Electronic Trading Platforms
Upcoming SlideShare
Loading in...5

Electronic Trading Platforms






Total Views
Views on SlideShare
Embed Views



0 Embeds 0

No embeds


Upload Details

Uploaded via as Adobe PDF

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
Post Comment
Edit your comment

    Electronic Trading Platforms Electronic Trading Platforms Document Transcript

    • ARTICLE IN PRESS International Journal of Information Management 26 (2006) 187–195 www.elsevier.com/locate/ijinfomgt Electronic trading platforms and the cost-effective distribution of open market option (OMO) pension annuities Jens Hagendorff, Robert HudsonÃ, Kevin Keasey Leeds University Business School, Maurice Keyworth Building, The University of Leeds, Leeds LS2 9JT, UK Abstract Over the next years, the ageing profile of the UK population will lead to a sharp increase in the volumes of pension annuity sales. Every individual that participates in a defined contribution occupational or a personal pension scheme is obliged to convert the capital accumulated into a regular post-retirement income by purchasing an annuity before the age of 75. To ensure a more competitive market the UK Financial Services Authority has ruled that from 1 September 2002 pensioners must be informed that they have the right to purchase their annuities from suppliers other than their current pension provider—this is termed exercising an open market option (OMO). However, the complicated nature of pensions and annuities means the purchase of an annuity is highly dependent upon the information provided by the sellers of these products and the advice received. Given that OMO’s are supposed to encourage purchasers to be able to access information on a whole range of annuities from the various suppliers in the market, a single web-based hub that linked manufacturers, distributors and existing industry portals seemed the obvious solution to the challenges facing the industry following the government legislation. However, while the industry recognised that a single product purchasing and servicing system would meet the data management needs of all its stakeholders and carry enormous potential to realise cost and business process efficiencies, the competitive nature of the industry and the slow decision making processes within the individual companies has meant that the project to build ‘The Annuity Exchange’ has suffered a number of setbacks and delays. This article describes the business case for ‘The Annuity Exchange’, its objectives and design, and the technical/industry engagement issues it has faced. r 2006 Elsevier Ltd. All rights reserved. Keywords: E-commerce; Financial services; Pension annuities 1. Introduction An annuity is an insurance contract that allows a lump sum to be exchanged for an income payable for the rest of the life of an individual. In broad terms its purpose is to ensure that an individual cannot outlive the funds they have accumulated for their retirement. Under UK legislation individuals that participate in defined contribution occupational pension schemes or in personal pension schemes are obligated to purchase an annuity on retirement with the proceeds of their pension schemes. The annuity purchase is normally ÃCorresponding author. Tel.: +44 113 343 1677; fax: +44 113 343 4459. E-mail address: rsh@lubs.leeds.ac.uk (R. Hudson). 0268-4012/$ - see front matter r 2006 Elsevier Ltd. All rights reserved. doi:10.1016/j.ijinfomgt.2006.01.001
    • ARTICLE IN PRESS 188 J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 undertaken at retirement but must take place by the age of 75 at the latest. The ageing profile of UK society means that the demand for annuities is expected to grow substantially for the foreseeable future. The UK Government has recognised the problems posed by an ageing society and in response to concerns about the adequacy of private pensions savings, the Financial Services Authority ruled that pension providers were obliged to inform retirees about their right to shop around for the highest annuity rate when their fund matures; this right is known as exercising an open market option (OMO). However, the fact that a majority of policyholders do not exercise the OMO and, instead, continue to take their annuity from the company with which they built up their pension fund means that thousands of future pensioners forsake part of their post- retirement income each year. The nature of pension annuities makes their manufacture and distribution highly dependent upon the information flows that underlie them and this, at least, partly explains why most people have not exercised the right to an OMO. Essentially, customers needed easier access to the full range of annuity products on offer and explanations of the various aspects of the various products on offer. The Annuity Exchange was established to meet the needs of consumers and suppliers following the change in legislation, which led to consumers being offered the opportunity (OMO) to purchase their annuities from the whole range of suppliers in the industry. This article describes the business case for ‘The Annuity Exchange’, its objectives