* Watchdog sees risk of unfair profit maximisation
* FCA opens competition probe into wider retirement market
* FCA says not clear yet if any enforcement action needed
* Pensions campaigner says watchdog must act straight away
By Huw Jones
LONDON, Feb 14 (Reuters) - An important part of Britain's pensions market is disorderly with insurers maximising profits and failing to give the best deal, according to a watchdog review that drew criticism for ruling out immediate reforms.
The Financial Conduct Authority's review of annuities, where a pot of money saved over a working life is swapped for an annual income until death, found too little competition and said those with the smallest pension pots were worst hurt by having only a handful of annuity providers to choose from.
The findings come at a time when the government wants more people to save for their retirement as they live longer and national coffers cannot afford the generous state pensions needed to maintain a decent standard of living into old age.
About 420,000 annuities worth 14 billion pounds ($23 billion) are sold each year with each purchase irreversible, depriving people of the right to shop around that would leave four out of five people better off by 71 pounds a year on an average pension pot of 18,000 pounds.
About 168,000 of the annuities are bought from the insurance company a customer has saved with, and the company makes far more money out of them than from annuities sold to savers from elsewhere. The FCA said there was a risk that insurers would try to unfairly migrate their savings customers to their own annuity products to maximise profits.
Many annuity providers do not offer better terms to people who are ill or smoke and are likely to live for fewer years than their healthier peers. Annuity providers make the most money from people who die young, since the annuity payments cease on death. The review also found poor practices on all annuities comparison websites.
"All together this paints a picture of a disorderly market," FCA said.
Otto Thoresen, director general of the Association of British Insurers, said the insurance industry had addressed many of the issues raised but acknowledged more progress was needed.
"The market isn't working as well as it could... We recognise that our industry can do more to make the market work effectively for customers," he said.
Pensions Minister Steve Webb said in January that annuities "need a rethink" as they were designed for a world in which people lived for 10 years after retiring, not 30 years.
The minister is to propose draft legislation, as part of his "defined ambition" pension reform programme, that would allow creation of collective private pensions in which savings would be pooled into funds that would provide a retirement income, negating the need to buy an annuity.
NO BIG CHANGES YET
The FCA was launched last year to better protect consumers and end a stream of mis-selling scandals spanning three decades, notably of payment protection insurance.
The FCA said it could not say if there had been mis-selling in annuities, a sector dominated by big insurers like Standard Life, Aviva, Prudential and Legal & General.
David Barral, chief executive of Aviva UK and Ireland Life, welcomed the review: "We want the FCA to identify all those areas where consumers get less than they should on their retirement income."
He said the FCA should investigate insurers taking advantage of savers' inertia and brokers charging excessive commissions or keeping customers in the dark about what was available on the open market.
The watchdog said it would study sales practices and report in the summer, open its first competition probe into the wider retirement market and require changes to comparison websites.
Watchdog officials said it had not ordered immediate changes to the market because pensions were a complex topic and more data was needed before deciding if any rules have been broken or whether major market changes are needed.
"We are not yet in a position to say if firms are operating inappropriately, and we will look into all of these aspects over the next six months," said Nick Poyntz-Wright, FCA director of long-term savings and pensions.
Poor sales practices can trigger fines. A record 28 million pounds fine was levied on Lloyds for encouraging staff to sell 2 billion pounds of products customers did not need.
The FCA said any big reform would not come until at least after its review into annuities sales practices is published in the summer, when it will also have preliminary findings from its competition probe.
"I am certainly disappointed that the FCA is not acting immediately - every day that goes by risks more people buying the wrong product for life and never being able to change it," said Ros Altmann, a pensions campaigner and former Downing Street adviser.
"This market is failing customers and so is the regulator."
The competition probe will be completed by early 2015. Structural changes appear inevitable as FCA officials said requiring more disclosures would simply drown customers in more off-putting jargon.