Framing Annuities More Attractively

FramingMy latest Research magazine column is now available. Here’s a taste.

“The view of the income annuity as anything like a routine first-choice retirement income option remains a good ways off. Too many individual factors can get in the way of using guaranteed income annuities despite their obvious benefits. However, the new research is clear that if and when partial annuitization strategies are regularly offered and recommended, especially when they are well framed, the idea that income annuity usage would be “extremely rare,” as Modigliani observed nearly three decades ago, will no longer be remotely accurate. And that would be a very good thing indeed.”

I would appreciate it if you read the whole column. Indeed, I recommend the entire magazine.

Framing Annuities More Attractively

My August Research Column

RES_0813_CoverMy latest Research magazine column is available here.  The column focuses on some new research by Felix Reichling of the Congressional Budget Office and Kent Smetters of the University of Pennsylvania’s Wharton School on annuity optimization concluding that low market demand for annuities isn’t a puzzle at all. Instead, they claim that annuities are overused. A snippet of my column follows.

Smetters and Reichling are surely correct that people with insufficient means get little benefit from owning annuities. They are also correct that annuities can be purchased much more cheaply after a health shock. But since we are all prone to optimism bias (the expectation that things will turn out well even if not planned out well) and the planning fallacy (our tendency to overestimate our ability to impact and manage the future), and since we routinely and generally tend to underestimate our life expectancy, the need for some form of longevity insurance to make sure we don’t run out of money entirely is likely to be much greater than we tend to think.

Unreasonable Expectations Highly Desired

Rose Colored GlassesI spend a significant amount of time talking and working with advisors of various sorts and most of them have a decent working knowledge of the retirement income literature and have a good sense of what the advantages and disadvantages of the various approaches are.  In short, they generally know what ought to be done in most situations.  But they struggle with recalcitrant clients and prospects and how to handle them. For example, their clients and prospects resist annuitized floors.  They don’t delay Social Security. Continue reading

Guarantees v. Control

My friend Wade Pfau has some new material available at his blog concerning the trade-offs between income guarantees on the one hand and personal control of one’s assets on the other as they relate to retirement income planning.  I have linked them below.  As usual, Wade’s work in both interesting and helpful.  As Wade notes, “It seems like retirement income strategies boil down to where you want to fall on the spectrum between having control of your assets and hav[ing] guaranteed (inflation-adjusted) protections for life.” 

I agree.  But I would add that more control over one’s assets necessarily means being more susceptible to random — potentially negative and perhaps disproportionately negative (on account of statistical “fat tails”) — outcomes and thus (paradoxically) less ability to “control” one’s life in the long run. 

I encourage you to read these posts and all of Wade’s (exceptional) work.

Guarantees vs. Control

On the Pros and Cons of GLWBs

Safe Withdrawal Rates: Have I been barking up the wrong tree?

More Nonsense from the Financial Press

P.T. Barnum is famously said to have opined that nobody ever went broke underestimating the intelligence of the American public.  In a similar way, it’s hard to overstate how poor the financial press in this country — and most especially the monthly consumer magazines – is (despite some notable exceptions to the rule).  It’s enough to make me want to scream for mercy.

In another tired re-cycling of the anti-fixed index annuity meme, Marla Brill offers the same ‘ol, same ‘ol criticisms and bromides (you can read about some of the issues at a higher level here and here).  My thoughts on that topic will appear in the next issue of Research magazine and are outside the scope of my missive today, even though it seems to me that Brill ought to offer the other side of the story.

My comments today (and the object of my ire) relate to the closing lines of Brill’s piece, which are apparently offered as the last word in doing the right thing.  Brill quotes Jerry Miccolis, chief investment officer at Brinton Eaton Wealth Advisors, apparently with respect to retirement income.

“For most people, even those who are already retired, a diversified portfolio is still the best way to stay ahead of inflation and generate income,” he says. “And if market volatility is a concern you can smooth the ride out by tilting your portfolio more toward bonds.”

I’m hopeful that Miccolis is merely stating his preference for such a portfolio to the deferred annuities Brill is criticizing and not ignoring the obvious benefits of immediate (income) annuities for retirement income.  If so, Brill is placing his remarks out of context. At a minimum, Brill had a duty to provide the majority view of unbiased academic experts along with her view — especially in what purports to be a news story rather than an opinion piece.  Kevin McCormally of Kiplinger’s Personal Finance makes a similarly silly mistake here.