and design, and the technical/industry engagement issues it has faced. By replacing the current patchwork of industry portals and supply by individual providers, The Annuity Exchange (a single product purchasing and servicing platform that supports every stage of the annuity purchasing process) has the potential to realise substantial cost and process efficiencies for manufacturers, distributors and consumers. Most importantly, it can provide the quality financial advice that is required for consumers to make well-informed judgements about their post-retirement income needs. While the increased availability and quality of financial advice and the pervasive process efficiencies for those involved in the manufacture and distribution of retirement products of The Annuity Exchange have been recognised by all the industry players, competition within the industry and slow decision making within the individual companies has hampered The Annuity Exchange and the benefits it can bring UK society as a whole. 2. Background: the UK pensions system and the regulatory structure of advice 2.1. Recent trends in the UK pensions system Increasing longevity and low birth rates will result in a substantial increase in the number of people aged 65 and above and the proportion they form of the population. In a report initiated by the Government, the Pensions Commission (2004) forecasts a doubling in the percentage of the population aged 65 and over in the next 50 years and calls for substantial adjustments in public policy as well as in private retirement and savings behaviour. In the UK, a low level of state pensions is combined with an extensive system of private funded pensions; the latter being responsible for the bulk of income replacement after retirement. Participation in employer-sponsored pension schemes varies greatly by sector—from about 30% in the private sector to an average of 90% of all public sector employees. Alternatively, employees who are not members of employer- sponsored schemes and self-employed individuals may subscribe to personal pension arrangements. Within the employer-sponsored sector, there has been a major shift from ‘defined benefit’ (i.e. final salary) to ‘defined contribution’ (DC) pension provision after years of low equity returns. Under the terms of a DC scheme, employees accumulate capital with a pension fund throughout their working life, which they eventually turn into a regular post-retirement income by purchasing an annuity. Individuals with personal pension arrangements are also obliged to use the capital they have accumulated to purchase an annuity. The most common types of pension annuities include standard level (i.e. the annuity rate is fixed over time), fixed rate increasing (increases by the same amount year), and inflation-linked (e.g. RPI-linked). The income from annuities is paid for life (single annuity) or, alternatively, is passed on to the spouse upon the death of the annuity holder (joint life annuity). Finally, impaired life annuities take into account the shorter life expectancy of their holder by paying a higher rate than conventional annuities. It is a crucial aspect of the UK pensions system that consumers, once their pension fund matures, are given a choice of whether to buy an annuity from their pension provider or, alternatively, to use the capital
    • ARTICLE IN PRESS J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 189 accumulated in the fund to buy an annuity from another insurance company. Currently, only one in three consumers exercises their ‘OMO’ and ‘shops around’ for the highest annuity rate; however, the shift to DC schemes and rising levels of customer awareness are expected to lead to a sharp increase in the total numbers of OMO annuity purchases. 2.2. The changing structure of advice The Financial Services Authority (FSA), the chief financial regulator in the UK, is not satisfied with the level of quality and availability of advice given to consumers on financial products and has, hence, commissioned a major overhaul in the regulatory framework of advice (FSA, 2002). Previously, under a polarised advice structure, consumers could only choose between tied advisors that act as agents of the manufacturer whose product range they market and independent financial advisors (IFAs) that are obliged to search the entire market in an effort to find the most suitable product for their clients. The new depolarised advice structure, by contrast, permits the emergence of multi-tied advisors that will not have to depend on the product range of a single large manufacturer and, instead, source the most suitable annuity products from different manufacturers on the basis of commercial considerations. By the same token, a growing number of manufacturers are expected to specialise in the production of those financial services for which they have a competitive advantage. This trend has already become evident in the insurance industry when Barclays announced in 2001 that it would close its life fund to become a distributor of Legal and General’s life insurance products. As regards the pension annuity market, it is conceivable that