Its two-stage 'thematic review' will take place throughout 2013, and will be taken up by the new Financial Conduct Authority (FCA) when it is established in April. It follows concerns that too many pension savers accept their current provider's offer when purchasing an annuity to provide them with an income in retirement, rather than 'shopping around' for a better deal on the open market.
"The FCA has set out its vision to make sure markets work well so consumers get a fair deal," said Nick Poyntz-Wright, the FSA's head of life insurance. "An annuity purchase is an important one-off decision that has long term consequences for individuals if they get it wrong. We want to understand the level of the potential detriment for consumers if they do not shop around to see if there are ways to make this market work better for consumers."
An annuity is a policy from an insurance company that converts a pension fund, or part of a pension fund, into a regular pension income. Since 2002, pension providers have been required to disclose that savers have the right to shop around for a policy rather than accept the one offered by their pension provider, however only around 40% of pension policyholders do so.
Annuity rates have been falling for a number of years as a result of low interest rates and poor yields on government bonds. According to figures from comparison service Moneyfacts the average standard annuity income for a 65-year-old male fell by a further 11.5% last year - the biggest annual fall since 1998. The firm also highlighted a £355 difference between the most and least competitive annuities available, based on a £50,000 pension pot for a standard level annuity without guarantee for a 65-year-old.
Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that the review was part of an industry drive to increase confidence in pensions following the launch of auto-enrolment for the largest employers last year. All workers will be automatically enrolled into a workplace pension scheme by 2017.
"For auto-enrolment to succeed workers don't just have to save decent amounts, they also need to know how to get the best possible pension from their savings when they retire," he said.
"We have known for a long time that too few pension savers shop around when they come to buy an annuity. Personal pension providers already have to give savers the option to buy an annuity on the open market, but too many seem unaware of this right. Recent ABI initiatives will ensure that members of personal pension schemes are better aware of their options and have access to published rates. It will be interesting to see whether the FSA thinks the pensions industry has done enough already," he said.
The regulator will consider the extent to which consumers suffer from not shopping around, and whether there are particular firms or groups of consumers where this is more likely to occur, it said. As part of this, it will examine pricing data from every annuity provider to investigate how much consumers are losing out from not shopping around, including a comparison of rates available on the open market and those only made available to existing policyholders, it said.
Depending on the outcome of this first phase of the work, a second phase will consider whether firms' processes for providing annuities make it easier or more difficult for consumers to shop around. This work will also take account of a new code of conduct on "retirement choices" from the Association of British Insurers (ABI), which is due to come into force from March. The new code will force insurers to disclose the rates they offer up front, and to make it clear to consumers that they are entitled to shop around for a better deal.
Responding to the announcement, the ABI's Stephen Gay said that the FSA's review was "timely".
"The annuities market is changing with ABI initiatives set to provide people approaching retirement with greater clarity and confidence as they prepare for retirement, and we are pleased that the FSA recognises this," he said.
"With 400,000 people buying an annuity every year, it is vital that we do everything we can to enable customers to make an informed decision, ABI members will work with the FSA as it undertakes this project and look forward to its findings," he said.