A probe by a Financial Services Authority (FSA) has revealed that insurance companies are failing to comply with rules designed to ensure consumers get the best deal.

The City watchdog uncovered the failings in “wake up” letters from insurers targeted at people approaching retirement.

The letters highlighted the “open market option” [OMO] which offers the customer the option to scour the market for most competitive annuity contract, rather than buy it from the insurer with which their pension has been saved.

In a document to insurance companies, FSA says that nearly 40% of the wake-up material reviewed did not meet regulatory standards.

However, FSA also found that materials from 24 firms could be improved to meet a standard of good industry practice.

The regulator said that 10 companies were found to produce letters that clearly spelt out the options, including the benefits of the OMO.

The regulator said that the 10 companies involved breached all regulatory standards.

This is not the first time Insurance companies have come under scrutiny from the FSA, earlier in the week, insurance comparison websites were found to be engaging in bad practice.

The website comparison companies were accused of not providing customers with fair, accurate or honest information on their sites regarding their featured products. Where information was provided on the sites, it was concealed under terms and conditions.

This latest review on insurance companies involved 80 "wake-up" packs from 55 firms or group of firms, 11 of which were found in breach of the rules and 10 of which had substantial failings.

The review is in line with FSA's "treating customers fairly" (TCF) programme, with which financial services firms must comply by the end of this year.

Sarah Wilson, TCF director and insurance sector leader, described the results of the OMO review as disappointing, adding that "a significant number of firms have improvements to make in this area if they are to meet the December 2008 TCF deadline". 

Earlier this week, the Association of British Insurers (ABI) said earlier this week that its members deliver "good rates for most customers including many of those who do not change provider".

According to a research by ABI, an estimated 85% of single life level annuity customers receive a rate that is at least 95 percent of the highest rate available. However, FSA believes that the difference in final pension pay-outs can be significant, according to their review; there was a 20% gap between the top and bottom annuity rates.

The gap leaves just over half of providers' rates within 10 percent of the cheapest rates available. There is still significant potential for customers to achieve higher incomes by exercising their option to shop around," Wilson says in the document, urging insurers to review their literature.

The findings by FSA have attracted bitter reactions from a section of the insurance market with many saying that the OMO practice was bad for the industry.

Commenting on the findings, Nigel Callaghan, a pensions analyst at independent financial services provider Hargreaves Lansdown, said: "Enough is enough. These investors have been saving with the insurance companies for 20 or 30 years.

Analysts say that those insurance companies offering OMO to the public were damaging the industry’s long standing good practice by flouting regulations. They said that it was unfair for insurers to target vulnerable groups in society especially given that the person’s life savings were at stake.

Nigel Callaghan said, "The least they should expect is to be treated fairly: offering them such poor value at a point in life when they can least afford it does the industry a huge disservice."