http://www.nber.org/papers/w18575.pdf

NBER Working Paper No. 18575
Issued in November 2012
NBER Program(s): AG

Abstract: We conduct and analyze two large surveys of hypothetical annuitization choices. We find that allowing individuals to annuitize a fraction of their wealth increases annuitization relative to a situation where annuitization is an “all or nothing” decision. Very few respondents choose declining real payout streams over flat or increasing real payout streams of equivalent expected present value. Highlighting the effects of inflation increases demand for cost of living adjustments. Frames that focus on flexibility, control, and investment risk significantly reduce annuitization. A majority of respondents prefer to receive an extra “bonus” payment during one month of the year that is funded by slightly lower payments in the remaining months. Concerns about later-life income, spending flexibility, and counterparty risk are the most important self-reported motives that influence the annuitization decision, whereas the desire to leave a bequest has little influence on this decision.

Stephen P. Zeldes is the Benjamin M. Rosen Professor of Economics and Finance at Columbia University’s Graduate School of Business. In his research, Professor Zeldes has examined a wide range of applied issues in macroeconomics and finance, including household saving behavior, social security reform, pension policy, retirement account portfolio choices, annuitization and retirement security, the effects of government budget deficits, and the relationship between consumer spending and the stock market. In his current research, Zeldes is studying choices made by defined-benefit pension recipients between life annuities and lump-sum payouts, designing new financial products to provide longevity protection, analyzing the implications of wage risk for pensions and Social Security, and estimating cost savings from corporate pension freezes. His research has been published in the leading academic journals.

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NAFA President Kim O’Brien:

“These are unprecedented times in America. The number of retirees is increasing exponentially year after year and seniors are living longer. There’s a continued volatile and soft stock market and a sustained low-interest environment. Despite these economic and demographic realities, in addition to other challenges, the outlook for the annuity marketplace is shining with unlimited opportunities.

As a participant in this industry for almost three decades, I have seen many boom and bust markets. Periods of high interest and periods of low interest. New regulations and legislation. However, I have never witnessed such a shackled economy or regulatory and litigious fever. Nonetheless, our industry has always met challenges with innovation and creativity. The fixed indexed annuity, for example, was the answer to a sustained soft bond market. Meeting challenges with innovation is the story of our industry and a story in which we can all take pride.”

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Advantage Compendium’s Jack Marrion:

The average annualized index annuity returns collected by Advantage Compendium for the period 2007 to 2012 averaged 3.27%. Whether this was good or bad depended on where else you might have been. Compared to rolling over one-year certificates of deposit, owning an index fund or owning the average stock fund, the average index annuity return looked pretty good. However, compared to a five-year CD you might have purchased back in 2007, the index annuity return was maybe a percent short, and many bonds and bond funds also beat the average index annuity for the period.

As five-year periods go, the most recent one had the lowest returns so far recorded, but it also shows the attractiveness of the concept. This last period included the mortgage bond crisis, the crash of ’08, a severe recession and a sluggish recovery. The S&P 500 index itself finished lower than where it began, but in spite of all this, the index annuities produced returns that ranged from 1.2% to 5.5% a year.

The competitive environment for index annuities over the next five years is more positive mainly, because alternatives are more negative. The reality is low interest rates will keep caps and overall index participation low for most of the period. So, which crediting method is best going forward?

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