Why are retirees wary of annuities, Shlomo Benartzi rhetorically asks?
Let us count the ways: high commissions, outrageous surrender fees, hidden expenses, mortality tables that favor carriers, dishonest marketing, complexity of the product, and on and on.
Which, when taken in total, match Benartzi’s larger point—in the eyes of the consumer, it’s all about fairness, he wrote Tuesday in The Wall Street Journal.
Referencing Limra Secure Retirement Institute, he noted: “Americans bought approximately 39,800 immediate lifetime annuities in 2017, which equates to a little more than 100 annuities a day.”
Considering that roughly 10,000 baby boomers retire every day, he added, it means that only about 1 percent of retiring Americans actually buy a lifetime annuity.
Yet “fairness” doesn’t necessarily equate with rational.
He pointed to research from his colleagues Suzanne Shu and Robert Zeithammer at UCLA, as well as John Payne at Duke University, and their finding that “the individual difference that best predicts interest in annuities is a person’s sensitivity to issues of fairness.”
Consider his example:
A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.
Please rate this action as:
- Completely fair
- Acceptable
- Unfair
- Very unfair
“While traditional economic theory assumes that higher demand should lead to higher prices, 82 percent of subjects thought it was unfair of the hardware store to take advantage of the short-term spike in demand. To them, it just felt wrong.”
Three recommendations
Yet decumulation strategies could use more think and less feel, more head than heart.
“First, don’t let emotional reactions like fairness scare you away,” he advises. “If you feel strongly about violations of fairness—say, if you always think it’s unfair for the store to raise prices after a storm—don’t dismiss annuities out of hand.”
Second, “While the shared-risk model might seem unfair, annuities can provide an important protection against longevity risk.”
Third, annuities aren’t right for everyone, but when they work for a particular situation, they should be customized to individual circumstances.
“While the accumulation of retirement savings can be improved using non-personalized nudges such as auto-enrollment in a company’s 401k and auto escalation of contributions,” Benartzi concludes, “decumulation requires a highly personalized approach, in which the solutions are tailored to reflect the goals, circumstances and preferences of the individual.”