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Why QLACs compete with New Coke for epic FAIL title

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In the past two years, the government decreed the new availability of retirement products that promised to pave the way to post-career happiness by answering the direst needs of savers everywhere. Both the MyRA and the Longevity Annuity came out with such fanfare you’d think regulators had parted the Red Sea.

It turned out not to be the Red Sea, but merely a faded red can of New Coke. Sure, the wizards down in research and development could design anything based on any specs. And the policy wonks thought they had a winner with these particular specs. Regulators thought the MyRA and the QLAC offered the answers to what academic research insisted were the most pressing wants of the working class. So the financial engineers built it, only they didn’t come.

We’ll set aside MyRAs as a fait accompli, and, instead, focus on the much heralded longevity annuity.

After years of the incessant drumbeat of “retirees want guaranteed income,” the powers that be ordained that longevity annuities could legally be placed in 401k plans and IRAs beginning July 1, 2014 (within certain limitations, perhaps a tacit recognition of the silliness of the idea in the first place).

In hindsight, we could have probably done a simple pricing analysis before we even started and concluded QLACs just couldn’t compete against the alternative. (For an example of one such analysis, see “Square Peg QLACs Can’t Seem to Fit in 401k Fiduciary Round Hole,” FiduciaryNews.com, August 4, 2015.)

Forget the pricing problem, let’s get to the real problem with the QLAC. Not even favorable pricing can overcome this obstacle (and woe be the insurance company that thinks they can underprice this challenger).

As alluded to before, the QLAC seems to have been designed by researchers, not by the potential buyers.

The bean counters behind those ivy-covered walls insisted the most rational decision a retirement saver could make was to buy a longevity annuity. Why?

Because the greatest fear people claim to have is the fear of outliving their money. QLACs represent a form of insurance that could mitigate this fear.

Perfect, right? A match made in heaven. Except for one thing.

Researchers made two unfortunate assumptions. First, they assumed all consumers exhibit a cold rationality far beyond that of mortal men. Second, and directly related to the first assumption, advocates of QLACs failed to take into account the psychological upside of alternatives.

Here’s what I mean about that second assumption, and I’m sure you’ve seen analogous examples of this concept in plenty of other places.

Take any random group of people. By definition, their expertise on a given subject would be distributed along the classic bell curve.

Half would be above average. Half would be below average.

Now, ask each one of them how they would assess their relative strength on this particular subject, and, more often than not, more than half the people would rank themselves “above average.”

Remember, you already know only half the people in this sample set are above average.

What accounts for this behavioral tendency towards overconfidence?

It’s called “the Lake Wobegon Effect.” You remember Garrison Keillor’s popular PBS show called “Lake Wobegon,” where all the women are strong, all the men are good looking, and all the children are above average.” Well, I guess, in our own eyes, we’re all Lake Wobegon children.

Now, I’m not sure overconfidence is necessarily a bad thing (because sometimes it’s the single reason why we succeed well above expectations). But — and here’s the critical point — imagine the impact this overconfidence has on the typical consumer’s value analysis of a QLAC.

Yes, they may be worried that they’ll outlive their retirement savings, and, yes, they recognize others have, indeed, outlived their retirement savings.

But brush this logic away with a sweep of their hand and insist “I’m above average and I can figure out a way to make sure this doesn’t happen to me.”

The QLAC may be able to part the Red Sea, but it can never part Lake Wobegon.