some pension providers will start sourcing annuities from a range of insurance companies instead of converting funds into regular post-retirement incomes themselves. In a recent paper, Littler and Hudson (2004) argue that the depolarisation and the wider product adoption between manufacturers that will immediately follow it will lead to increased specialisation within the industry. Specialisation, in turn, gives rise to increasingly complex information flows between the manufacturers and distributors of pension annuities as demonstrated by Fig. 1. The emergence of enhanced linkages between manufacturers and advisors will crucially depend on whether information flows between the two parties can be organised in an administratively efficient and profitable manner. Against this backdrop, there is a clear need to develop business interfaces that cater to the increased need for interactivity between the firms (manufacturers and distributors) involved in the annuity purchasing process. The success of these interfaces in facilitating information flows will ultimately depend upon whether Increasingly Specialised Manufacturers A B C D Bancassurer Adopted Product Adopted Product Set of A Set of D Whole Market Multi-Tie Single IFA Tie to A, B & D Consumers Fig. 1. Interactivity between firms (Source: Littler & Hudson, 2004, p. 288).
    • ARTICLE IN PRESS 190 J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 distributor firms can engage in product comparisons, sales and servicing activities across different OMO annuities cost efficiently. Further, the administrative effort involved in selling annuities is a major concern to the insurance industry, as is the quality and availability of advice to consumers and financial regulators. In short, the success of business interfaces in managing increasingly complex information flows that underlie the OMO annuity purchasing process will depend upon whether it can bring about real benefits to all stakeholders. 3. Previous information management strategies and their shortcomings E-commerce has been a major component of the information management strategies employed by the manufacturers and distributors of private pension products. The distribution process of regulated financial products is advice and administrative-intensive, which is why it offers immense scope for cost savings and business process efficiencies through appropriately designed e-business solutions. Fig. 2 illustrates the complexity of information flows that underlie the sale and servicing of OMO pension annuities. Owing to the pervasive need of the IFA sector to survey product conditions and prices on the widest approximation of ‘the entire market’, a number of e-business standards have emerged that enable firms with different IT standards to communicate. The Origo business standard, for example, homogenises the information flows that underlie investment processes ranging from customer quotations to applications processing and commission tracking. Based on these industry standards, a number of electronic portals like The Exchange, IFAEngine and Assureweb have been set up in the UK to allow IFAs to compare various types of pension and non-pension financial products (none of these existing portals provides an annuity service suitable for the exercise on OMO). However, a major reassessment of the industry’s information management strategies is necessary, given (i) the expected increase in OMO annuity purchases, (ii) the emergence of multi-tied advisors with informational needs that are similar to the IFA sector, and (iii) the general pressures for cost and process efficiencies within the industry. More specifically, maintaining a disparate number of IFA portals of varying quality and depth is becoming a burden to all market participants (the suppliers of products), because each of the intermediary portals only covers a limited range of products. In the case of annuities, the annuity rates are historic (i.e. they have been entered into the system at some point in the past), and very few details other than price are provided. Further, only distributors have access to these interfaces, which are, on top of that, technically oriented and require a high level of user expertise. Product comparisons, therefore, turn out to be a time-consuming process especially for the many non-specialist advisors, which undertake this work infrequently. The time and effort spent on making annuity comparisons across disparate systems is often not justified by the commission payments (normally less than 1%) from an average value pension fund of just below £ 20,000. Additionally, existing business interfaces have been developed to facilitate information flows between the manufacturers and distributors of OMO annuity products—with consumers completely left out and only able to contact either of the two for advice. This is a mistake as consumers that are in a position to educate themselves about the product options available to them would substantially shorten the process of multiple quotes and re-quotes that advisors usually undertake prior to any OMO transaction. Most importantly, however, the electronic