To explore the alternatives and implications Allianz worked with Professor Shlomo Benartzi of UCLA to reach out to a number of academics in the field, several of which were on hand at a meeting in New York City to present some of those findings and their implications.
The findings, which Allianz said it submitted as its response to the February request for information by the Department of Labor and Treasury Department on retirement income products, was produced under the title “Behavioral Finance and the Post-Retirement Crisis”, broadly defined as being “about outliving your assets.”
Indeed, while the issues attendant with crafting an effective retirement income solution are many, much of the panel’s discussion was oriented toward the challenge presented by longevity risk, simply stated the risk of outliving one’s savings. To kick things off, Benatzi used the example of ten high school friends who retire at age 65. Of those, Benatzi said that the first of the 10 would die just four years into retirement, at age 69, while the last in the group to die would, according to statistics, not die until age 99.
This post-retirement crisis is magnified by the poor financial decision-making of retirees, who according to the research presented, pay too much attention to recent stock market performance (those retiring after stock market increases of six to 12 months are much more likely to select the lump sum option rather than lifetime income), have trouble making financial decisions, and are "hyper" risk averse.
“Nudging” the Annuity Decision
Dr. Alessandro Previtero of UCLA highlighted a finding that would seem to defy “common wisdom” about annuities, specifically the reality that, when given choice to pick a lump sum as well as an annuity in a defined benefit plan, the vast majority opt for the lump sum. He cited a study that found that in a period from 1999 to 2005, only 2% to 6% of retirees elected guaranteed lifetime income when it was available in their 401(k) plans – much lower than expected, and a disparity he referred to as the “Annuity Puzzle" (the puzzle being why people don't choose annuities).
However, Previtero recently conducted new research with what was described as “a unique dataset of more than 100 defined benefit plans”, covering more than 100,000 retirees. Each of these individuals had to actively choose between guaranteed lifetime income and a lump sum. Because there was no default, they had to decide themselves how to withdraw funds – and Previtero said that 49% of retirees making an active choice between guaranteed lifetime income and a lump sum actually picked the lifetime income option.
He went on to note that defined benefit payouts are typically communicated in terms of producing monthly income, and annuity payout options tend to look attractive to participants accustomed to thinking of those benefits in like terms; but he contrasted that with cash balance plans that are often, like defined contribution plans, are communicated in terms of account balances or lump sums. Previtero said he found that retirees in defined benefit plans were 17% more likely to choose the guaranteed lifetime income than their peers in cash balance plans.
The recommendation; make retirement income solutions available in 401(k) plans and, somewhat ironically considering the panel’s general affinity for using defaults to help participants make better choices - “nudging” retirees to actively make a choice.