The bias that makes retirees shun annuities

by Leo Almazora13 Feb 2019

In a new report titled The Social Implications of Pensions, experts commissioned by the Canadian Public Pension Leadership Council touched on the significant longevity risk weighing on retirees — and their puzzling aversion to one solution.

“[A]s few as one in 10 Canadians say they are using or plan to use annuities to help manage their longevity risks,” they said, citing a statistic from an RBC Insurance study released last year. The authors suggested various reasons: retirees’ ignorance of longevity risk, an aversion to administrative fees, or an unwillingness to ponder their mortality.

A new study from academics at UCLA and Duke University in the US, as noted in the Wall Street Journal, highlights another possible factor. Surveying more than 900 people between the ages of 40 and 65, they collected a plethora of information including the subjects’ marital status, income, risk tolerance, levels of financial literacy, and whether they wanted to leave a bequest.

Among all the variables they looked into, only one was predictive. “[T]he individual difference that best predicts interest in annuities is a person’s sensitivity to issues of fairness,” wrote Suzanne Shu, one of the study’s authors, and Shlomo Benartzi in the Journal.

Specifically, subjects were asked questions about fairness relevant to annuities, such as “It is fair that the insurance company is allowed to keep the excess funds [if a person dies].” The ones who were sensitive to such questions were also found to be much less likely to turn to annuities for retirement income.

Even when the researchers asked subjects to consider annuities that paid out more than the subjects paid in, the sensitive respondents still rejected them. “This suggests that their dislike of annuities … stemmed from an aversion to the shared-risk model,” Benartzi and Shu said. Even though early deaths are necessary to subsidize those who live longer than expected, the anti-annuity retirees considered it deeply unfair.

Instead of rejecting annuities emotionally, the duo stressed, retirees are better off educating themselves on the workings and expected benefits of annuities. They should also bear in mind the possible negative consequences and regret associated with not availing of such income protection, such as having to rely on one’s children for medical expenses.

“[But] make sure your choices are customized to your circumstances,” the pair said. While a person with significant health problems are likely not going to get the most out of an annuity investment, those who expect to live longer are better off considering one.

 

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