portals in use fall short of realising their potential for process cost savings. This is because they were designed mainly as advanced product comparison tools with little emphasis on streamlining other stages of the OMO annuity purchasing process like product purchase and servicing. In short, the current e-commerce solutions are sub-optimal for the stakeholders in OMO annuity activities. The insurance industry currently bears the costs associated with the development and maintenance of a patchwork of intermediate portals and direct links that provide narrow and often outdated information and fail to integrate customers into the early business process stages. As a result, annuity purchases are administrative-intensive and time-consuming processes for all parties involved. It is for these reasons that The Annuity Exchange was developed. 4. An industry-wide dynamic quotations model In light of the industry developments detailed above, a single web-based computer system ‘The Annuity Exchange’ of real time rates has been developed for annuity providers, financial advisors, existing information
    • ARTICLE IN PRESS J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 191 Process Annuity Advisor Client Pension Regulator Provider Fund Establishing Approach Respond Contact Post-Retirement Collect and Provide Income Needs Evidence Analysis Compliance Evidence Whole of Obtain Market Search Produce Quotes Quotes Justify and Accept Annuity Evidence Selection Compliance Evidence Accept Apply Notified Proposal Cooling Off Period Cancel Proof of Medical Request & Confirm Reconcile Provide and Legal Details Transfer Transfer Request Capital of Funds Fees and Receive Commission Calculate Payments & Send Issue Issue Receive Policy Fig. 2. Information flows for OMO Annuity Pensions.
    • ARTICLE IN PRESS 192 J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 portals and consumers. The dynamic quotations portal acts as an ‘expert system’ that offers a complete account of the annuity market—there are around 12 OMO annuity providers in the UK—with rates for different product options as well as extensive product information accessible to all parties. A single hub substantially simplifies and streamlines the OMO process leading to substantial cost and time savings for all parties involved. As well as providing electronic live rate feeds into a single industry source, the portal supports all stages of the annuity purchasing process, which makes it a complete end-to-end product servicing and purchasing system. Furthermore, in phase 2 of the project money transfer facilities and automatic underwriting for insurers will be integrated into the hub along with a range of front/back-end functionalities aimed at distributors and consumers (e.g. financial scenario planning, inheritance planning) already achieved in phase 1. Fig. 3 illustrates a typical end-to-end process that can be performed within the interface. More specifically, some of the functions available include:  Quick and full quotes on a range of user-selected annuity parameters with the facility to compare incomes from different benefit structures, get real-time quotations, rank the top annuity providers, store a history of personal and pensions input data along with previous quotations and product comparisons.  Annuity application and money transfer facilities which permit OMO annuities to be purchased online via regulated individuals or, possibly, directly by consumers.  View and print pension, annuity and retirement information from a learning lounge area on the site.  Advisors will be able to create bespoke files for individual clients and download key data into their internal systems for auditing purposes. 4.1. Access to the intermediary portal A single hub can, however, only organise the information flows between the various parties involved in OMO activity more efficiently if it, unlike current business interfaces, provides access to all market participants. In this vein, access can either be direct via the internet—by client browsers over HTTP/S—or, alternatively, indirect via live-rate feeds from the intermediary portal into the internal systems of distributor firms. The former is likely to be the preferred mode of access for small IFAs and consumers, while the latter will most likely to be the preferred option for large professional users. As part of a holistic solution, the hub has been offered to be ‘white-labelled’ so that most of the functionalities of the web presentation layer (e.g. input and result screens) can easily be integrated into host-branded environments such as existing IFA portals or systems of branch-based bank and insurance companies. Communication between the single portal and the existing internal systems of annuity providers, on the other hand, has been via online XML links, but, in the absence of such interfaces, has also been based on email requests (more of which later). However, only XML interfaces enable real-time processes with annuity quotes XML Origo Standard Annuity Setup Online Application Obtain Application IFA Quote Processing PDF Printed Application Fig. 3. End-to-end annuity purchasing process.
