For roughly a decade, pundits in the retirement financial industry have been predicting that sales of immediate (income) annuities, and annuitization of previously purchased deferred annuities, would soar as baby boomers enter retirement.
After all, their reasoning went, the number of retirees receiving pensions from defined benefit plans has steadily decreased over the last quarter century in the private sector (public sector pension plans largely continue to provide life annuities to participants). If retirees were not receiving a company life pension, surely they would create a personal pension by converting assets to a life annuity, they said.
That has not happened. My research indicates sales have been ebbing or flat.
Yet immediate annuities and annuitization remain only a small part of the overall annuity scene. Just one carrier in our database comes close to a double-digit annuitization selection rate for existing deferred annuities.
So, why the continuing predictions of a surge? Why won’t boomers buy immediate annuities to replace the company pensions they have lost? Look to economic behavior–rational and normal.
Rational behavior. Actuaries and quantitative experts who predict growth are relying on the idea that annuitization is often the rational thing to do.
The logic is inescapable. Unless one feels the need to bequeath money upon death, it makes rational sense to annuitize–i.e., to receive the maximum possible income for one’s life (or that of a surviving spouse).
However, even when bequests are not a factor, researchers have found that very few people convert assets into life annuities. So the rational crowd keeps looking for rational reasons for not choosing immediate annuities.
For instance, could it be because life annuities typically do not offer cost-of-living increases? This appears to be more of an excuse than a reason given for not buying one. Academic research shows that keeping up with inflation does not appear to play a huge factor in many consumer financial decisions. Even when inflation-indexed annuities appeared in this country, they were not snapped up.
Maybe it’s because people already have an immediate annuity? Some academic studies say people will not buy immediate annuities if Social Security–a life annuity–represents too large a percentage of their retirement assets. The same studies also reason that since Social Security becomes a proportionately smaller percentage of total retirement income among the more affluent, wealthier people will buy more immediate annuities. That reasoning may be in error, however, since the wealthy are not known to buy immediate annuities more than anyone else.
Selecting an immediate annuity is often the most rational choice for a retiree. But the factor behind low immediate annuity sales is that consumers typically do not act rationally, but normally.
Normal behavior. Based on my research, it strongly appears that there are 4 behavioral reasons for not buying these annuities. They follow, in reverse order.
Reason 4: fairness. It is widely known that many consumers view annuitization as akin to gambling, and they believe immediate annuities are rigged in the carrier’s favor. My research shows that consumers strongly overstate the possibility of dying early–and therein lose the annuitization bet–and understate the chance of living too long.
Reason 3: admitting mortality. There is a big psychological problem with annuitization. This is has to do with death. Annuitizing is seen as admitting there is no longer hope of building assets for future use because one will die. “Thinking of dying? Time for immediate annuity buying!” is simply not a very catchy advertising slogan.
Reason 2: overconfidence. Why do money managers and individual investors persist in attempting to beat average stock market returns even though, over the long haul, the vast majority does not? Because they think they can. These same people believe they can beat the carriers.
And reason 1: loss of control. $1 million might produce life annuity income of $80,000 a year. If no bequests are planned, the life annuity solution provides a very attractive alternative to self-insuring longevity risk. However, the minute a person buys the annuity, the person has turned from millionaire into pensioner. Gone is the freedom to spend the asset. Now, there is an element of mistrust, because the carrier has full control.
For these reasons, deferred annuity sales, both variable and fixed, should continue to grow, especially the products that have the new guaranteed withdrawal features. The withdrawal feature enables consumers to keep control, plays to their overconfidence, permits them to deny mortality, and enables them to try for “another gain.” Even though the withdrawal payout is less than an immediate annuity would pay, this is perceived as “fair” because of the advantages mentioned.
Agreed, immediate annuities are a rational solution for retirement income, and their sales should grow if the carriers lower costs and reduce adverse selection, thereby making them more competitive. Also agreed, the market for inflation-indexed immediate annuities will continue to grow. However, I believe the behavioral reasons cited above will continue to keep immediate annuity sales and annuitization of existing deferred annuities in check. The best prospects for immediate annuities will be the most risk averse consumers.
Jack Marrion is president of Advantage Compendium, a St. Louis based research and consulting firm. His e-mail address is firstname.lastname@example.org