As the financial crisis and its aftershocks roll on, vigorous discussion continues about how America’s retirees, whose needs are more and more met by defined contribution plans like 401(k)s and 403(b)s, will be able to fund their retirement. Considerable hopes have been pinned on encouraging retirees to roll their savings into annuities.
The insurer Allianz (AZ) based a set of discussions on this topic by leading advocates of behavioral finance. Organized and edited by Shlomo Benartzi of UCLA with contributions from colleagues at American and British universities, the report included some interesting suggestions. In sum, they argue that because people have a difficult time making good financial decisions for themselves, plans should be designed to “nudge” them, as Richard Thaler and Cass Sunstein of the University of Chicago and Obama’s regulatory brain trust would have it, into making better decisions.
Many of the suggestions advanced are likely uncontroversial: If you present an annuity as a consumption option (“paying $650 monthly for life”), people are more likely to select it than if you present it as an investment option (“returning $650 monthly for life”). Other suggestions will go down much less smoothly. For example, David Laibson of Harvard argues that cognitive functioning declines precipitously across an aging population as the incidence of dementia rises. His research found that the quality of decisions “started declining at 53 and continued to diminish thereafter.” Logically, then, governments should nudge retirement plan providers to encourage people to irrevocably allocate a portion of their retirement assets to a fixed annuity before their ability to make optimal decisions becomes likely to trend downhill.
This is not easy to say, and will prove much more easily said than done. At the end of the day, there’s a lot of tension in the streets these days about the government’s perceived encroachments on people’s liberties. Despite the events of the last few years, Americans want to be free to run their lives and make their own mistakes. Benartzi and Allianz’s collection of comments came as a response to a request for information from the U.S. Department of Labor (DOL), asking whether “Agencies could or should enhance, by regulation or otherwise, the retirement security of participants in employer-sponsored retirement plans and in individual retirement arrangements (IRAs) by facilitating access to, and use of, lifetime income or other arrangements designed to provide a lifetime stream of income after retirement.”
The DOL received 600 letters in response. Here is a direct quote from one, which is in tone representative of the majority of a random click-through: “Keep your hands off of my money! I am perfectly capable of making my own investment choices. Why would I trust the government to handle my retirement money when they can’t even handle the plan they have set up now, i.e., Social Security?? I have investments precisely because I don’t expect Social Security to be around when I retire!” It's worth noting that the DOL does not state an intent to make whole or partial annuitization mandatory, nor does the "libertarian paternalism" espoused by Thaler and Sunstein advocate such a strong hand. People are concerned, rightly or wrongly, about the slippery slope the government has set off down. And this popular perception, or misperception, depending on your point of view, should be a concern to the government.
A portion of the public is apoplectic at the government, and maintains equal anger about being played for suckers by financial services companies. People want to be free to make their own decisions, but then are furious when these decisions bring them harm.
Insurance companies want to market products like whole life and fixed annuities by saying “we can help you make the right decisions for yourself” (which means, implicitly, that they will help “protect you from yourself”), but people are wary of financial intermediaries and insurance salespeople. People’s lack of trust in insurers and their representatives is a widely cited hurdle in the industry.
The behaviorists’ core thesis is that people are not rational actors. Policy, therefore, should encourage people to act more rationally, playing Spock to the investor's Captain Kirk. The problem is, we know who invariably wins that argument. Insurers must learn to play the role of Dr. Bones McCoy.
Disclosure: Author holds positions in indices only