The Pensions Advisory Service (TPAS) have just put out some statistics about the number of pensioners who hit retirement age, don’t take their pension annuity, and choose to carry on working. 

Figures produced by the Office of National Statistics (ONS) show that there are now 1.3 million people who’ve reached state pension age, but are continuing to work because they can’t afford to retire. Not only that, but the people in this group are the fastest-growing age group in the UK workforce and, over the last three months they’ve accounted for a staggering 46% of the UK’s entire rise in employment (of 76,000 people).

Now, getting old and working on isn’t necessarily a bad thing, but what would be nice would be if people did so out of choice. The implication here is that the people ‘choosing’ to work on have little choice in the matter.

Should the terminology surrounding annuity options at retirement be clearer? Should the term ‘open market option’ (the option to shop around for a better annuity rate) be replaced with something that clearly spells out the value of shopping around.

Many do not understand what the term means and end up with an inferior annuity. Companies that believe the term ‘open market option’ should be made more consumer-friendly include HBoS, HSBC Life, NFU Mutual, NatWest Life, Norwich Union, Scottish Life and Skandia. NFU Mutual says anything more consumer-friendly would be of great benefit, while HBoS says it does not use the term ‘open market option’ in literature, instead referring to it as ‘buying from another provider’. However, Prudential says: ‘The key is that consumers should be clear they have choices. A simple name change will not make the concept more consumer-friendly’.

Consumers should be encouraged to shop around. However, often as a result of misleading literature and time pressure, people sign up to the annuity offered them by their insurer without realising they have the right to shop around. Companies say the open market option should not be the ‘default option’. Scottish Widows says it is key that people are made aware of the annuities from their pension fund provider because they may offer preferential terms, such as a GAR option.

Too many people have saved too little so need to get the best value from their pensions savings, and insurers are a key part of this…..clearly some are committed to putting their commercial greed before their customers’ interests.

Maggie Craig, Director of Life and Savings, Association of British Insurers: ‘Customer communications on annuities are of mixed quality, as the ABI has acknowledged. Buying the right annuity is very important and customers must be empowered to make an informed choice based on their needs, wants and personal circumstances.

‘The ABI is working hard with companies, consumer groups and the regulator to produce new wording for ”wake-up” letters. We want to ensure that people are aware of all the different types of annuity available and of their rights to exercise the open market option by shopping around. ‘We hope to implement these changes by the end of the year.’

Some good news for those people buying annuities, even though the world economy is going through significant changes which we are all suffering from. There is an adverse impact on house, food and utility prices. However, with this particular cloud, there is a silver lining. Annuities are cheaper than for some time, which means anyone retiring can enjoy a boost to their pension.

The gilt and bond market has been through a relatively challenging period recently, linked to the credit crunch, the expected rise in UK inflation and uncertainty about interest rates. This has had a knock-on effect on annuities. Annuity rates are now at their highest for five years and developments in the bond markets recently suggest that attractive rates will remain in the short term at least. It could be a good time to buy that annuity.

Statements from Jean-Claude Trichet, President of the European Central Bank, have been interpreted as signalling an upward move in interest rates despite economic conditions. Gilt yields have jumped in response.

So what has happened in the market in recent months to cause such a rise? Gilts are issued by the Government to raise money, and pay a fixed interest in return for the loan, their main attraction to investors being security.

Corporate bonds are issued by companies and work in a similar way, but compared with Government bonds are less secure as they have a higher risk of default.

Towards the end of last year, following the Northern Rock crisis, we saw a degree of panic among investors who, in a flight to quality, sought greater security of investment return.

This meant demand for Government gilts rose significantly. In tandem there was a reassessment of risk on corporate bonds, which were perceived to be more risky than their price implied. Investors therefore pulled out of bonds, causing prices to fall.

Previously, ’spreads’ (the difference in yield between bonds and gilts) were around 1%, implying that 1% was a reasonable reward for taking the risks that companies might not make payments. Investors, however, concluded this was not an appropriate differential, and demand for, and the price of, corporate bonds fell.

The combined effect of high demand for gilts and low demand for corporate bonds pushed the difference in yields between the two types of investment to historically wide levels in the last quarter of 2007, with investors demanding an extra 2.5% per annum return for investing in corporate bonds rated ‘A’ by Standard & Poor’s.

