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Amy Finkelstein’s Deep Dive Into Annuities & Insurance

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If you think of academic research as initiating a circle of influence, you’ll understand the impact of Amy Finkelstein, Ph.D., on the retirement industry. The John & Jennie S. MacDonald professor of economics at the Massachusetts Institute of Technology is an expert on the nexus of insurance markets and consumer behavior.

A winner of the John Bates Clark Medal from the American Economic Association, Finkelstein is a high-echelon researcher who produces rigorous scholarly studies that retirement experts rely on for rich revelations and deep insights. Ultimately, her analyses are passed on to financial advisors for practical client application. Last, but certainly not least, the economist’s work has helped shape U.S. government policy.

At its summer conference, the Retirement Industry Income Association — in partnership with Research on Wealth magazine — will honor the prolific Finkelstein with its 2017 Achievement in Applied Retirement Research award. Past recipients include economists Shlomo Benartzi, Zvi Bodie, Laurence Kotlikoff, Brigitte Madrian, Moshe Ayre Milevsky and James Poterba.

The focus of Finkelstein’s insurance research chiefly concerns how individuals’ private information impacts their behavior when buying annuities, long-term care and health insurance, and how it affects insurance companies and insurance markets — all of which influence government policy.

“Amy was chosen for the character quality of her academic work and also, very clearly, for the substance of her work,” said Francois Gadenne, the chair, executive director and co-founder of RIIA. “Everything about retirement from both the viewpoints of gerontology and funding cannot be addressed without proper thought about the areas that she has researched.”

A jury of prior RIIA award recipients chose Finkelstein as this year’s honoree from a field of about 20 economists.

“The award goes to a researcher who exemplifies the virtues that RIIA seeks: independence, real research and respect for previous academic researchers whose thinking is anchored in an authentic genealogy of concept,” Gadenne explained.

In an interview, Finkelstein expressed her hope that her analyses of the evidence she finds help influence thinking and individuals’ retirement decisions. “It’s a great honor to be selected,” she said. “It’s always very exciting whenever one’s work has some impact outside just the small set of colleagues that also work on these topics and that it can potentially reach a broader audience. I’m tremendously flattered,” explained Finkelstein, who has received more than 35 honors and awards.

What sparked her interest in the insurance markets was finding “problems, such as private information, that — absent government policy — might [cause] the markets to not operate well,” she said. “That opened the possibility of asking: Was there scope for improving government policy as a result? This has been a question that’s animated a lot of my interest for many years.”

Data Detective

Finkelstein’s most important contributions center on the development of evidence-based tools for looking at where market failures — or inefficiencies — exist in health, annuities and long-term care insurance due to private information, similarly known as adverse selection, anti-selection or asymmetric information.

“We’re interested in seeing whether these [inefficiencies] exist because we then want to think about the implications for government policy,” she explained.

Finkelstein’s M.O. is interesting: She’s gained access to large data sets of administrative records, such as insurance-plan choices, claims and other information, which she examines to foster understanding of economics, insurance and health care markets. The MIT professor has answered questions, for instance, on why people buy or do not buy such insurance and the influence that consumer behavior has on annuity pricing.

“Amy is a superstar in economics, and her work in annuities and long-term care insurance is important to retirees. She’s helping the retirement industry,” said Moshe Ayre Milevsky, finance professor at York University’s Schulich School of Business. “If I were a financial advisor who sold long-term care insurance, I’d really want to understand what Amy’s insights have been about that. If there’s ever a Nobel Prize in economics in the insurance category, chances are very good that Amy would win it.”

Part of what’s fun for Finkelstein in conducting studies and experiments is the element of potential surprise, she says. Such was the case with the Oregon Health Study of 2008-2010, a high-profile experiment in which, via lottery, uninsured low-income adults were given Medicaid, while a control group was not.

The experiment sought to learn how having this government insurance changed people’s behavior. One finding was that the group with Medicaid used the emergency room — a costly form of health care — more often than the others did.

This refuted the assumption that the Medicaid group would seek help at free private care clinics or doctors’ offices. Hence, the study had implications for the Affordable Care Act, which aimed to reduce costs by giving more Americans access to health care.

Annuity Analysis

In annuities, Finkelstein has helped improve the understanding of adverse selection among purchasers; that is, they know something about themselves that the insurance company does not — and such knowledge motivates them to buy.

“This means that people end up paying more, because the people who are voluntarily buying annuities are signaling to the companies that they’re in a bigger risk pool,” Milevsky noted. “They probably have a longer life expectancy than others. This has been an axiom in actuarial pricing for many years, but Amy has measured it. That’s very important because it helps us to understand the magnitude of this.”

Indeed, private information, or adverse selection, drives up annuity prices for others, so that “even people who would like to buy annuities at prices that would be fair to them given their mortality risk cannot do so or don’t want to” Finkelstein pointed out.

