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Clark Troy has worked in the financial services world since 2000, most recently for a registered investment advisor in Durham, NC, where he obtained a Series 65 license. He is currently working assiduously towards a CFP® certification. He worked for years as a management consultant in the... More
  • The Annuity Option for Defined Contribution Plans: Implications for Insurers 0 comments
    Feb 9, 2010 5:53 PM | about stocks: PFG, MFC, PRU, MET, ING, GWLOF
    Background

    The New York Times recently ran a story about how the Obama administration is promoting the use of fixed or single premium annuities to help middle class savers in defined contribution (DC) plans to manage longevity risk. The article refers to a document released by the White House Middle Class Task Force chaired by Vice President Biden, which advances a goal of: “Promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income, reducing the risks that retirees will outlive their savings or that their retirees' living standards will be eroded by investment losses or inflation.” Naturally this announcement has occasioned considerable glee amongst the insurance community, and particularly amongst those insurers who sell lots of fixed annuities. But what are the implications of this announcement? How quickly could it measurably impact sales? Who stands to benefit most? How should insurers and the vendors servicing them position themselves to best take advantage of a possible uptick in sales?

    Certainly promoting an annuities option would not mean mandating that annuities be used, which is fortunate, because there would surely be considerable resistance to such an option from the investing public. A study released in January by a mutual fund trade group, the Investment Company Institute, found that seven in ten 401(k) participants surveyed would oppose mandatory annuitization. The survey’s language was, however, clearly intended to incite opposition, asking whether: “The government should require retirees to trade a portion of their retirement plan accounts for a fair contract that promises to pay them income for life from the government.”

    It is much more likely that the government will choose to promote annuities adoption by 401(k) participants through a variant of the “Libertarian Paternalism” advocated by the behavioral economists Richard Thaler and Cass Sunstein in their best-selling book Nudge: Improving Decisions About Health, Wealth, and Happiness. Libertarian Paternalism, in Thaler and Sunstein’s construct, undergirds policies that incent individuals to make decisions that will benefit them in the over time.

    Ron Lieber of the Times suggests that a likely option along these lines might come from a white paper co-authored by a member of the White House Task Force, J. Mark Iwry, under the auspices of the Brookings Institute. Iwry and his co-authors suggest that annuities could be promoted by instituting a default or automatic option of a fixed annuity “test drive” when 401(k) plan participants arrive at retirement age. This option would let retirees try out an fixed annuity for two years, and then be permitted to either take a lump sum distribution or opt in to a permanent fixed annuity.

    Precedents

    How quickly could such a solution find purchase? There is already substantial precedent for uptake of automatic features in DC plans. The chart below demonstrates the rapidity with which these features have been adopted by defined benefit plan sponsors since 2005:
    • Automatic Escalation -- Defaults plan participants into increasing contributions to plans when raises are given.
    • Automatic Enrollment -- Defaults new hires into 401(k) plans.
    • Target Date -- Sets “target date” funds -- with a target of the plan participant’s assumed date of retirement, as the default investment option within a plan.

    The rapid ascent of the Automatic Escalation figure -- from 9% of plans in 2005 to 44% in 2009 -- is particularly noteworthy when one considers that as recently as 2003 it had been no more than a white paper by Thaler and his colleague Shlomo Benartzi, backed up by a handful of experimental implementations. This demonstrates how quickly innovations suggested by the behavioralists can gain traction in the marketplace.

    Potential Beneficiaries

    Lifetime annuity options are already present in a significant number of DC plans. A recent survey estimates that 22% of plans offer them to participants, though their popularity is limited by lack of uptake by participants and administrative complexity.
    Who might be best positioned to quickly integrate and implement a program of automatic or “test-drive annuities”? Certainly insurers with large books of DC business would. Collating various lists (Plan Sponsor, Workforce.com, JP Morgan Market Share Bible) of DC plan administrators in recent years, an alphabetical list of these firms would include: Great-West, ING, John Hancock, Mass Mutual, New York Life, Principal Financial, Prudential, TIAA-CREF. If we cross reference this list with the Life Insurance Market Research Association’s top 20 marketers of fixed annuities, the list reduces to five:
    • ING
    • John Hancock
    • New York Life
    • MetLife
    • Principal Financial
    Additionally, leading DC provider Fidelity has a significant business selling fixed annuities. One would assume that these firms -- by virtue of strong networks of internal annuities wholesalers -- could roll out and support scalable automated or “test drive” fixed annuity solutions quickly, and should therefore be positioned to get out in front of this trend. An additional advantage may be had by firms that have internally developed defined contribution platforms, as opposed to ones that are licensed from external software providers. As the retirement savings market shifts its focus over the next decade from asset accumulation and management to decumulation and supporting the lifestyles of an aging population, the opportunity will only grow.

    Defined Benefitization

    All of these features add up to what one may (and others, in fact, have) term a creeping "defined benefitization" of defined contribution plans:  more and more DC plans look and feel like old school defined benefit pensions.  They have the virtue, however, of always being funded, unlike their shrinking uncles in the traditional pension world. But target date funds have not always lived up to their billings, as many prominent fund companies and plan sponsors did not adjust equity allocations as might have been advisable, and got pounded by the market, critics, and SEC (yes, even the SEC) in turn over the course of the credit crisis.  And the reaction of the ICI survey participants cited above -- however skewed the survey may have been in its verbiage -- demonstrates that the gentle paternalist nudges of the government may upset the delicate china of tea party investors.


    Disclosure: Only index funds: FUSEX, FSTMX
    Themes: Life Insurance, 401(k) Stocks: PFG, MFC, PRU, MET, ING, GWLOF
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