Comments on: Mandating annuities in retirement A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: TFF Sat, 02 Oct 2010 00:49:32 +0000 As an aside, most of the annuities sold seem to be fixed — not adjusted for inflation. You get a much higher initial payout on a fixed annuity, but the longevity risk attached to such a product is very scary. I don’t want to be 10 years into retirement and living on half the purchasing power that I bargained for.

By: TFF Sat, 02 Oct 2010 00:45:43 +0000 Ah, I see… I agree at least that far. Estimating the longevity of an individual is almost impossible, which is why (if self-insuring) you almost have to plan on living at least 30 more years into retirement.

I guess my problem is that the numbers I’ve seen seem to have a very large profit margin built in (either that or a very low ROI). At a 4% annual real return, a 30-year inflation-indexed annuity of $3000/month has a present value of $628k. Extending the life expectation has minimal effect. The annuity could last 100 years and still only rise to a PV of $880k. Yet the Schwarzenegger article (and subsequent discussion) priced a lifetime inflation-indexed annuity of $3000/month at $1 million!

If my life expectancy at retirement is 30 years, and I can manage my investments for a 4% real return, then the insurance company is overcharging by a factor of 50%. When the profit-premium is that high they are no longer insuring against longevity — they are insuring against the possibility that your investments have a real return that is less than 4%.

So what real return is necessary to justify a $1M price tag on a 30-year inflation-adjusted annuity? Seems the insurance company is willing to pay me a piddling 0.5% real return on my money! Thank-you-very-much, I’ll do it myself.

By: Mostannoyed Fri, 01 Oct 2010 10:05:41 +0000 0Short%20Report.pdf

Some interesting stats in here suggesting individuals underestimate average longevity and their own longevity in comparison to the average. At the end, where individual underestimates are given (from a British study) women underesimated their lifespan by almost 6 years and the men by 4.5 years.

Moral of the story is, people think they will be able to manage this risk without insurance when, from a purely actuarial standpoint, they may just be better off using insurance to assist them manage this risk.

Now, if they decide they want to live with the risk for the possible benefit of, say, leaving money to the children in the event of their early demise, then that is (for Americans at least) up to them. But the studies suggest that most people are not good at understanding and measuring the risk and therefore may not be making the most rational decision.

By: Mostannoyed Fri, 01 Oct 2010 09:49:58 +0000 Leigh Caldwell – you’re forgetting this is insurance and this is how insurance works. It’s not – dread word to Americans – socialism! It’s just insurance which is based on pooling of risks. There’s no moral weight attached to the outcomes. You insure your house and you pay every year and if your house goes up in flames you get a payout made up of all the premiums paid in by all the other house-owners who didn’t have a fire. Same with longevity. You have the (in retirement terms) bad luck to outlive your savings – you get a payout (meaning an ongoing annuity payment) made up of all the premiums paid in by people who didn’t live as long.

TFF, it’s been a long time since I worked in this area but if I can dig out the studies, I will. I think the studies actually suggest that people live longer than they think they will – and that’s why it’s rational for some (and it’s only for some) to buy an annuity. But people find it very difficult to predict their own longevity (despite their better knowledge of family history). Hence the tendency not to buy an annuity given a free choice in the matter. I suppose many would also choose not to buy car insurance if they had the choice. People think they are more in control of their own safety in a car than they really are.

By: TFF Fri, 01 Oct 2010 01:05:00 +0000 Mostannoyed, I’d be interested in seeing the assumptions in those academic studies that suggest buying an annuity is the rational choice.

If you don’t have enough saved, your best bet may be to use it up faster than an annuity would allow, and then (if you happen to be unlucky enough to live to a ripe old age) throw yourself at the mercy of the government.

If you have more than enough saved, then there is little risk of outliving your savings and thus no strong reason to pay insurance companies their cut on the product.

I’m not saying the studies are wrong, but I’d want to double-check the details before accepting them.

By: LeighCaldwell Thu, 30 Sep 2010 15:44:01 +0000 “…people who died at a younger age would help to subsidize those who live a very long time — as should happen in any good pension system.”

Really? Is that a given? People who die early not only DIE early, but they also get taxed for it?

I can see where you’re coming from, but if someone has made a personal choice to smoke, drink, rock and roll with the intention of saving little and dying early, shouldn’t they be allowed to?

By: Mostannoyed Thu, 30 Sep 2010 10:23:06 +0000 The UK system requires you to buy an annuity. To avoid the gaming you suggest, you cannot withdraw your retirement savings from your pension fund (above a small amount) at any point so all those with retirement savings spread the risk among each other. It’s a basic insurance principle – the risk of the long lived is shared by the short lived. The quid pro quo for this constraint is the tax relief that you get on pension saving as opposed to any other kinds of saving.

To understand this setup you have to understand what the government cares about. They do not care about your lifestyle in retirement or whether you buy a yacht or choose to pass money onto your children or anything. All they care about is that you do not end up reliant on social security – so in return for the tax break you must buy an annuity.

Although the debate in the UK is about freeing this up (and the government is set to loosen the restrictions on buying an annuity) academic studies suggest that for many, buying an annuity is absolutely the rational choice and studies have questioned why more Americans who have that choice don’t make the choice, voluntarily, to insure themselves against living too long.

By: FifthDecade Thu, 30 Sep 2010 02:25:57 +0000 The Swiss run a compulsory private system with 100% participation. Employees and Employers must pay 5% each of pensionable salary into employees’ pension pots which must grow by at least 2.5% a year until retirement; after that, a government set annuity rate, higher than the free market rate, is paid. It seems to work rather well. The high participation rates ensure good economies of scale, even in such a small country.

By: maynardGkeynes Thu, 30 Sep 2010 02:18:09 +0000 @ Magellan — The government TSP plan (like a a (401k)) is extremely well run, with extremely low expenses, run absolutely on behalf of the interests of the employees. That is because it gets close scrutiny from the Federal Government, which private 401K plans do not.

By: Magellan1234 Thu, 30 Sep 2010 00:21:10 +0000 We already know how this story plays out… The investments offered by 401k plan have expense ratios that average above 2%, as compared with under .2% for low-cos index funds.

This a classic agency problem. Employers (or government selected annuity providers) can’t be expected to watch out for the interests of workers as well as workers would watch out for their own interests.

Immediate life annuities can be a good choice for retirees, but only if they’re offered in a competitive market, where the consumer gets to choose.

As an aside, 401k plans should be changed immediately to allow any plan participant to roll their entire balance to an IRA at any time, without having to quit their job. This would force 401k plan providers to compete again and would end the days of plan providers wining and dining financially illiterate HR folks and scoring multi-million dollar lard-fests at the expense of hapless employees.