are not doing so, yet the discrepancy between the best and worst paying providers can still be as much as 30%.

An estimated 40% of people in the UK could access even higher rates than those offered by the most competitive standard annuity providers, by purchasing 'enhanced annuities.' And advisers have a key role in communicating this message to clients.

Standard annuity rates are determined by the average life expectancy of males and females ' with annuitants who fall short of average life expectancy subsidising those who outlive the average age life expectancy. Standard annuity providers enhance rates to some degree by offering better rates to males than females because males have a reduced average life expectancy. Enhanced annuities work in much the same way, awarding preferential rates on the basis of anticipated shortened life expectancy.

There are four kinds of enhanced annuity. These are targeted at smokers, people with semi-impaired or impaired health and those working in risky occupations.

Smokers

If your client smokes five or more cigarettes a day and has done so for the last 10 years, they may qualify for enhanced annuity rates from the likes of Britannic Retirement Solutions, British Life and GE Life. If your client stops smoking after having purchased an annuity, the income will not be affected.

However, it is estimated that less than 10% of smokers in the UK, who could qualify for an increased income from a special rate smokers' annuity, are actually buying them. The Annuity Bureau believes last year only 2,500 to 4,000 smokers bought smokers' annuities from a potential 40,000 individuals who could qualify.

A male smoker aged 55 and a client of The Annuity Bureau recently obtained an uplift of over 16% above the annuity rates offered by his existing provider by switching to a smokers' annuity. This is the equivalent of an additional retirement income of over £435 a year for the rest of his life.

Impaired health

Your clients may qualify for enhanced annuity rates if they are in ill health, or have had previous illnesses or major surgery likely to reduce their life span. These types of annuities can typically be split into two groups:

n Semi-impaired. Applies to people with illnesses such as diabetes, liver impairment, hypertension that cannot be controlled by medication, high blood pressure and obesity as well as people with a combination of these illnesses. Individuals within this group may qualify for better annuity rates without having to undertake a full medical examination. This is a growing market which is still evolving.

n Health impaired. Applies to people with more life-threatening illnesses such as heart conditions and many types of cancer, whether or not they are in remission. Annuities for these people take longer to set up than usual, as correspondence between doctors and the annuity companies will often increase the administration time by a few weeks and a full medical may be required.

For both groups, the health of the client's spouse or partner should also be assessed, because this may improve the income received on a joint life annuity basis ' even if the main life is healthy.

Occupation

In the past few years, attention has also shifted to the impact that geography and occupation has on life expectancy and how this should affect annuity rates. The Office of National Statistics (ONS) conducts regular studies looking at how the population in different areas of the UK is susceptible to deadly diseases.

The survey covers cancer (general, lung, prostrate and breast), heart disease, stroke and alcohol-related deaths. In August last year, the study indicated a massive North/South divide, with Scotland and the North of England having a higher than average incidence of deaths from most of the diseases covered. This is in part due to lifestyle. In Scotland, in particular, a much higher proportion of the population smokes and has an above-average consumption of alcohol.

The survey highlights the vulnerable areas elsewhere which include the poorer sections of big cities, older industrial belts and some surprising hot spots for certain diseases. Prostrate cancer, for example, has a higher than average incidence in Hampshire and Dorset.

The ONS survey focuses on another factor that impacts on life expectancy ' occupation.

The study reveals people in professional or managerial occupations are likely to live longer than those in manual or poorly- paid work.

Life expectancy factors highlighted in the ONS surveys were the key drivers behind the development of MGM Assurance's Select Annuity. It offers enhanced rates to people living in the north of England, the Midlands, Scotland, Wales and Northern Ireland working in manual occupations. This means a perfectly healthy postman in Yorkshire can obtain a better annuity rate than those offered by the best standard annuity providers.

Postcode lottery

In the summer, CGNU announced it is also conducting its own research into the link between life span and location, with a view to using this data to help calculate annuity entitlements.

By including UK postcode information in its annuity mix, CGNU hopes to identify areas where life expectancy is low and areas where residents typically experience increased longevity.

This announcement provoked a lop-sided reaction from some annuity critics who claim wealthy retired people will lose out because they tend to live in areas where life spans are long.

The first point is that is unlikely postcode information would be used in isolation, since it would be unlikely to base annuity rates solely on where someone lives. Annuity providers are more likely to use several demographic and lifestyle factors when calculating rates.

The second point is the wealthy should not lose out due to where they live since the annuity rate they achieve should be in line with their particular life expectancy ' with their annuity paying out an income for as long as they live.

Just as general insurers use post coding to match the right premium to the right customer, it is likely that CGNU, just like MGM Assurance, will also use this additional information to provide more competitive annuity rates.

There is likely to be much more innovation in this field in the years to come, but even as the market stands now, the take-up of impaired life annuities is appallingly low.

The Financial Services Authority may be flagging up the importance of shopping around for an annuity, but still too little is done to alert retired people to the existence of this wide array of specialist products. Timing is opportune for advisers with clients approaching retirement. Helping people enhance their pension income by up to 40% will create tremendous goodwill and word will spread like wildfire.

However, ensure you know what you are doing because if the wrong annuity is purchased, the decision is irreversible and your client will be stuck with an inferior income for life. With investor confidence languishing on the floor, it is vital for retired people to make informed decisions. If they do not, it is the surest way for them to lose out on valuable pension income. Advisers would be wise to alert potential clients to the fact that there are many annuity options for them to consider.

Peter Quinton is managing director of the Annuity Bureau