The picture of the retirement landscape isn’t a pretty one. Boston College researchers estimate that only about half of American households will be able to maintain their current standard of living in retirement.
Annuities provide guaranteed lifetime income, something that should be attractive to those who fear running out of money in retirement. So why aren’t more Americans buying annuities? Athene and the National Association for Fixed Annuities attempted to answer that question in a recent webinar.
It’s not that consumers don’t appreciate what annuities can do. Seventy percent of respondents told a TIAA survey that receiving a guaranteed monthly “paycheck” in retirement is important. But that same survey revealed only 13% of working-age individuals have purchased an annuity, and only 12% of individuals plan to buy an annuity at the time of retirement.
Over the past 15 years, researchers have attempted to solve the puzzle of why Americans like the idea of annuities but are reluctant to buy them.
The list of likely reasons ranges from price to loss aversion. But two behavioral researchers from UCLA said the list of reasons boils down to one factor: uncertainty. And there are four sources of that uncertainty:
Hal Hershfield, associate professor of marketing and behavioral decision-making at UCLA’s Anderson School of Management, broke down those four sources of uncertainty.
One of the uncertainties over longevity centers on the question: How long will I live? he said. Nobody knows the answer to that question and many people don’t want to ask.
Uncertainty is exacerbated by something called mortality salience, which suggests people recognize they will eventually die but there’s nothing they can do about it, Hershfield said. “People either act like ostriches or they engage in some symbolic kind of immortality. Because annuities bring up the thought of death, people may naturally avoid them.”
Consumers also have a bias around loss aversion, Hershfield said. “It’s the idea that losses loom larger than gains. The loss of an equivalent amount will feel worse than the gain of the same amount will feel good. People will act to avoid losses because they are so painful, and people fear they will lose money on their annuity because they will die early.”
Hershfield recommended overcoming longevity uncertainty by avoiding any mention of death in promotional material. “If it’s possible, frame annuities as a product that enables people to have income for as long as they live,” he said. He also recommended framing the annuity purchase as buying “enhanced financial security.”
Spending is a source of uncertainty among prospective annuity buyers because many of them don’t know how much their expenses will increase or decrease during retirement, Hershfield said. This spending uncertainty is exacerbated by consumers’ perceptions of trade-offs between sacrifices they need to make now and sacrifices they need to make later.
Consumers are more likely to opt for smaller rewards now instead of waiting for larger future rewards. For example, he said, when consumers were asked whether they want $500 now or $1,000 in five years, most chose the $500 now. “Applied to the annuity space, people may discount their future needs and spending because it just doesn’t apply to the present,” he said.
Many consumers think a lump sum is worth more than it really is, he said, and is worth more than an annuitized stream of funds. When consumers fork over a large sum of money to buy an annuity, he said, it may seem to them like it is more money than what they will receive month by month.
How to solve that issue? “Bring the future closer,” he said. “Get people to think more closely about what they will be doing in the future; make the future more vivid and closer to the present.”
Hershfield also advised linking accumulation with decumulation. “Allow consumers to contribute a little bit to an annuity with each bit of retirement saving they do, so it doesn’t seem too painful to part with a large sum of money,” he said.
Investment outcome uncertainty stems from consumers not knowing how much they will receive from an investment, said Craig Fox, professor of psychology and medicine at UCLA. Investor overconfidence plays into this uncertainty.
“People think they can do better investing on their own,” Fox said. “They think the future will be great. They think bad events are less likely to happen to them.” Consumers also may fear the insurance company may not make good on its guarantees.
Fox recommended overcoming investment outcome uncertainty by educating consumers on the difference between insurance and investments and on building trust with consumers.
The uncertainty around decision-making occurs when consumers ask themselves if they are making the right choice to buy an annuity, Fox said. “They may procrastinate. Retirement planning decisions are complex, and most consumers are not financially literate. The more facts and numbers you give people, the less confidence they have in their own ability to make a decision. This can cause them to not make a decision at all.”
Decision uncertainty is “a formidable problem to overcome,” Fox said. He recommended simplifying annuity presentations to consumers and limiting the number of options available in selecting an annuity.
In addition, Fox recommended advisors set reminders and prompts to help people as they consider their retirement savings and income planning.
“We need to remind people to begin the process,” he said. “People are more likely to implement it when they have an action plan.”