BeFi Conference Topic 11

Brainstorming on Decumulation:The Annuity Puzzle

by David BlakePensions InstituteCass Business School

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Brainstorming on Decumulation:The annuity puzzle

David BlakePensions Institute

Cass Business School

Very little thought goes into decumulation

Yet it is THE most important stage in any pension plan

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Need to brainstorm on …

• Is it best to annuitize?

• If so, when?

• If so, what type of annuity?

• Is there a role for government?

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Individuals underestimate how long they will live

Sources: O’Brian, Fenn, and Diacon, 2005, self-estimated life expectancy compared with GAD forecast life expectancy; Prudential analysis.

Number of years by which consumers underestimate life expectancy

WomenMen60-69

50-59

40-49

30-39

20-29

0 2 64 8 10

Age

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Is it best to annuitize?

• Ever since Yaari (1965) economists have said ‘YES’

• Annuities are the only financial instrument ever devised that can give lifetime income security however long an individual lives

• But:– They are regarded as being poor value– And what about bequests?

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If so, when?

• Perhaps not immediately

• Giving up the equity risk premium

• To begin with the mortality cross subsidy is very low

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If so, when?

Annual Mortality Cross Subsidy

0%

5%

10%

15%

20%

65 67 69 71 73 75 77 79 81 83 85 87 89 AGE

BO

NU

S

Limited Value fromannuitization – Death benefit seen as more

valuable.

annuitization essentialto provide income for life

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If so, what type of annuity?

• Level

• Index-linked

• Investment-linked/ variable rate

• Money back/ premium refund

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Money-back/premium refund annuityOn death any excess of the original purchase price over the gross

annuity payments already received is returned to the annuitant’s estate

65 67 69 71 73 75 77 79 81 83 85

AGE AT DEATH

ACCUMULATED INCOME DEATH BENEFIT

AC

CU

MU

LATE

D

GR

OSS

PA

YMEN

TS

MBA allows a pensioner to lock into investment and longevity guarantees while providing death benefits in early years.

£Purchase price

10

MBA defers annuitisation

MBAs allow annuitization to increase gradually over the early years of the contract

Money-Back annuities allow the mass market to defer annuitization without incurring the risks, costs and complexity of Income Drawdown

AGE

PROPORTION OF FUND ANNUITIZED

65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90

ANNUITIZED FUND FUND RETURNED ON DEATH

£

All very clever….

…. but consumers are still not rushing in

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Is there a role for government?

• In improving education about annuities?

• In making annuitization compulsory by a certain age?

• In increasing the perceived value of annuities by helping to hedge an aggregate risk that annuity providers cannot hedge alone:– Longevity risk?

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Longevity fanchart for 65-year old males

2005 2010 2015 2020 2025 2030 2035 2040 2045 205016

18

20

22

24

26

28

30

32

Ye a r

Exp

ecte

d fu

ture

life

time

P aram eters unc erta in

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How about this new advertising message?

•SPORT:

•Annuitize now and spend more today!

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Questions

• Is it best to annuitize? – What about bequests?

• If so, when?• Is there a role for government?

– In improving education about annuities?– In making annuitization compulsory by a

certain age?– In helping to hedge longevity risk?

P R E S E N T E D B Y

Shlomo BenartziCo-Founder, BeFiAssociate Professor Co-chair of theBehavioral Decision Making GroupThe Anderson School at UCLA

Warren CormierCo-Founder, BeFiPresident, Boston Research Group

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