    • ARTICLE IN PRESS J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 193 and electronic underwriting administered in seconds. Email interfaces, by contrast, are cheaper to develop, but response times are slow and heavily dependent on the number of requests at a certain point in time. Typical email responses take hours at best and, thus, leave many of the potential time and cost savings of a real time intermediary portal untapped. 4.2. Costs and benefits of The Annuity Exchange The original intention behind the intermediary portal was that it was to be financed on a fee-basis charging annuity providers according to the sales volumes of OMO pension products generated through the system. In addition to sales-related ongoing fees, insurers have also had to bear the costs of setting up XML links (or email interfaces) to the web portal. Critically, the single hub was to remain free of charge for both the distributors and consumers of annuity products. The sunk cost and fees paid for by annuity providers are small given they will be able to appropriate the following process efficiencies in return:  Online annuity quotes and purchases replace the bulk of predominantly paper-based ad-hoc correspondence with distributors and clients and, thus, economise on corporate resources.  Similar arguments apply to marketing material that can be viewed online and printed out by consumers, saving insurance companies printing and postage costs.  Live-rates are fed into a single system, which allows insurance companies to react swiftly to market developments and to avoid confusion about which set of rates is currently valid.  By educating consumers online, enquiries to customer helpdesks can be reduced when costumers explore different ‘what-if scenarios’ and the associated product options themselves.  A single hub puts an end to the duplicated efforts of servicing different IFA portals. In spite of the above benefits, the annuity providers were slow to sign up to the fee paying solution and towards the end of the first phase of the project, the business model had to be changed to charge consumers and IFA’s for the services provided by The Annuity Exchange. In terms of consumers, The Annuity Exchange considerably reduces their search costs and for a fixed fee of £10 they are able to search through as many different quotation types for a period of 6 months. Consumers’ need for impartial advice has been vastly neglected under the electronic architecture that generally supports the annuity purchasing process. By contrast, The Annuity Exchange for the first time provides consumers with access to live annuity rates from all insurance companies that engage in OMO activities as well as to learning material which—freed from the providers’ technical jargon—helps them to educate themselves about how different product options can meet their post-retirement income needs. As a result, users are in a position to make informed decisions when purchasing annuities either online or via regulated individuals that the hub provides access to. One of the crucial differences between industry practise and The Annuity Exchange is that high quality advice is no longer accessible only for the holders of large pension funds, but also for the vast majority of consumers that have accumulated less capital under their occupational pension scheme when they retire. For IFAs to participate in a holistic industry solution, any electronic portal has to substantially reduce their administrative burden and costs of regulatory compliance. Beyond the general simplification and streamlining of the OMO purchasing process, the single portal may additionally support distributors through extra functionalities targeted specifically at their information management needs. Progress tracking tools, for instance, or an online database that stores records for each of their clients and lets advisors download data into their local systems for internal and regulatory audits are just two of the many services provided by The Annuity Exchange. Also, the impact that self-informed consumers have on shortening the iterative decision- making process of quotes and re-quotes with IFAs should not be underestimated in this context. 4.3. Issues with The Annuity Exchange project The Annuity Exchange project began in 2002 with a meeting where all the major suppliers of annuity products in the UK got together to discuss the design of the hub and any issues, which might hamper the
    • ARTICLE IN PRESS 194 J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 project going forward. At this ‘kick off’ meeting all the providers signed up to the project and this was critical to its eventual success as the hub was supposed to be the one place where consumers and IFA’s could access all the major providers in the market place. In spite of this initial sign up meeting the project has been hampered by a number of on-going issues:  The different providers use different terminology for the same annuity items and they have interpreted the legislation regarding annuities differently. This has involved a lot of translation issues when assembling the final hub.  