Immediate Annuities Face Behavioral Resistance
February 25, 2008
The vast majority of retirees opt against voluntarily annuitizing retirement savings. So, insurers need to better educate consumers about immediate annuity benefits.
Mental accounting keeps investors away from immediate annuities, according to an article published in the CFA Institute's Financial Analysts Journal. They particularly fear illiquidity, bankruptcy and/or an early death.
"Retirees tend to evaluate annuities from a gambling perspective: `Will I live long enough to make back my initial investment in the annuity?'" said Wei-Yin Hu and Jason S. Scott, authors of the article, published in November/December.
"Actuarially fair immediate annuities will be rejected because the loss from a possible early death looms twice as large as a gain from living long enough to earn back the annuity premium."
Hu, director of investment analysis, of the Retiree Research Center at Financial Engines Inc., Palo Alto, Calif., and Scott, the center's managing director, explain the overall low demand for annuities. They also discuss the types of annuities available, by applying behavioral finance principles.
The study's bottom line: Buying an annuity can seem like a gamble that increases risk, rather than a type of insurance that can curtail risk. Annuity marketers and financial advisers should counter this misconception, the two say, by positioning the annuity as longevity insurance.
Longevity insurance diminishes the need for precautionary saving and, therefore, permits annuity holders to consume more in retirement.
With longevity insurance, people invest during their working years knowing that they will get a guaranteed stream of income when they retire. By contrast, an immediate annuity is viewed as a gamble on principal because it shifts money from the present to the future, according to the researchers. People also believe that they should not spend from their principal during retirement.
Immediate annuities are more palatable if they are purchased as a life-with-period-certain annuity, the authors said. This payout option helps reduce an individual's feelings of uncertainty because the contract provides for a guaranteed minimum number of payments. People are more comfortable knowing that their beneficiaries continue to get the annuity income when they die.
The researchers said longevity annuities, which are purchased today and begin payouts in the future as immediate annuities, are more likely to be accepted. These deferred investments are viewed as 401(k) defined contribution plans, which are not thought of as risky.
"Having longevity insurance in the form of an annuity should reduce the need for precautionary savings, and thus allow annuity holders to consume more in retirement," the authors said.
Insurers agree that people are hesitant to give up their assets to the insurance company in return for lifetime income. But variable annuities with guaranteed withdrawal benefits may bridge the gap between saving and retirement income.
"There is a lack of liquidity with immediate annuities, said Joe Jordan, MetLife senior vice president. "Investors want to be able to invest 70% of their money in equities and get a guaranteed source of lifetime income. They don't want to give up control of their assets." Those at the ages of 55 to 64 have a long time to invest and want the guaranteed withdrawal benefit, he adds.
Persons in their 70s are more apt to select a fixed immediate annuity because they can get a high guaranteed lifetime stream of income.
"In the long run, they [retirees] will be annuitizing," he said. But some of these tools are bridging the gap."
Financial planners said there are other reasons people don't put money into immediate annuities.
Lance Wallach, CLU, ChFC, Long Island, a Plainview, N.Y.-based financial planner, said agents don't sell the product because of low commissions-despite the benefits. More would purchase this type of annuity if agents received higher upfront and trailing commissions.
In addition, the investment options offered by variable income annuities are too complicated for most to understand, he said. And if people do invest, they have the potential to put too much into the annuity and lack enough liquid assets during retirement.
"The commission is not high enough," he said. "But these may be the only products that are good for seniors if they pick right."
So what actions can insurers take to make immediate annuities more desirable?
Avi Bodie, finance professor at Boston University, believes that immediate annuities will become more popular when more carriers offer payouts indexed to inflation.
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