Creating a secondary annuity market – the regulatory details start to emerge

The next steps in enabling a secondary annuity market to be created were taken last week with the publication of three consultation documents, which are summarised in the articles immediately below.  This follows the Government’s response to the original consultation which set out what needed to happen during the course of 2016 (see Pensions Bulletin 2015/53).

Missing from the action plan are the following:

• The removal of the general prohibition on the assignment of annuities – via changes to the Occupational Pension Schemes (Discharge of Liability) Regulations 1997
• Extending access to Pension Wise to sellers and contingent beneficiaries – the FCA plans to consult on standards for the extended Pension Wise service later in 2016
• Potential adjustments to the social security deprivation rules in order to provide greater protection for public expenditure and more certainty over how annuity assignment interacts with means-tested benefits
• The level at which annuity holders will be required to take regulated advice and what constitutes “appropriate advice” in this regard

More detail is expected to emerge in the coming weeks and months.

Proposed rules and guidance for the secondary annuity market

The Financial Conduct Authority has set out its proposed new rules and guidance for the secondary annuity market with a strong consumer protection focus.  Acknowledging that there is a “significant risk of poor outcomes for consumers in the secondary annuity market” the FCA seeks to mitigate this through a number of measures.

The FCA lists no less than seven risks for sellers in the secondary annuity market, all of which will be apparent to anyone who has given thought to how this market could operate.  The FCA’s policy interventions to address these include the following:

• Disclosure – annuity firms approached by a seller must issue risk warnings (the FCA sets out draft wording for eight risks), recommend that the seller takes advice (even if not required by legislation) and access guidance (such as Pension Wise). In most cases annuity firms must check that “appropriate advice” has been taken.  They must also recommend that the seller shops around and warn them that consent from a contingent beneficiary may be necessary.  Buyers, brokers and adviser-brokers will be subject to cost disclosure requirements
• Presentation of offers – buyers, brokers and adviser-brokers will be subject to a number of requirements – in particular that they must, in most cases, provide a quote of the current replacement cost of the annuity income the consumer is looking to sell if it was to be bought new on the open market. This must be presented in a standardised format alongside the firm’s quote for the annuity income.  That quote must be supplied on an unconditional basis, presented in pounds sterling and net of costs.  Brokers or adviser-brokers must present multiple quotes for an annuity income in a descending order of price
• Restrictions on charging – brokers and adviser-broker firms will need to set out their charges up-front, in writing, and agree them with the seller, rather than being paid potentially variable commissions set by buyers. An annuity provider will only be able to cover reasonable costs when charging to help facilitate annuity income assignment to a third party, or charging for tasks that need to be carried out when buying back

The FCA also proposes that the sale of an annuity income will continue to fall within the scope of the ombudsman service and the Financial Services Compensation Scheme.  A number of record-keeping and other regulatory requirements are also listed.

Consultation closes on 21 June 2016 and the FCA intends to make the final version of the rules in Autumn 2016 in order to help firms to adjust their systems and make any other necessary changes in time for April 2017.

Comment

This paper exposes the well-founded concern that the FCA has for this new market.  But as Government policy is now set, the FCA has to tread a fine line between putting in place consumer protections whilst not imposing undue costs on market participants that will inevitably be passed on to the consumer.  Whether it has struck the right balance (and come up with the most appropriate mechanisms for the market to operate efficiently but safely) will hopefully be tested as part of the consultation process.

The tax framework for the secondary annuity market

HMRC has set out its thoughts on how the existing tax framework will need to adjust in order to accommodate the assignment or surrender of annuity income.

As a reminder, there will be three ways in which the lump sum proceeds of the assignment or surrender are delivered to the individual:

• to a flexi-access drawdown fund – which will be taxed as pension income as normal as the fund is drawn
• to purchase a new flexible annuity – on which income tax will be paid as normal as the annuity is paid
• directly as a lump sum – under which the whole amount will be subject to income tax

Returning to the paper, not surprisingly, significant adjustments need to be made to the tax framework, as follows:

• Conditions under which the payments made as a result of either the assignment or surrender of annuity income constitute authorised payments – with anything falling outside these conditions being unauthorised. The paper sets out different conditions according to whether the proceeds are paid to a flexi-access drawdown fund, to purchase a new flexible annuity or are paid as a lump sum
• Adjustments to the PAYE provisions so that they will operate on the payments received by the individual
• Ensuring individuals who take the proceeds directly as a lump sum are subject to the £10,000 money purchase annual allowance. However, the Government intends that individuals surrendering or assigning “low value annuities” purchased before 6 April 2016 will not be subject to this – details on this are to follow
• Creation of a new benefit crystallisation event for Lifetime allowance testing – applicable in the narrow case where the assignment / surrender takes place after the individual has reached their normal minimum pension age, but before the annuity has come into payment
• New HMRC notification requirements applying variously to insurers who issued the annuities being surrendered or assigned, to those insurers buying back the annuities and to individuals assigning or surrendering their annuities
• Ensuring that where the annuity income is assigned, the recipient of the income is taxed in accordance with the purchased life annuity regime, rather than through PAYE

Consultation closes on 15 June. The intention is to publish draft legislation setting out how this framework will operate for consultation later in 2016, with any remaining changes included in the Finance Bill 2017 for which draft legislation will be published for consultation in Autumn 2016.