In spite of the project being signed off as a high priority by the pension/annuity departments, this was often not communicated to the IT departments who had to build the necessary XML links. This involved endless negotiations with IT departments. This dislocation between the priorities of business departments and IT departments has been and continues to be a source of concern. While there are potentially a range of possible reasons for the dislocation, the current project seems to highlight two major reasons. First, the IT departments of the large insurers have been under a lot of pressure to bring e-commerce solutions into the businesses without the range of staff and skills they need. It is worth remembering that these IT departments have been built to deal with large legacy mainframe systems. This issue has been compounded by the number of mergers, which have taken place across the insurance sector and the need to integrate disparate systems. Second, because of these pressures, IT departments have had to constantly juggle projects as ‘priorities’ from the various business departments change. This problem is compounded by a lack of understanding by the business departments on the resources needed to fulfil a given IT project and a lack of understanding on behalf of the IT department of the business benefits of a given project. This leads to noise in terms of working out the costs and benefits of different IT projects.  Similarly, even when the XML links had been built, the testing regimes often did not receive any kind of priority and this slowed down the eventual development of the hub.  The annuity providers which did not wish to build XML links also had problems on agreeing an email protocol to send back quotation requests.  Given the length of time taken by providers to provide XML and email links, the market for annuities changed and this meant reworking the basic design of the hub.  Finally, in spite of the above issues and problems over agreeing a business model, which was acceptable to all the various stakeholders, The Annuity Exchange went live during the summer of 2005. 5. Conclusions In the UK, every individual with a defined contribution occupational pension scheme or a personal pension is obliged to purchase a pension annuity. The effects of an ageing society coupled with a shift from defined benefit to defined contribution occupational pension schemes will lead to a sharp increase in the number of OMO annuity purchases. Additionally, changes to the regulatory structure of advice will add further momentum to the separation between manufacturing and distributing firms—that has already become apparent in the UK financial sector—with a corresponding need for increased interactivity between market participants. Against this backdrop, the various business interfaces currently used by the industry to provide the linkages that facilitate information flows between manufacturers and distributors seem increasingly outdated. The functionalities of existing electronic industry portals are restricted to comparing and searching for different annuity products on the basis of historic rates and little product information. As a result, OMO annuity purchases are advice and administrative-intensive processes, which many non-specialist advisors are reluctant to engage in. This article has shown how a single electronic portal, The Annuity Exchange, can meet the needs of annuity providers, financial advisors, existing industry portals and consumers. We have described the business case for a real time intermediary portal that all market participants can freely plug into. As well as live rates from all OMO annuity providers, the hub offers expert advice to consumers and financial advisors as well as a range of front/back-end functionalities (e.g. financial scenario planning for consumers and tools tracking the application progress for advisors). As a complete product purchasing and servicing system, the hub will
    • ARTICLE IN PRESS J. Hagendorff et al. / International Journal of Information Management 26 (2006) 187–195 195 eventually (with the completion of phase 2) simplify all stages of the annuity purchasing process from product comparisons and applications to the transfer of funds and after sales services. The dynamic quotations model described in this article streamlines and simplifies the annuity purchasing process for all market participants. Quotes and re-quotes are in real time and instantaneous, with XML interfaces and email communication replacing previously paper-based business processes. In spite of all the benefits brought by a single electronic hub for the purchase of annuity products, the article has briefly described some of the issues, which have had to be overcome to bring phase 1 of the project to fruition. What has become apparent, is that business logic does not always rule the day in the competitive but Byzantine UK insurance industry. References Financial Services Authority (FSA). (2002). Reforming polarisation—Making the market for consumers. Consultation Paper 121. London: Financial Services Authority. Littler, K., & Hudson, R. (2004). The impact of depolarisation on e-commerce development in the distribution of regulated financial products. International Journal of Information Management, 24(4), 283–293. Pensions Commission. (2004). Pensions: Challenges and choices. The first report of the pensions commission. Norwich: The Stationary Office. Jens Hagendorff is a Ph.D. student. Robert Hudson is a Senior Lecturer in Accounting and Finance. Kevin Keasey is a Professor in Accounting and Finance at Leeds University Business School.