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Looking At The Value Of Annuitization

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A seminar here on retirement in America looked at questions that many consumers are starting to ask as they consider their own retirement and then seek to answer those questions.

The session, titled “Retirement In America: What’s Next? What Do We Do Now?” was sponsored by Barclays Global Investors, based in San Francisco.

Among possible solutions discussed were working longer, saving more and using annuitization to relieve the amount of savings that will be required.

The session kicked off with an overview of recent trends in the U.S. retirement area presented by Dallas Salisbury, president and CEO of the Employee Benefit Research Institute, Washington.

Citing the 2002 annuity mortality table, Salisbury noted that males age 65 have a 50% chance of living to age 85 and a 25% chance of living to age 92. For females, the respective numbers are a 50% chance of living to age 88 and a 25% chance of living to age 94. For couples, there is a 50% chance of one survivor living to age 92 and a 25% chance of one living to age 97.

One problem, he noted, is that people think life expectancy represents the end of life and do not understand that it is a median age.

The trend toward longer life and what that costs is being pressured by other trends including the growth of health care costs as a percentage of total benefit dollars spent, he explained. As evidence, Salisbury cited statistics from EBRI based on data from the U.S. Department of Commerce which indicate that as a percentage, health care expenses grew to 41.2% of benefit dollars in 2004 from 14.2% in 1960.

Salisbury also discussed the value of annuitization, noting that it “can allow you to save 34% less than if you try to do it yourself, on average.” The average life expectancy for a male at 65 is now 81, he noted. So, he explained, if you annuitized your savings at 65, you could do that by having saved about 8% of income from ages 20 to 67, 16% from ages 40 to 67, or 27% from ages 50-67. However, Salisbury continued, if you were to do it yourself without an annuity and actually lived to 100, you would have to save 13% from ages 20-67.

Risk of running out of money

Olivia Mitchell, Ph.D., a professor of insurance and risk management at the Wharton School of the University of Pennsylvania, reiterated the need to address the risk of running out of money in retirement.

That risk is broken out into factors that include undersaving, living too long, and having health problems, she explained.

What can help alleviate that problem, she said, is to work longer. An American in the median wage quintile would need an additional 17.3% of savings to replace income if that person retired at age 62 but only 7.7% of income if that person retired at age 65.

“Annuities are a very undervalued product,” she noted. “There are good ones and bad ones, but in principle, they are very important.”

Those who purchase immediate annuities tend to live longer and insurers price for that, Mitchell said. If one looks at population mortality data, an annuity may seem like a “bad deal” with a return of 81 cents on the dollar, but if one looks at the annuity survival tables, it is a better deal at 93 cents on the dollar, she added.

She said that the issue of having enough in retirement becomes even more important when one looks at projected out-of-pocket health care expenses. At age 65, the cost, according to a Fidelity study, is $160,000 without long term care and $290,000 including LTC. At age 60, she continued, the cost is $200,000 without LTC costs and $330,000 with these costs included.

In addition to working longer, Mitchell mentioned other possible alternatives such as reverse mortgages.

Salisbury said that in his view, it would be better for a retiree with a defined benefit plan to annuitize retirement income with the retiree’s company up to the level covered by the Pension Benefit Guaranty Corporation, Washington. If the retiree still had concern about the company, then annuitization through an insurance company could be considered, he added. But, this would impact less than 10% of retirees, he noted.

Focus on life expectancy

What is important is to get them to focus on their life expectancy and then discuss how annuitization can help provide them with sufficient retirement income, he said.

The question was raised about whether insurance companies would be able to participate in helping people annuitize and create a stream of income in retirement.

In order for that to happen, according to M. Barton Waring, managing director and CIO with Barclays in San Francisco, insurers need to make the process easy, transparent and safe for their customers.

On the issue of transparency, he continued, insurers use book value in their financial reporting rather than marking-to-market. Consequently, underfunding could be concealed, Waring added.

When asked about new features and guarantees in some annuity products, Waring said, “There is a lot of creative stuff but the underlying promise is the same as it has always been.”

Waring also noted that different states have different guarantee levels offered through their guarantee funds. “There are wide variations state by state.”

The discussion of annuitization also included comments noting that Congress had considered a Fannie Mae/Freddie Mac approach that would purchase and then securitize annuities, offering protection through diversification.


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