Comment

This all appears to be a perfectly logical blueprint, although no doubt, there will be a number of technical points to be addressed, either as a result of this consultation, or when the draft legislation is seen.

Creating the permissions for secondary annuity market operators

HM Treasury has published a technical consultation on the necessary secondary legislation to create three new specified activities in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 that will apply to any person wishing to operate in the new secondary market for annuities.

As the Government intends to restrict buyers in the secondary annuities market to FCA authorised buyers, amendments are necessary to the Regulated Activities 2001 Order to create a new specific regulated activity for purchasing rights under an annuity on the secondary market.  In addition, separate and specific regulated activities are set out for annuity providers buying back an annuity, and for parties acting as an intermediary.

In relation to the first two activities, certain exemptions will be defined by the Department for Work and Pensions in regulations to be laid in May 2016.   The paper does not indicate what these might be.  There will also be exclusions in relation to the annuity broking activity.

The consultation paper also sets out amendments to the Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001, whose purpose is to prohibit retail investment in the secondary market for annuities.

Consultation closes on 2 June 2016. 

Comment

This is a narrow and highly technical consultation with no obvious departures from Government policy as set out in its December 2015 paper.

FCA updates its rule book to reflect some “freedom and choice” issues whilst deferring action in more tricky areas

More than six months after launching a consultation on updating its rules for pension providers in light of the “freedom and choice” regime (see Pensions Bulletin 2015/43), the FCA has finalised its rules and guidance, broadly as proposed in relation to the more straightforward items, whilst deferring action in the more tricky areas on which it had consulted.

Those rules and guidance that have been finalised will, amongst other matters:

• Prevent firms from sending product application forms with wake-up packs and reminders
• Restrict firms sending illustrations that are not requested or required to only those that fulfil the purpose of comparing all the decumulation options offered by the firm, excluding small lump sum payments
• Require firms to make customers aware of the key factors relevant to the option they are seeking information about (and add guidance as to what these factors might be for each option)
• Set out the methodology for firms providing illustrations to customers wishing to access their pension savings flexibly
• Remove the requirement to illustrate a future annuity when a customer goes into drawdown
• Where there is a planned pattern of regular withdrawals, allow firms to show the age of the consumer at the date when funds will expire at each of the assumed projection rates
• Provide a number of suggestions for the ways in which firms can provide information to customers on the sustainability of their income so that consumers have a better idea of how long their funds are likely to last
• Extend existing rules and guidance to uncrystallised fund pension lump sums
• Introduce flexibility in relation to the retirement risk warnings to allow firms to start asking the consumer questions (to identify which risk warnings should be given) before the consumer has decided how to access their pension savings
• Remove the requirement for a firm to go through the question and answer process of the rules where a consumer has a pension pot of £10,000 or less and where there are no safeguarded benefits (but firms are still required to give appropriate risk warnings)

Those matters that have been deferred for further consideration include the following:

• Non-advised annuity purchase – The FCA had it brought to its attention that consumers may experience no saving through purchasing an annuity without advice compared to that purchased through a full advice service. The FCA has chosen to take no immediate action, but instead to gather evidence on the annuity market and the issues involved before coming to a view, via its Retirement Outcomes Review, on the harm which could exist
• Lifestyling investment strategies – The FCA had expressed concern that a number of lifestyling investment strategies may no longer be appropriate in the new environment of much greater choice at the decumulation stage. However, it has decided that its existing rules provide enough clarity as to its expectations and deliver sufficient consumer protection, so it will continue its supervisory monitoring of how firms’ lifestyling investment strategies are evolving in response to the pension freedoms and review its requirements again if necessary
• Pension transfers – The FCA had flagged some important concerns about the pensions transfer value analysis (TVA) that must be undertaken when assessing suitability of DB to DC transfers. But in the light of the responses received it has decided to look further into the issue.  It promises to expose its developing thinking later in 2016

Some aspects of the finalised rules and guidance come in immediately, whilst others will not apply until later – potentially until 6 April 2017.

Comment

It is frustrating that the FCA is no further forward in its thinking on the adjustments that are crying out to be made in relation to DB to DC transfers – both to the TVA methodology and the manner in which information is communicated to clients.  The FCA accepts that the current TVA comparisons are “unlikely to be helping consumers to make informed decisions” – indeed, they say that “it is doubtful if the document is being read”!

Although views differ as to what should be done, there is consensus that something needs to be done.  The current position of testing against a conventional annuity is unhelpful to consumers who may well take retirement income in a different manner.  But quite how TVA may evolve is saved for another day.

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law.  For further help, please contact David Everett at our London office or the partner who normally advises you.