Low rates affect bonus of guaranteed pensions

Throughout the 1960s and 1970s, unless you were employed by a company that provided a defined benefit occupational pension scheme, the only people who commonly owned a private pension were high-earning self-employed professionals such as doctors, lawyers and accountants. Most other self-employed people simply made do with savings, property and other investments.

The private pensions were mainly with-profit ones, sold by traditional mutual life assurers. Many included pension guarantees, specifically, minimum annuity rate guarantees that may have been as high as 12 per cent. High rates were even being guaranteed

up to the mid-1980s, though by then, unit-linked pensions became much more widely sold at the expense of the traditional with-profit ones.

Unfortunately, the low interest rates we are now experiencing, which have had a consequential impact on gilt rates - the underlying investment for the annuities - mean that there is a significant cost for companies that offered high guaranteed annuity rates as part of their with-profit pension package 30 years ago.

In Britain, where there would have been many more such policies sold than here, the issue came to a head recently when the Equitable Life, a company that has capitalised on its low-cost, pro-consumer image, is being accused of penalising newly retired pensioners with guaranteed annuity contracts. Such customers are finding that their final discretionary bonus, paid in the last year of their pension contract, has been reduced compared to retirees who did not opt to take out the guaranteed pension plan.

Critics claim that Equitable is cutting the terminal bonuses in such cases to cover the fact that they must pay a higher guaranteed minimum rate on the main part of the pension fund.

One case that has been highlighted in the British press concerns an Equitable customer whose guaranteed annuity rate was 10.15 per cent. He received a discretionary bonus in the final year that was worth £22,674. The annuity that was purchased with the proceeds of his total pension fund (which would have probably been worth about £150,000) resulted in an annual income of £15,209. However, had he opted for the current annuity rate of 9.5 per cent instead of the guaranteed one of 10.15 per cent, he would have received a final bonus worth only £12,438 of the total pension fund, but would have ended up with the same pension income of £15,209. The fact that the same income emerged, despite different annuity rates is due to the fact that the 10.15 per cent annuity rate was applied to a total pension value in which the final year's bonus value had been reduced - in effect to "pay" for the fact that the person had been guaranteed a higher annuity rate when they took out the contract 20 or 30 years earlier.

Though the British Equitable office insists that it is not penalising customers who opted for the guaranteed contract, saying instead that the bonus payments are never guaranteed and are always discretionary, critics, including the Financial Services Authority are not happy with the way Equitable Life has interpreted the terms of the guarantee - in its favour. (This problem has not arisen in the Republic, where Equitable has only been operating for five years.)

Here, this problem of annuity guarantees has also happened, say financial advisers who believe some companies have cut terminal or final bonuses. They also believe contracts now being sold with built-in annuity guarantees of 10-11 per cent cannot be sustained in the current annuity market which is quoting rates of 8.5 per cent.

The other danger of these so-called guarantees, say some advisers, is that they do not apply if the person opts for a different type of annuity than the one specifically stated in the contract.

Even more serious, and commonplace they say is the fact that too many employers and pension companies fail to remind the pensioner that they hold a valuable guaranteed annuity contract with their pension company. Instead, they allow the retiree to (inappropriately) exercise their right to buy their annuity on the open market, thus losing the benefit of the higher, guaranteed rate included in their original contract.

These advisers want stricter regulations dictating the sale of - and the information offered about - annuities introduced (preferably by the Pensions Board). They also want the annuity market to be opened up more, and more types of annuities to be made available. Until then, they recommend that anyone about to retire should look carefully at their pension contracts before they buy any annuity and to seek independent professional advice.