Annuiphobia: Cause & Effect
Annuitization or buying a life income immediate annuity provides the highest possible guaranteed life income and yet a very small percentage of retirees select an annuitization income solution.
There is a contradiction. Study after study finds people saying they want a stable lifetime income in retirement. Study after study finds a significant percentage of these same people saying they don’t want an annuity. Why the disconnect?
The primary goal in retirement planning is to provide adequate lifetime income – bequest needs and money for emergencies are typically secondary. Life income annuities based on annuitizing a lump sum are the most efficient way to provide the income; the reason is the mortality credit. The insurance company knows that a certain percentage of annuity owners will die early and the income not paid out to them is used to increase the income for all. This is how the annuity can have a higher payout than the yield on the insurance company’s portfolio.
The life annuity provides not only a very competitive income, but one that is guaranteed to last through retirement. Why don’t more people choose it? Many don’t because they are afraid they might lose.
Cause: The Perception That You Might Wind Up a Loser
The thought process is this: You are age 65. Let’s assume you have no bequest needs, or if you do, you’ve taken case of those and any emergency cash needs with other assets. You also know that since Mom and Dad are still alive you have a decent chance of living a long time. You’ve seen the numbers and the life income annuity provides the highest initial income by far over the alternatives. Based on all of this, it makes sense to buy the annuity, but you don’t want to, because if you get hit by a truck two years from now, the insurance company keeps all of the remaining money you put in it – they won, you lost.
The insurance company has explained about the mortality credit which allows the annuity to pay more than, say, a bond, because in the pool of people that bought the life annuity some will die early, and the savings in payments from the early deaths allows everyone to be paid more each year. However, that answer doesn’t help, because it focuses your attention on dying early and you begin to recall everyone you’ve ever heard of that died soon after they retired.
You become so focused on dying early that it affects your reasoning. The actuaries can show you that there is a 2 out of 3 probability that a 65-year-old will make it to age 80, but you know the real odds of dying at age 65 are 1 in 2 – because either you’re alive or you’re dead. And even though you have other assets that are liquid, you become so focused on the annuity money that is “lost” you feel that even buying the annuity means the money is lost. Besides, age 85 or 90 is a long way. Even if you do live a long time, you have time to do something about it down the road and can postpone a decision today.
There can be several reasons for annuiphobia, but the overriding one seems to be a fear that converting an asset into an annuity income stream may result in the insurance company winning and the consumer losing due to early death. There are a few things that can be done.
Change the focus from the risk of dying early to the risk of living longer by getting the consumer to recall relatives that lived a long time. Begin the annuity presentation by asking, “Do you have any relatives that lived into their nineties?” This then causes the consumer to think of Uncle Bob who is still alive at age 97 and Aunt Ethel that made it to age 99.
Bring the future into the present. The year 2035 seems so far away, but do you remember 1995? The consumer might reply, “Sure, the Atlanta Braves won the series, I saw Braveheart at the theater and the OJ Simpson trial was in the news every day.” Well, 2035 is just as near to us today.Make the annuity guaranty vivid. This annuity will provide $18,000 a year, every year, for as long as you live. Not maybe $18,000, not a projected $18,000, not a Monte Carlo simulated $18,000, but a real, guaranteed check that will never go down and will be paid to you until you die. Annuity money is real money.
Show the annuity as a part of the whole. An annuity is often presented alone, kind of like a separate story, and that concentrates any concerns. Instead, make the annuity an integral part of the retirement process. It’s not “and we place $100,000 in the annuity,” instead it is “we’ll allocate 25 percent of your retirement assets to guaranteed income.”
Treatment: Take Losing Off The Table
Reframing helps annuiphobia by showing that the risk of dying early is not only overstated, but more than offset by the positive benefits of buying the income annuity. However, the reality is there are times when the fear of losing is so strong that it can’t be overcome.
When don’t you feel like a loser? When you’ve gotten back as much as you’ve paid into it. As long as you break-even, then you’re okay. Breaking even ignores opportunity cost (how well you would have done with a different choice) and the time value of money, and the internal rate of return doesn’t matter; it’s all about getting back the initial premium.
The way to take losing off the table with an immediate annuity or a deferred income annuity is to make payments guaranteed, either for a period of years (period certain) or to cover the entire principal amount (installment refund). The disadvantage is this cuts into, and can eliminate, the mortality credit. Yet, sometimes the annuity will not be purchased any other way and sometimes the cost to guarantee some of the income isn’t too bad.
For example, I priced a $100,000 premium immediate annuity for a male age 65 and the annual income was $6,760 as life only with no period guarantees. If I added a 10-year period certain option, so that the income would continue for the longer of ten years or life, the income only dropped to $6,640 and this means the worst case is the cash returned is $66,400, which might be acceptable to the buyer that really doesn’t think he’s going to die, but is afraid of getting hit by a bus. If the consumer wanted to ensure that at least the $100,000 is returned, the income drops to $6,190, but the annuiphobia caused by not wanting to lose is pretty much eliminated.
When I’ve talked with agents, they’d tell me they present the highest income first, which is the life only, and then proceed to greater period guarantees if they encounter resistance. The problem with this is every time you announce a new income amount, it is lower than the last and that makes it look like the annuity income is shrinking. It may be better to start with the installment refund income quote, which has the strongest premium back guarantee, and see if the consumer asks if there is a way to get a higher income. This way when the period certain is mentioned, the income amount is higher than the installment refund quoted and the life-only amount is higher still.
The most powerful way to remove the loser card is to never be in a losing position. A deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) means that the asset is not converted into an income but remains an asset. The disadvantage is the withdrawal payout is less than the immediate annuity payout, but getting, say, $5,000 a year from the GLWB may be preferable if it means being able to access the lump sum (less any surrender penalties).
My research indicates that annuiphobia is best handled by either framing the immediate annuity or deferred income annuity as a part of the entire retirement planning process, or to avoid it altogether by using a deferred annuity with a GLWB. Another treatment that will increase the purchase of all types of annuities is education. We tend not to fear what we understand.
The main reason many people casually dismiss all annuities from consideration is they are operating from a stereotype. For them an annuity is always a stream of income and never a lump sum. If having a lump sum available is important to them, then this stereotype stops any annuity purchase.
The good news is when a stereotype is based on bad information providing good information often gets rid of it. Telling the consumer that deferred annuities are typically designed for growth and that the vast majority of deferred annuities do not have to be converted into an income stream, may be enough good information to dismiss the stereotype and permit the annuity story to be heard. Educating consumers that deferred annuities can be used for growing assets and need not ever be annuitized cures much annuiphobia.
Jack Marrion is President of Advantage Compendium Ltd, providing research and consulting services to select financial companies. He has twice been asked to address the National Association of Insurance Commissioners on annuity issues. His insights on the annuity and retirement income world have appeared in hundreds of publications, including Business Week, Kiplinger and The Wall Street Journal, and his research is frequently referenced by regulators.