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Citi Perspectives for the Public Sector |
2014
5
Yet life annuities are often unpopular, for
three reasons. First, annuitizing interferes
with bequests from the accumulated account.
Consider the situation of someone who
annuitizes a large balance upon retirement and
then passes away a year later; no bequest is
left for heirs. For this reason, some annuities
offer a partial bequest feature, but that
undermines the effectiveness of the annuity.
The only way annuities work is for those
who die earlier than expected to wind up
transferring resources to those who die later
than expected.
In addition, when annuities are voluntary, they
are priced to the annuitant pool, which tends
to have longer than average life expectancy.
As a result, the pricing often involves an
expected loss in present value for the typical
person. Finally, many people do not appreciate
the risk of outliving their assets, so don’t see a
need for the product.
In the absence of a life annuity, other
approaches are often adopted, such as phased
withdrawals in which each year the withdrawal is
recalibrated based on additional life expectancy.
Yet none of these alternative strategies provides
full insurance against living too long.
Experiences across the globe
Experiences with life annuities vary across
the globe. In the United States and Australia,
life annuities are voluntary, and very few
people annuitize.
In Canada and the United Kingdom,
previous rules requiring life annuities have
been loosened over the past decade, but
annuitization is still quite common. Very
recently, the UK government proposed a further
loosening of these requirements.
In Singapore, by contrast, the government
recently made life annuities mandatory:
as of March 2013, Singapore requires a life
annuity, called CPF Life, for those who turn 55
in January 2013 or later and whose account
balances exceed certain limits.
New approaches and best practices
Policymakers concerned about the risk of
people outliving the assets accumulated in
defined contribution accounts but cognizant
of the unpopularity of annuities may want to
consider several ideas:
1. Raise the retirement age. Although it is
politically difficult, delaying the age at which
individuals can retire as life expectancies
rise can help to ease the tradeoffs involved.
Policymakers should be aware, however,
that in many countries life expectancy
trends differ by socio-economic status, and
particular attention should be paid to whether
life expectancy is increasing in general or only
for sub-segments of the population.
2. Provide targeted education to participants
regarding the need for planning and enable
scenario planning to help them realistically
assess their best payout alternatives.
3. Ensure pension benefits from different
sources (e.g., mandatory social security-like
offerings and private plans) are coordinated
and policies are in place to minimize the
opportunities for gaming the system. A
concern in Australia, for example, is that
individuals can access their superannuation
funds (government sponsored, mandated
contribution DC funds) at an earlier age
than the basic means-tested pension
provided by the government. Yet the
superannuation funds are not annuitized,
and many people take them in the form of
a lump sum, opening up a “double dipping”
possibility that the superannuation funds
are spent down on purpose to meet the
requirements for the means-tested pension.
4. Encourage advanced life deferred
annuities. This product provides an
annuity payment beginning at a certain
age, such as 85, rather than immediately
upon retirement. It thus lessens concerns
about not being able to leave a bequest,
while allowing people to plan withdrawals
for the non-annuitized period by providing
certainty around how long that period will
last. Research suggests that it can provide a
substantial share of the longevity insurance
associated with an immediate life annuity,
but at a small fraction of the cost.
1
5. Use defaults rather than requirements.
Behavioral economics has shown the
power of defaults in retirement behavior.
Automatically annuitizing account balances,
perhaps in the form of an advanced life
deferred annuity, while allowing individuals
to opt out of the annuitization under certain
conditions may be an attractive option in
many countries.
■
1
See for example, Guan Gong and Anthony Webb, “Evaluating the Advanced Life Deferred Annuity – An Annuity People Might Actually Buy,”
Center for Retirement Research, Boston College, Working Paper 2007-15, September 2007.
In the
absence
of a life
annuity, other
approaches
are often
adopted, such
as phased
withdrawals
in which each
year the
withdrawal is
recalibrated
based on
additional life
expectancy.