The public hears good things about annuities, such as annuities can keep you from running out of money, said Meir Statman at a retirement income conference here.
In fact, a working paper written in 2003 by C.W.A. Panis for the Pension Research Council shows that people who do not have annuities are unhappy, less satisfied and depressed, said the Glenn Klimek Professor of Finance at Santa Clara University, Santa Clara, Calif.
If that is so, why don’t more people own annuities? he asked.
Standard reasons include desire to leave money to heirs, loss of liquidity, high fees and mortality expectations, he said.
But there are also behavioral reasons, Statman noted, addressing the annual managing retirement income conference, co-sponsored by the 2-year old Retirement Income Industry Association, Washington, D.C., and the Institute for International Research, New York.
One example is the feeling some people have that annuities have “the smell of death” about them, said Statman. During the sales process, he explained, there is often too much focus on fear and not enough on hope.
Advisors should frame the discussion so that the sale is “about the upside potential, not just the downside protection,” he said.
Many people have a mixture of risk-seeking and risk aversion behaviors, he explained. “We want to be secure but we also want the upside. That’s why people (who own insurance) also buy lottery tickets.”
People who buy lottery tickets have hope, he said.
Where annuity sales are concerned, “be careful not to extinguish hope.” Instead, combine discussion about downside protection with discussion of upside potential–and “don’t annuitize everything,” Statman said.
He presented several other reasons from the behavioral economics point of view, plus some suggestions for dealing with them. Here are examples:
o Frame how buyers think about their “money illusion.” For instance, talk about moving the money less from the perspective of keeping a stock of money and more from the perspective of setting up a flow of money. That concept is not always easy for consumers to grasp, he allowed, explaining that they tend to think of their money being reduced when they purchase an annuity. But advisors understand it–and they should explain it to clients.
o Deal with the desire to save the best for last. This is what people like to do, Statman said. They also want to have a better year next year. But they don’t see buying annuities in that light, he exlpained. Their view is, they have the money now, but it will be reduced after they buy the annuity, and “then it’s all downhill.”
This ties in with loss aversion. With a single-life annuity, for instance, “you feel like a loser from the day you bought it. You fear you’ll lose with buying an annuity.”
One solution would be to have a cash refund feature on the annuity, Statman suggests. It would assure people that they will get their money back, he said. Another would be to invest part of the money in an annuity/ life insurance solution and the rest in a growth portfolio.
o Address feelings of buyers who have aversion to regret. The regret is, if the customer buys an annuity today and the stocks zoom up the very next day, “regret kicks in, and you kick yourself” for buying the annuity. Statman suggested these strategies: Use windfall money to buy the annuity, because that money is in a separate mental account; or use money that is in bonds, because the value won’t go up and down as much as do stock values; or use dollar cost averaging to buy the annuity. Also, if you can, “make annuitization mandatory,” he said, because “there is no regret when there is no responsibility for choice.”
o Address concerns about “dipping in to capital” to generate income. Spending from dividends or interest is often acceptable, he said, but for many people it is sacrilege to dip into capital. One way to help customers overcome this would be to use current income as a guide for consumption, or what is permissible for them to spend, he said.
If buyers perceive that they have little income to spend in retirement, they will spend little, Statman cautioned. They’ve learned to delay the gratification of spending. But those who have learned to save will need to unlearn delayed gratification, he suggested. “The question is, can they learn to spend?”
Advisors should find ways to obscure the dips into capital, he suggested. They can use covered calls as an equity income strategy, for example. “Point out that you get the dividend and the 4% premium on the stocks that you sell.”
Remember, said Statman, there are both cognitive and emotional reactions to small probabilities. He cited, for example, the range of reactions to the chance of winning the lottery versus the chance of running out of money. Does the subjective probability equal the objective probability? he asked. Does the customer savor the lottery winning as much as anticipate the loss of money?
His suggestion: “Make the idea of running out of money as vividly dreadful as the lottery ads make winning vividly wonderful.”
Maybe the real problem with managing retirement income is not that people spend too much in retirement and so will deplete their money, the professor concluded. Rather, it is that they need to spend enough, and they need to convert money into income to do that. “Annuities are one way to increase consumption.”
The industry needs ways that take not just the rational but also the emotional aspects of this into account, he said.