Companies selling variable annuities that are available with a host of investment choices face the private information problem, Milevksy noted. “It’s about who knows what; but today the companies are learning more. Amy has been very good at measuring this [type of] anti-selection,” he said.

As a Harvard government major, the New York native says she became interested in economics because “it was an exciting way to synthesize history,” a favorite subject of hers in high school. She went on to pursue a master’s degree in economics at Oxford and then a doctoral degree in the subject at MIT.

Early on in her studies, economics led the budding academic to dive deeper into empirical political science. “The more I became involved, the less interested I was in the question of why policies were the way they were and more [interested in] the question of what was the impact of the policies or what the policies should be,” she explained.

She then took classes on social problems in the American economy and found that “rather than just arguing about questions based on ideology, as my friends and I were doing, you could use data to look at [issues like]: Do divorce laws affect divorce rates? It turned out that you could do research on such issues. As someone who was really interested in the world around me, the idea that you could use data to answer these questions rather than just to debate them was extremely exciting and transformative,” she said.

Insurance Interest

Her fascination with insurance markets stems from working for a year as an economist at the Council of Economic Advisers during the Bill Clinton administration. That interest prompted her to select the subject of her Ph.D. dissertation, written as an MIT grad student: market failures in the health insurance and annuity markets.

Concerning annuities, she stresses that “if you have private information about how likely you are to live and how your parents lived, annuities are a better deal for people who are likely to live longer than the insurance company might expect based only on their age and gender, which is what they price them on.”

Finkelstein also has examined the pricing of long-term care insurance and found it to be unfair: Many people were being charged too much; others, too little. There, private information once again came into play. For example, the more likely an individual thought he or she was going to need nursing home care, the more likely this person was to buy long-term care insurance.

However, she found that pricing did not cause the long-term care insurance market’s small size. Instead, one reason was that “the existence of Medicaid as an insurer of last resort for people with very high nursing home costs reduces demand for long-term care insurance. So it seems that there are real market problems and real reasons for government intervention,” Finkelstein said. “But to design a [government] policy [for this] is a lot harder than I had realized — as an academic trying to think how to design one.”

Health Care Work

Another of her influential studies looked at how the introduction of Medicare in 1965 affected demand for health care and the subsequent implications for government policy. She found that in areas of the U.S. where Medicare had a substantial effect on expanding health care coverage, a big increase in health care spending emerged. With insurance provided, people consumed more heath care since the price was lower, an example of the phenomenon researchers call moral hazard.

Managing health care expenses is of course a major issue in retirement; and it is critical for retirees to approach it thoughtfully, Finkelstein says. They should strive not to make “insurance decisions based on: ‘Oh, wow! I had a big expense last year, so I should lower my deductibles this year,’ or ‘I didn’t have any health care costs last year, so maybe I should get rid of my insurance.’ It’s important to think about the risks you face and reduce your exposure to them, not look at what happened to you the previous year,” she explained.

Carefully studying the details of a long-term care policy before purchasing one is smart, too. “Small differences can make for a very big deal. For example, most people buy long-term care insurance when they’re in their early- to mid-60s [expecting they will be] entering a nursing home, which, on average, most people do in their early 80s. If there’s an escalation of benefits that’s linked to inflation, that might look like just a footnote; but it’s extremely important with a policy you’ll get benefits from in 15 years,” she said.

As with the work of past RIIA award winners, Finkelstein’s sophisticated academic research will be integrated into the curriculum for the Association’s Retirement Management Analyst Designation for financial advisors. RIIA’s July conference, which has the theme “Mapping Solutions for the DOL’s Fiduciary Rule and Beyond,” features presentations from experts including Meir Statman, professor of finance at Santa Clara University.

Because Finkelstein’s research is used by the government-policy community, the economist declined to discuss current administration policies. She did hint, though, that the hot topic of Social Security reform could be a future research topic for her.

“How to think about political risk, how you make your long-term care insurance savings decisions when there is not only uncertainty about your mortality and health care costs but political uncertainty about what the nature of social insurance programs may be in the future, is a fascinating topic and a hard problem — but not one that I have anything to say about yet,” she said.

The MIT professor’s principal areas of research are current top-of-mind concerns for the retirement industry, if not most aging Americans, to be sure. But they also are “core economic issues that come up all the time,” she says. “Economics is an extremely powerful and useful discipline for shedding light on important issues.”

Letting her research speak for itself, Finkelstein refrains from advocating for specific government policies or for any industry changes based on evidence she’s uncovered and examined.

“I wouldn’t feel comfortable in that role, but I hope I’m helping influence people’s thinking and discussion. My research is one part of a larger picture,” she said. “Opinion on any given policy will be affected by many things, of which empirical work such as mine is, hopefully, a part.”


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