Either way, had Brill done even a little bit of research, she would have recognized that portfolio approaches to retirement income do not deal with longevity risk and do not deal with sequence risk.  Moreover, at current market levels, failure risk is extremely high.  More importantly, by touting a portfolio approach to the exclusion of income annuities, Brill (and perhaps Miccolis too, even though I hope not) contradicts the full weight of academic authority (a  presentation I recreated on this subject is available here).  Unfortunately, such ignorance is common

Representative examples of the best answers for retirement income — from prominent academics who are hardly unscrupulous insurance agents seeking commissions — follow.

  • “Lifetime income [products] may not be the perfect financial instrument for retirement, but… they dominate anything else for most situations.”  Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 2008).
  • “To achieve a similar riskless guarantee of income throughout one’s uncertain lifetime without life annuities would cost between 25% and 40% more.”  Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).
  • “[T]he market for privately purchased individual [income] annuities in the United States is very small,” which represents a “remarkable disconnect between theory and practice” because income “annuities ought to play an important role in the portfolios of elderly households.”  Brown, “Life Annuities and Uncertain Lifetimes” National Bureau of Economic Research, NBER Reporter (Spring 2004).
  • “Lifetime income annuities may not be the perfect financial instrument for retirement, but when compared under the rigorous analytical apparatus of economic science to other available choices for retirement income, where risks and returns are carefully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck.”  Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 12, 2008).
  • “For all time periods and for all portfolios, the addition of the annuity leads to a decline in the portfolio failure rates.”  Ameriks, Veres & Warshawsky, “Making Retirement Income Last a Lifetime,” Journal of Financial Planning (December 2001).
  • “If…the Social Security program will not generate sufficient income to satisfy minimal consumption needs, then it should be supplemented with the purchase of high-grade private annuities.”  Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).
  • “Without additional guaranteed lifetime income streams…, middle-income Americans are at high risk of outliving their financial assets and living their final years in poverty.”  Ernst & Young, “Retirement Vulnerability of New Retirees,” Americans for Secure Retirement (June 2009).
  • “I have reviewed over 70 academic studies that have appeared since 1999, analyzing lifetime income annuities vs. other alternatives, and coauthored another major study. …The consensus of the literature from professional economists is that lifetime income annuities should definitely play a substantial role in the retirement arrangements of most people. How great a role depends on a number of factors, but it is fair to say that for most people, lifetime income annuities should comprise from 40% to 80% of their retirement assets under current pricing. Generally speaking, if a person has no bequest motive, or is averse to high risk, the portion of wealth allocated to annuities should be at the higher end of this range.” Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 12, 2008).

If quoted accurately, what Miccolis said is common.  If a retiree annuitizes, the advisor doesn’t get paid much and loses control of the money.  And Miccolis isn’t obligated to provide alternative approaches, no matter how misguided his may be.  Brill, on the other hand, surely does.

This isn’t rocket science.  Really, we all deserve better from the financial press.

White’s Wrongs

Jane White has written a piece at Huffington Post that is about as ignorant, deceptive and misguided as one could imagine.  Essentially, White claims that all annuities are “the biggest financial rip-off on the planet” and that the government’s effort to make income annuities available via defined contribution plans is foolhardy.

There is so much stupid in White’s article that it’s hard to know where to begin.  But here goes anyway (White’s words quoted and in italics).

“Why are annuities toxic? As an annuity owner you’re not only paying a fortune for an investment product that can’t fill an empty nest egg but you’ll likely be charged huge penalties if you move your money out of one and if you die there’s a good chance the insurance company is the beneficiary, not your spouse. The losers are the surviving spouses who will no longer be able to access the annuity to pay expenses, despite the fact that that’s the point of buying one in the first place.”

White badly misunderstands what the government would like to accomplish here and confuses deferred annuities with immediate (income) annuities.  As Treasury’s Mark Iwry said (as one example among many), “There’s been a fair amount of discussion in the literature taking the view that perhaps there ought to be more lifetime income.”  That view is consistent with a paper he co-authored for The Brookings Institution (“This paper proposes a policy that would increase the role of lifetime income products in future retirees’ overall retirement planning”).  See also Live Q&A Session with Labor Secretary Solis (December 7, 2009). 

