“People are more willing to purchase a guaranteed stream of income for life than an annuity; the product may be the same, but the title matters.” states a Morningstar study authored by Stan Treger.
With an annuity, a client signs a contract with an insurance company by which he gives an amount of capital to the insurer in exchange for a guaranteed revenue to the end of his days. This is not an investment in some fund or other which the client can retrieve at any time. The client gives their money to the insurer in exchange for revenue. For example, the client hands over $100,000 dollars to the insurer, who then pays a steady yearly income of $5,000 or $6,000. There are countless variants (indexed to inflation or not, with an allowance to a surviving spouse or not, etc.), but this is the basic framework. At the client’s death, the money stays in the insurer’s coffers.
“Annuities, which offer a ‘guaranteed income stream for life’ (GISL), could be instrumental for many retirees who have concern over or are facing the potential of depleting their nest egg, notes the study. Albeit beneficial to many, annuities are still largely unpopular,” said Treger. Indeed, the current rock-bottom rates and the small income streams annuities can provide have considerably diminished their appeal.
A Rose is a Rose… But a Vase Helps
Treger’s enquiry studied the “framing effect” to find out “whether the label of the product alone can “make or break” its appeal to prospective retirees. Indeed, the complex nature of annuities may itself be a deterrent for those who prefer a simpler route to save.” He also wanted to know if parting with one’s money is a major deterrent: “People may be reluctant to part with a lump sum of money that they amassed over decades.”
He submitted a number of questions, most of them with values ranging from 0 to 6, to 1,067 participants over 30 years of age. He asked participants 1) to what extent they were concerned about running out of money during retirement; 2) to what extent they expected to run out of money during retirement, 3) if they would exchange a portion of their retirement savings for a guaranteed stream of income vs. an annuity, 4) how much of their savings they would exchange (0% to 100%), 5) whether they would prefer to pay a larger lump sum to gain a stream of income immediately after retirement (immediate annuity) or to pay a smaller lump sum to gain a stream of income later in retirement (deferred annuity) and which they would choose to obtain this: a guaranteed income or an annuity; 6) whether they would delay Social Security benefits in order to receive more money later in retirement.
At the same time, they are meant to obtain information about a participant’s situation and financial preferences, the questions contain the trap of the “framing effect”: GISL or annuity.
Overall, participants reported concern over the prospect of running out of money during retirement and these concerns predicted readiness to exchange a portion of one’s savings for the insurance product, whatever its name. “For example, states the study, the more concern one had about running out of money in retirement, the larger the portion of their retirement account they were willing to exchange for the insurance product.”
Small Bump to Seismic Shift?
Here’s the key finding: participants were more willing to exchange a portion of their retirement savings for a guaranteed income stream than for an annuity, showing a difference of 0.4 points between those who felt more comfortable with a GISL rather than with an annuity.
A preference of 0.4 points might appear anti-climactic. Wrong. “It is a massive difference,” says Steve Wendell, head of behavioural science at Morningstar, who puts the findings in perspective. “Annuities represent 5% of entire savings (in the U.S.). This represents a potential increase of 16% of that capital. To get such a shift of people’s money would be huge. Sure, it’s a small amount per participant, but it piles up to a huge amount for the industry.”
Indeed, as Treger concludes in his study, “these results hint that a simple product title change can make a difference in its appeal. People who see annuities for their intended purpose, a guaranteed stream of income that insures against depleting retirement funds, find them more appealing and are thus more open to purchasing the product.”
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