With the potential for retirement to last 30 years, it is essential for retirees to address both increasing life expectancies and the long-term risk that inflation poses to purchasing power.
Insured alternatives are readily available, but many people still choose to self-insure on both counts by personally managing their nest egg throughout their retirement years.
Those using self-managed strategies often find themselves dealing with discomforting questions:
o Will my savings last the rest of my life?
o Will my income keep pace with inflation?
o Will a market correction reduce the value of my nest egg, forcing me to live on less or risk running out of money?
Self-insurance involves risk that retirees may be unprepared to handle. People with retirement savings of $1 million or less may find it difficult to absorb significant bumps in the road. Even those with more resources may value the comfort that comes from insuring some of their income against longevity and inflation.
To transfer these risks to an insurance company, many financial advisors recommend annuities. However, to meet the changing needs of the 78 million baby boomers preparing for retirement, and to capitalize fully on this growth opportunity, industry leaders must re-engineer the traditional income annuity.
Why? Almost every U.S. life insurance company offers a traditional income annuity, also known as single premium immediate annuity (SPIA), and the vast majority are identical in design. Over the past few years, SPIA sales across the industry have been relatively modest.
So the question is: Why don’t more retirees use traditional income annuities to insure the risks associated with retirement income?
One important reason is the failure of SPIAs to keep pace with the complex needs of today’s retirees. It is hard to believe, but the typical SPIA has changed little in the past 50 years. Imagine the effect on permanent life sales if life insurance ceased to evolve beyond traditional whole life–no interest-sensitive life, no universal life, no variable universal life. It is difficult to find another insurance product where such is true, but that’s the case for the typical “Life with 10 Years Certain” SPIA.
The growing focus on retirement income security has raised awareness among insurers that it’s time to improve the SPIA product.
Some companies have provided liquidity by permitting commutation of remaining certain payments. Others now include flexibility to advance future scheduled payments on a limited basis, and a one-time window to “reprice” if interest rates, and presumably inflation, move higher. A few have introduced annual adjustments to income payments based on changes in the Consumer Price Index.
But these product changes are largely piecemeal attempts to fix a product design that is out of touch with boomer clients.
Start with clean slate
In contrast, it makes more sense to start with a clean slate by re-thinking the traditional income annuity with the generation of baby boomers in mind. The best way to accomplish this is by examining 2 important questions: What do retirees need and what do retirees want?
What retirees need: A significant amount (40%) of baby boomers and retirees are worried about running out of retirement income, according to a recent survey conducted by the Lincoln Retirement Institute. With the potential for retirement to last decades, keeping pace with inflation is equally important. A re-engineered annuity should help clients accomplish both objectives. For the portion of retirement income provided by a fixed immediate annuity, the retiree should enjoy the comfort that comes from knowing the risk is insured and shifted from the retiree to the insurance company.
What retirees want: This question gets at the heart of why retirees seldom use SPIAs. While the primary objective is lifetime income that keeps pace with inflation, seniors are understandably reluctant to relinquish control of such a large amount of money should unexpected needs arise.
If the insured solution removes access, it makes them feel less secure, not more.
A similar issue exists with the possibility of premature death. Many retirees believe that if they were to die shortly after retirement their beneficiaries would have been better served if the retiree had self-insured, thereby preserving most of the nest egg for the beneficiaries.
Fixed immediate annuities do provide alternatives to a pure “Life Only” payout, which limit the amount of forfeiture associated with premature death. But retirees often have had difficulty relating to the way such guarantees are packaged.
Therefore, to meet retirees’ needs and wants, the new generation of traditional income annuities must guarantee lifetime income and lifetime protection of purchasing power, while providing access to money for unexpected needs and preserving the remainder of the money for the retiree’s beneficiaries.
For the industry to succeed in the future, it is essential for products such as SPIAs to evolve to meet the complex needs of baby boomers.
C. Phil Elam, FSA, MAAA is an senior vice president and the individual fixed annuity business leader at Lincoln Financial Group, based in the Greensboro, N.C. office. To e-mail him, write to: email@example.com.