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BeFi Conference Topic 11
Brainstorming on Decumulation:The Annuity Puzzle
by David BlakePensions InstituteCass Business School
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eFi F
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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
© B
eFi F
orum
200
7