However, in recent months we’ve seen spreads narrow again as gilt valuations have started to fall back and bond valuations have started to rise, which suggests that the market had overreacted.

One aspect of the market at present is uncertainty, and this is affecting all asset classes. Some experts believe that investors are seeking out returns wherever they can be found and to a large degree the fundamentals, that is the core statistics normally used to assess the value of the bond such as the likelihood of companies being able to make interest or principal payments, are largely being ignored. Consequently there is still significant volatility in the market.

This market activity has impacted on annuities, which are priced on the expected returns on the investments that back them, mainly corporate bonds. When product providers set annuity rates they look at the rate they expect to earn on assets that they invest in, such as long-dated corporate bonds. Over the past year the rate on corporate bonds has increased, and so too have the annuity rates on offer. The amount of income you can buy with a £100,000 fund has increased by more than 6% since the start of the year.

Whether these high rates continue depends on whether insurers can continue to invest to get these high returns. This in turn depends on how the market continues to view the risk of investing in corporate bonds, and how it views long-term interest rates, which will affect gilt rates.

We are starting to see some reduction in spreads as some confidence returns to the corporate bond market. However, spreads are still well above long-term levels and it will take some time to get back to levels based on fundamentals.

The good news for those about to cash in their pension pots and buy an annuity is that it looks like rates will continue at these relatively high levels for some time.

Do we understand enough about annuities to love them? Do we understand how important an annuity is in the context of the job it does? As Jane Austen wrote in Sense and Sensibility in 1811: “An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it.”

Over half of Britons would be worried about financing their retirement if they were to live for 10 years longer than today’s average life span of 82 years, according to research released by Life Trust. People are living longer than ever before. A person aged 50 today has a one-in-two chance of reaching 90 and a one-in-10 chance of reaching 100.

This adds more pressure to existing concerns for many about their finances. Four in 10 people questioned for the research said that they were worried about financing their retirement if they were to live for the average life span.

Pensions continue to be the most advantageous way of financing retirement from a tax perspective, but lots of people avoid them because you have to buy an annuity. Paying all your retirement fund to an insurance company for what often seems a disappointingly low level of income (which disappears when you die) can seem unattractive.

But increasing longevity arguably makes annuities more attractive. For anyone worried about the significant risk of living to 100, an annuity, particularly an index-linked annuity that rises with inflation, is probably the most attractive solution available. It provides a guaranteed income for the rest of your life and it takes away the worry associated with looking after your money and investments. 

It is fair to say that retirees are often not being offered the right annuity. All too often they get an annuity under a ‘one size fits all’ guise, which is clearly wrong. Insurers should provide customers with annuity options according to their marital status, health and need for financial protection. The ‘open market option’ (OMO) is important.

When insurers send customers details of the annuity they can buy, most offer few options. Typically, they quote for single life, even though the retiree may be married, with income level throughout retirement, thereby providing no protection against inflation.

Payments are typically guaranteed for five years, which means that if the purchaser dies early, the estate receives a sum equivalent to five years worth of payments. Most insurers issue these quotes on the basis of a customer either taking maximum tax-free cash, typically 25% of the pension pot, or no tax-free cash at all. Many insurers quote this way.

Some insurers are more customer friendly. Prudential, for example, provides annuity quotes with or without guarantees and also with income either remaining level or escalating at 3% annually. It also quotes both with and without a spouse’s pension.

Really, all insurers should offer the option of an enhanced annuity. Only around 10% of retirees purchase them, even though 40% are eligible.

A number of insurance companies offer customers annuities that pay an enhanced income in recognition of their poor health. Insurers pay more because they expect the annuitant not to live as long. Among those now providing enhanced annuities include Canada Life, Just Retirement, Partnership, LV=, Norwich Union, Prudential, Scottish Widows and Standard Life. 

All insurers should make great play of the benefits of shopping around. According to the FSA, 40% of companies fail to spell out properly the benefits of shopping around. The Pensions Advisory Service is uesful here…it gets users to consider all the key annuity issues - such as guarantee periods, protection against the ravages of inflation and financial protection for spouses.

Other insurers, prompted by the FSA, also promise to give greater prominence to OMO. Some will point customers in the direction of both the FSA MoneyMadeClear and The Pensions Advisory Service websites.