As we’ve seen, annuities offer excellent guaranteed income, and some designs can even offer spousal income guarantees and downside protection. Economists have used standard investment assumptions to show that annuity buyers are assured more annual income throughout their lives compared with people who self-manage their portfolios.
But behavioral economics suggests that investors actually tend to shy away from complex options like annuities and other “uncertain” retirement products. Economists call this the “annuity puzzle.”
“The latest research says that we humans don’t make financial decisions as logically as we used to believe,” explained Linda Eaton, executive vice president and performance improvement specialist for Cannon Financial Institute and author of the white paper “The Silent Value: Advice for the 21st Century.” “It tells us that clients tend to slip into patterns of thinking that can cloud their judgment, ultimately impacting not only their investments, but their lives.”
Eaton’s paper explored basic principles of neuroeconomics and how advisors can use those principles to improve client service and communication.
Behavioral economics actually supports the idea that the financial advisor is more significant than ever. And behavioral economics can help advisors better select, recommend and sell annuities to investors who can benefit from them. Following are four steps — along with their associated rationale according to behavioral economics — that advisors can take to better explain and recommend annuities to investors who may benefit from the products.
1: Get inside your client’s head
Clients often don’t realize that their preconceived thought patterns, or biases, drive their decision-making — they believe it’s based, instead, on straight logic. Advisors can administer profile tests to help them see their actual underlying beliefs, ultimately identifying their financial personalities and biases.
Such a profile also offers a glimpse into the client’s head, allowing the advisor to plot an advice-driven approach that is client-specific. Using the results of these assessments, financial professionals can approach a client in a more persuasive way that avoids showering advice upon deaf ears and instead highlights the appropriateness of any given solution.
2: Think like the client
Research shows that “the more important any decision is to a person, and the more complex a decision becomes, the more strongly it is lodged in the emotional regions of the human brain.” Pitched emotion, in other words, can impair a person’s ability to make good decisions.
Instead of counteracting the investor’s argument with logic, advisors should acknowledge and help them deal with their emotions, overcoming them as necessary to take a more logical, effective approach.
“Moving gently [and] making smaller, more gradual changes in a portfolio can often be more effective than trying to force a major change with which a client is uncomfortable, no matter how financially appropriate it may be,” Eaton wrote.
3: Reframe your advice
Framing can affect the way people view a product, which may, in turn, affect their evaluation of that product. Financial professionals can provide a different perspective than that of the client by simply reframing their advice, as well as offering more information about the benefits of annuities. For example, hearing that annuities are “lifetime retirement benefits products” could make an investor more likely to consider annuities, as it highlights its actual benefits and explains the timeframe during which it will benefit them.
It’s also smart to reframe the benefits of annuities to heirs. Beyond explaining that the investor can set aside some portion of a retirement nest egg for bequests, an advisor can also show how, when the investor manages their own money or invests in products that don’t guarantee a lifetime return, the investor can risk running out of money in retirement and potentially create a burden of support for their loved ones — an increasing possibility thanks to longevity.
It’s also effective to base recommendations on a client’s specific personal situation instead of presenting a solution based on the investment itself or the markets.
4: Close the deal with tailored annuity products
Finally, advisors can make stronger use of newer annuity products developed on the principles of behavioral economics. Those products are more appealing to many investors because they take into account typical aversion to loss, risk, and large, irreversible purchases; their need for liquidity; and other issues.
The phased purchase of immediate annuities during retirement is one example; an annuity that focuses on the risk of living longer than expected (e.g., longevity insurance annuities or advanced life delay annuities) or a combination of an annuity and long-term care insurance or inflation-indexed annuity are other options.
In the end, a firm grasp of the nascent but growing field of behavioral economics can help advisors not only understand the “annuity puzzle,” but solve it, creating happier, more financially secure clients.
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