Accordingly, the goal is in no way to pitch deferred annuities during the time when people are saving for retirement.  Instead, consistent with mainstream (and virtually unanimous) scholarly opinion, the goal is sustainable income streams throughout retirement – income annuities.  Income annuities are simple and non-controversial products that provide a guaranteed stream of income that a retiree cannot outlive.  The societal need for sustainable income is exacerbated by the ongoing disappearance of defined benefit plans that produce pension income in retirement.  Moreover, income annuities don’t sell well even though they should (economists call this disconnect between what ought to happen and what happens the “annuity puzzle”), in large part because they don’t pay the advisor very much to sell them.

“How did this come to pass? Amazingly, all of the comments Treasury received on its proposal were favorable because they must have come from the insurance industry or the agents that generate commissions from selling their products.”

Had she bothered to do even a bit of research, White would have discovered that positive comments are to be expected because unbiased, scholarly opinion is essentially unanimous in supporting the benefits of income annuities.  Representative examples — from prominent academics who are hardly insurance agents seeking commissions — follow.

  • “Lifetime income [products] may not be the perfect financial instrument for retirement, but… they dominate anything else for most situations.”  Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 2008).
  • “To achieve a similar riskless guarantee of income throughout one’s uncertain lifetime without life annuities would cost between 25% and 40% more.”  Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).
  • “[T]he market for privately purchased individual [income] annuities in the United States is very small,” which represents a “remarkable disconnect between theory and practice” because income “annuities ought to play an important role in the portfolios of elderly households.”  Brown, “Life Annuities and Uncertain Lifetimes” National Bureau of Economic Research, NBER Reporter (Spring 2004).
  • “Lifetime income annuities may not be the perfect financial instrument for retirement, but when compared under the rigorous analytical apparatus of economic science to other available choices for retirement income, where risks and returns are carefully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck.”  Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 12, 2008).
  • “For all time periods and for all portfolios, the addition of the annuity leads to a decline in the portfolio failure rates.”  Ameriks, Veres & Warshawsky, “Making Retirement Income Last a Lifetime,” Journal of Financial Planning (December 2001).
  • “If…the Social Security program will not generate sufficient income to satisfy minimal consumption needs, then it should be supplemented with the purchase of high-grade private annuities.”  Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).
  • “Without additional guaranteed lifetime income streams…, middle-income Americans are at high risk of outliving their financial assets and living their final years in poverty.”  Ernst & Young, “Retirement Vulnerability of New Retirees,” Americans for Secure Retirement (June 2009).
  • “I have reviewed over 70 academic studies that have appeared since 1999, analyzing lifetime income annuities vs. other alternatives, and coauthored another major study. …The consensus of the literature from professional economists is that lifetime income annuities should definitely play a substantial role in the retirement arrangements of most people. How great a role depends on a number of factors, but it is fair to say that for most people, lifetime income annuities should comprise from 40% to 80% of their retirement assets under current pricing. Generally speaking, if a person has no bequest motive, or is averse to high risk, the portion of wealth allocated to annuities should be at the higher end of this range.” Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 12, 2008).

When I emailed White for comment she declined except to rail against “academic nitwits”and “”consumer ripoffs.”  She also noted regulatory actions in several states but these were all against deferred (not income) annuities. No surprise there.

White is correct that most people have not saved enough for retirement.  It is also true that an income annuity cannot correct that problem.  However, while it is not the only tool worth considering and using, an income annuity is the best tool we have to provide sustainable retirement income that cannot be outlived.  For White to make the blatantly false claims she does is unconscionable.

Worth Watching

I spoke at Investment Advisor’s 4th Annual Retirement Income Symposium, Now or Never—2011: The Year Baby Boomers Turn 65, on October 17 at the Hilton Boston Back Bay.  My session was entitled “Red Pill Retirement Planning” and focused on the need for what Bob Reynolds, the CEO of Putnam Investments and another speaker at the event calls “assured retirement income.”  A recreation of that presentation (without the fun of a live audience and without the excellent jokes) is available here.  I have made the sources for my presentation available here.  My PowerPoint alone is available here.