In “Better Financial Security in Retirement? Realizing the Promise of Longevity Annuities,” released by the Retirement Security Project at the Brookings Institution, University of Maryland Professor and former Council of Economic Adviser Member Katherine Abraham and Brookings Fellow Benjamin Harris note that the longstanding shift from employer-provided pensions to account-type saving plans has left workers with trillions in financial assets, but without adequate products for achieving retirement security. Longevity annuities—deferred income annuities that offer a monthly benefit beginning at some relatively advanced age and function as an insurance product—cost less than conventional annuities but offer the same pay-outs, and should be a viable retirement option, they write.
Longevity annuities either can markedly improve retirement wellbeing or have the promise to do so if the market becomes slightly more competitive, they find, suggesting ways to improve take-up of these products by addressing obstacles to consumer participation, employer participation and insurance company participation. The longevity annuity market has been under-developed because few plans are offered by employers due to concerns about fiduciary responsibility, it is rare for workers to choose to buy them outside of the workplace, insurance companies have concerns about mortality risk, the elderly have challenges with financially literacy and often do not get good investment advice, there are fears of the long-run viability of life insurers, and consumers do not account adequately for the risk of outliving their retirement savings.
The authors review data from the Health and Retirement Survey to find that individuals do not do a very good job of predicting their lifespan, with actual survival rates exceeding the anticipated probability of survival—sometimes by a wide margin. Roughly half of those who predicted that they had no chance of living to 75 actually did, and even among the groups who thought they had a 40% to 50% chance of living to age 75, the share actually surviving to that age was considerably larger (69% and 75%, respectively). This under-predicting of the risk of outliving one’s retirement may lead to diminished consumer demand, Abraham and Harris believe.
The authors note that the use of automatic enrollment in retirement plans has helped increase retirement security, which could be a useful tool for expanding longevity annuities. Policymakers are looking to expand retirement savings to those beyond those who only have access through their employers, which could help some 23 to 43 million more Americans save for retirement. They also point out that recent regulations have lowered the barrier to these products by easing restrictions on purchasing a longevity annuity from retirement accounts. Consumer fear of life insurers’ inability to pay out due to future solvency is not borne out by recent history, they find, but this stability is not well-understood in part due to restrictions on insurers advertising insolvency safeguards.
The authors suggest steps to increase the use of these products:
- Creating a set of government guidelines aimed at helping older Americans make sound financial decisions such as a financial security graphic, similar to the food pyramid, which could be disseminated by a reputable government agency such as the Consumer Financial Protection Bureau or the Social Security Administration;
- Product certification, including extending preferential tax treatment to certified products;
- Allowing insurance companies to advertise the state guarantee; and
- Offering longevity annuities to government workers via their Thrift Savings Accounts or through 401(k)s.
Increasing employer participation:
Reform Department of Labor rules so that plan sponsors can easily verify the soundness of insurers offering longevity annuities.
Increasing insurer participation:
- To help firms hedge against risk related to demographic trends, U.S. Treasury could issue bonds indexed to aggregate mortality trends; and
- A government agency such as Social Security could produce an official mortality index on which private-sector longevity bonds could be based.
“Longevity annuities [could] play a useful role in a retirement landscape increasingly dominated by defined contribution accounts. We are optimistic that longevity annuities can significantly increase expected lifetime well-being for middle- and upper-income retirees who have substantial financial assets at the time of retirement. An array of public policies, including policies aimed at consumers, employers and insurers, can help better support this nascent market. In particular, the combination of improved consumer awareness, reduced barriers to employer-based accounts, and better risk management strategies for insurers could go a long way toward turning longevity annuities into a mainstream product for retirees,” the paper authors conclude.