If you are interested in the future of deferred income annuities in the retirement plan market, check out a new release by the Brooking Institute: http://www.brookings.edu/research/papers/2014/11/06-retirement-longevity-annuities-harris
The comprehensive analysis is titled Better Financial Security in Retirement? Realizing the Promise of Longevity Annuities. Both the title and contents reflect what may soon become a new U.S. federal government policy objective – promoting DIAs as "defined benefit look-alikes" for defined contribution plans.
Given the authors' enthusiasm for DIAs in retirement plans, it's interesting that they acknowledge: "as far as we are aware, no U.S. employer currently offers a longevity annuity option as part of their defined contribution retirement plan."
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They then devote detailed analysis to the reasons why plan sponsors and participants haven't embraced DIAs yet. The biggest obstacles, they say, include:
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Survivorship bias, which occurs when only the healthiest people may choose DIAs, driving up costs.
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Consumers' confusion over how longevity protection works in these products, and why it's valuable.
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Consumers' concerns over the long-term financial viability of life insurance companies – including the possibility companies will drastically underestimate the cost of insuring longevity.
As the authors array solutions for addressing and overcoming these obstacles, it's not hard to see policy wheels spinning.
As we have previously observed, the federal government has a vested interest in lifetime income illustrations and DIAs in retirement plans because: 1) this will create a vast new buy-and-hold market for U.S. Treasuries; and 2) it will help to cushion inevitable cutbacks in Social Security benefits down the road, especially for younger people:
For example, the authors say that creating a "financial security graphic" similar to the Food Pyramid will help to educate plan participants on why longevity insurance is valuable.
The key to overcoming survivorship bias, they say, is enrolling vast numbers of people (both sick and healthy) in these products.
This could be achieved, in part, by offering DIAs in the 4.6 million-participant federal Thrift Savings Plan. To help insurance companies hedge longevity risk, they say the U.S. Treasury could issue a new type of bond indexed to aggregate mortality trends.
It's an interesting story to follow – and will become even more interesting if interest rates start rising (making DIA payouts more attractive) and insurance companies figure out how to embed annual cost-of-living adjustments (COLAs) into DIA payout schedules.
Stay tuned!
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