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Newsmakers

Why People Don’t Buy Annuities: They’re Confusing.

Liquidity lust isn’t the major barrier to annuity purchase, researchers have found. It’s complexity.

(April 19, 2013) - "Annuitization is popular in the UK the way paying taxes is popular: People do it because they have to," explained one—very patient—defined contribution (DC) expert at a major asset management firm.

(Ed. note: aiCIO's venture into the DC space is a path paved with stupid questions. See our next cover story for more in-depth coverage.)

But beyond those forced into it by tax law, why don't more new retirees use their DC savings to purchase annuities?

Because buying a longevity insurance product is more daunting a prospect than cashing a very, very large check, a Pension Research Council study has found.

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Valuing an annuity is, perhaps unsurprisingly, a task most individuals are not terribly competent at, the paper's four authors determined.

Jeffrey Brown (director of the University of Illinois' business and pubic policy center), Arie Kapteyn (senior economist at the RAND Corporation), Erzo Luttmer (social insurance expert at Dartmouth College), and Olivia Mitchell (Wharton Business School's employee benefit plans professor) empirically tested individuals' ability to value annuities.

The four researchers asked subjects to price the value of US Social Security benefits—as opposed to a hypothetical annuity product—in order to put the US participants on the most familiar turf possible. Still, the study found that valuations fluctuated widely based on how researchers framed the survey questions. The findings are based on a sample size of 2,210 complete responses.

Overall, respondents tended to think of an annuity as more valuable when offered the choice to exchange it for a lump sum, and worth less when in the position of purchasing one.

"Our results are consistent with individuals showing a strong preference for the simpler, more understandable option (the lump sum), and only being willing to consider the more complex option (the annuity) when it is an exceptionally good deal," the authors wrote. "This tendency is stronger among those who are less financially sophisticated. We also show that complexity matters, including the fact that people are sensitive to framing and starting values."

Their results suggest that DC plan sponsors could improve members' retirement outcomes by taking on a more paternalistic role—closer to that of a defined benefit scheme.

The study's conclusion aired doubts over whether individuals are broadly able to optimize the value of their savings when confronted with the lump sum vs. annuity question.

"Observers must be very careful when drawing conclusions about individual welfare based on observed behavior (i.e., "revealed preference") when it comes to annuities," the authors cautioned. "The fact that so few people annuitize their defined contribution pension balances when given the opportunity to do so cannot be interpreted as conclusive evidence that they do not value longevity protection." 


Read the entire working paper, "Complexity as a Barrier to Annuitization: Do Consumers Know How to Value Annuities?" here.

Home > News > Manager Selection > Third Point’s Loeb, AQR’s Asness Named on DB Pension Enemy List
Manager Selection

Third Point’s Loeb, AQR’s Asness Named on DB Pension Enemy List

The list, published by a top teachers union, names 34 hedge funds managers involved with organizations it claims are attacking educators’ DB pension plans.

(April 18, 2013) - The American Federation of Teachers (AFT) calls it a "watch list": 34 asset managers who it claims support think tanks and organizations bent on dismantling the defined benefit (DB) pension system for educators.

All other factors being equal, the AFT encourages pension trustees to invest with, for example, the pension-neutral buyout fund KPS Capital Partners rather than, say, Kohlberg Kravis Roberts. According to the union's report, founder Henry Kravis has contributed to the Manhattan Institute—a non-profit think tank which champions replacing public DB plans with fund-as-you-go defined contribution (DC) systems.

While termed a "watch list," the publication has already spurred decisive action from one member included. Yesterday, Dan Loeb, founder of the much-hyped hedge fund Third Point Capital, canceled plans to speak on corporate governance at today's Council of Institutional Investors conference.

Loeb is a co-founder of StudentsFirst New York, the regional branch of an education reform organization, according to his profile for an upcoming alternatives conference. StudentsFirst's policy agenda says that the group lobbies for states to "honor their existing obligations to defined benefit pension plans" but also "move from defined benefits to retirement plans that are more sustainable and can be immediately accessed by all teachers. 

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According to Reuters, certain pension funds had threatened to confront him at the Washington, DC event.

In a letter to the council's chair reviewed by aiCIO, Loeb cited "incorrect statements about my position on the issue of defined benefit pension plans" which had "derailed" the "critical conversation we planned to have about improving corporate governance." 

"Contrary to reports," he continued, "I have never taken a position against DB plans nor has any philanthropic organization I lead. In fact, my support for and contribution to DB plans is demonstrated by maximizing returns for union members who rely on us to deliver their pension goals." 

A spokesperson for AFT seemed puzzled by Loeb's denial. "StudentsFirst has been very public about its opposition to DB plans," the union representative told aiCIO. "I mean, it says so right there in the policy statements."  

At 1.5 million members, the AFT is the second-largest education union in the US. Many of the asset managers it targets are of similar stature: Kravis, Loeb, AQR Capital Management co-founder Clifford Asness, and an SAC Capital managing director made the list, among others.

"This is about transparency—a right to know," said AFT President Randi Weingarten. "America's workers and pension trustees deserve to know if the asset managers they are investing their hard-earned retirement savings with are also aligned with organizations advocating for the elimination of those same pension plans." 

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