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LONDON, Feb 14 (Reuters) - Annuities do not meet Britain's pensions needs and should be replaced with alternatives such as those used in the Netherlands, pension campaigners and politicians said in response to a proposed market shake-up on Friday.
The Financial Conduct Authority (FCA) said it had found insurers were maximising profits by selling annuities that offered customers a poor deal and proposed a shake-up to improve competition in the industry.
Annuities, which convert a pension pot into a guaranteed retirement income, are unique among financial products in that once you have bought one, you are locked in for life. Most retirees purchase one at a fixed rate.
The industry is worth around 14 billion pounds ($23.4 billion) a year.
"The system itself is geared to suggesting to people that they need to buy an annuity and that's not the case," said Ros Altmann, a leading pensions campaigner and former government adviser.
A more radical alternative being discussed is the idea of collective schemes, in which savings are pooled and income is generated from the pension fund itself, negating the need to buy an annuity from an insurer. They offer a kind of half-way-house between final salary and current defined contribution pension schemes.
"The best pension schemes in the world are in Denmark and the Netherlands, and it's because it's done on a collective basis," Shadow Pensions Minister Gregg McClymont told Reuters.
Pensions Minister Steve Webb is expected to propose legislation in the Queen's Speech in May, as part of his pension reform programme, that would allow these collective schemes to be set up.
But such schemes can be unfair, according to the insurance industry, which says younger members bear the risk of lower income in the future while supporting payouts of older members.
"(Collective) schemes are no more immune to lower than expected investment returns than other pension schemes," said Huw Evans, director of policy at the Association of British Insurers.
An alternative suggested in a January report by centre-right think tank Policy Exchange, would be for the government to issue annuity-type bonds.
James Barty, a senior consultant to the think tank, said this would be a "radical reform". The government would issue bonds with a minimum duration of 15 years and insurers would offer annuities that would only start after the bond expired.
"It takes almost all of the interest risk out of the equation and allows insurers to do what they do best - insure lives," Barty said.
The FCA said it will publish its findings from an interim review of the wider retirement income market in the summer.
The need to provide pensioners with a sufficient retirement income is becoming more pressing.
Low interest rates and longer life expectancy have helped bring down annuity rates - on an average pot of 36,800 pounds pensioners get an average annual income of just 1,340 pounds, according to figures from the ABI.
Final salary, or defined benefit, schemes are being phased out as more people build up pension pots in defined contribution schemes which require retirees to make a decision about what to do with their pension pots.
Pensions Minister Webb said in a newspaper interview in January that annuities "need a rethink" and were designed for a world in which people lived for ten years after retiring, not thirty years.
The insurance industry itself should look for a solution, according to Richard Graham, Conservative chairman of the All-Party Parliamentary Group on Pensions.
"It's down to the ingenuity of the financial sector to come up with creative solutions that meet what people are looking for...in a way that people can understand," he said.
Britain must move away from the "one-size-fits-all" approach to pension planning, Altmann added.