I watch in dismay as one insurance company after another continues the slow and torturous process of freezing, limiting and withdrawing the benefits from their guaranteed living withdrawal benefits (GLWBs). A week doesn’t go by without another shoe dropping. A payout percentage here, an equity fund there, a joint-life option over here and before you know it, your variable annuity (VA) has been neutered.
Even competitors enjoying their moment of schadenfreude must now contend with the inevitable cynicism and distracting questions that follow the fog and confusion. “So, when will you guys cut benefits?” Or, even worse: “Were you the guys that changed features?” These are legitimate questions that even the strongest companies must address as the trend towards lower payouts continues.
So what’s next? Will guaranteed rates go as low as the fed funds rate itself? Are we heading towards a GLWB that pays 0% income for life—or even joint life? I’m sure savvy annuity wholesalers can spin a tale to make any dog hunt, but at some point even they will realize the gig is up.
And so, perhaps the next step in the evolution of retirement annuities is to go back to the past. Maybe the annuity of the year 2020 pays out no cash at all, but instead offers an actual retirement service. Allow me to explain.
One of the lesser-known facts about retirement annuities—i.e., annuities that provide an income for the rest of your natural life, when you can no longer work or care for yourself—is that despite their illustrious 2,500 year history, it is only in the last few hundred years that their benefits have been paid in cash.
For the first few thousand years, retirement annuities provided something more reliable and useful than nominal cash or coin. Annuities paid out in units of service.
Case in point. The first known retirement annuity is documented in the Hebrew Bible, in Kings II, Chapter 25, Verse 27-30. Here is a direct translation. “And it came to pass.... that the king of Babylon did lift up the head of the king of Judah out of prison…. And he spoke kindly to him, and he did eat bread continually before him all the days of his life. And his allowance was a daily rate for every day, all the days of his life.”
According to most insurance historians, this places the first retirement annuity in the year 550 B.C. And, it was paid out in units of dinner.
During the Middle Ages, wealthy landowners and merchants purchased so-called corrodies from monasteries and abbeys, which provided them with food, clothing and often shelter for the rest of their lives. Wealth they had. It was services they wanted.
On a slightly more amusing note, the famous English poet and author Geoffrey Chaucer (c. 1343-1400) so enthralled King Edward III, that he was granted a rather unique annuity at the young age of 35. The retirement annuity was one gallon of wine daily for the rest of his life, to be served in the port of London. (That is 16 glasses of wine per day, and a newfound respect for The Canterbury Tales!)
But in all seriousness, only in the 16th century did it become commonplace for retirement annuities to be paid and received exclusively in cash. Until then you purchased the retirement annuity with cash, but the benefit itself was denominated in units of consumption—immune to inflation and the risk of debasing the currency. Perhaps it is time to reconsider the Biblical or Chaucerian annuity.
If this seems farfetched, consider the following. A few years ago, the U.S. Postal Service—an institution that itself might not be around in 2020—started offering what is called a “Forever Stamp.” Although the cost of mailing a first-class letter in the U.S. is currently 44 cents, and the price has been steadily increasing by approximately one cent per year, a Forever Stamp comes with no fixed monetary value. The stamp—effectively a financial derivative—entitles the holder to one unit of service, in perpetuity. The holder can use the stamp to mail one first-class letter somewhere in the U.S, forever. Pay the 44 cents today, and regardless of what it should cost to mail a first-class letter next year or 10 years hence, the cost of the service is locked in.
For the Postal Service, this is not as big a gamble as one might expect. First, by not having to print new and costly stamps every time that the price goes up, it saves in printing costs for the millions of people who need one- and two-cent stamps to make up the difference. At the same time, the Postal Service does get to keep clients’ money—money it needs—while clients keep the stamps in their drawers for the next decade. All parties are winners, which is critical for true financial innovation to flourish. Other countries, such as Canada, New Zealand and Singapore, offer similar stamps.
Now think of a retirement annuity where the benefit is modeled on a “forever” service. It might cover your water, gas or electric bill for life. Maybe it is denominated in units of days in a five-star nursing home, or units of Lipitor, Fosamax and Plavix. Or, perhaps it is a glass of wine a day. (Call it the Chaucer mini-annuity.)
Here is the bottom line. Remember that money is only a medium of exchange. Even if you do manage to find an entity that will guarantee you an income of $1,000 or $10,000 per month for the rest of your life—and you actually trust they will be around for the rest of your life—you still run the risk those dollars won’t be enough to purchase the services you really want. In the language of finance, you are not only incurring credit risk and inflation risk, you are taking on basis risk. That is the mismatch between the retirement assets you own and the liabilities that you face.
In today’s abnormally low interest-rate environment, perhaps the hunt for yield should be abandoned in favor of the hunt for institutions that can guarantee services an aging population will need to sustain itself. Would you buy a retirement-service annuity from a utility company? How about from a pharmaceutical company? An oil & gas company? Do you trust them—or like them—any less than your local insurance company?
Sure. There would be a host of regulatory issues these companies would have to contend with if they suddenly jumped into competition with century-old insurance companies and pension funds. But I believe it’s high time for someone to be disruptively innovative in the retirement income space. Where is the iPad of the retirement income industry? And, how about another glass of merlot while we wait?
Read one of Dr. Milevsky's prior columns in which he tackles the true cost of retirement.
Check out Rethinking Annuities, a Special Report landing page at AdvisorOne.