The 2020 Retirement Income Review observed that “more efficient use of savings in retirement can have a bigger impact on improving retirement income”. We all know the narrative: When it comes to retirement income products, Australians prefer account-based pensions to annuities. However, Australians fear running out of money in retirement, so they only draw down at the minimum rates.
It would be great if superannuation funds could offer their members a product that increases their confidence to spend, no matter how long they might live, thereby supporting a more fulfilling retirement. These products do exist. Lifetime retirement income products, the most common type being a lifetime annuity, provide income for life. Still, superannuation fund trustees are not offering them to members because they say members don’t buy them.
The annuity puzzle is why people don’t buy lifetime retirement income products if they help them be more confident in retirement. Fortunately, it is not just an Australian phenomenon, nor a recent one; researchers have been trying to solve the annuity puzzle for many decades.
It has always been challenging to sell lifetime retirement income products to Australian retirees, whether traditional lifetime annuities or one of the more innovative ones launched in the past few years.
Now that many superannuation funds are considering lifetime income products as they implement their retirement income strategies, it is worth looking at this research and seeing what we can learn about offering these products to our members.
Offer solutions, not products
Explanations for the low demand for lifetime retirement income products include the fear of losing control of finances, a desire to leave something to beneficiaries, nervousness about relying on an institution to pay an income for what might be decades into the future, and concerns about the cost.
These products tend to be complex financial products and difficult to understand. Research by the Melbourne Business School suggests that while people are interested in annuity products, they find choosing between specific products too difficult, highlighting the critical role of guidance and financial advice in encouraging people to purchase them.
A helpful analogy might be considering how consumers make decisions about purchasing a car. They don’t need to understand what goes on under the hood. They typically buy from a trusted brand, or from a car dealer who is able to explain how the car will meet their needs. If they do research, it will be talking to others to see how they like their cars rather than researching the intricacies of mortality credits.
Research by the Behavioural Economics Team of the Australian Government on supporting retirees in retirement in 2017 showed that “presenting key information in a relatively simple manner helped people to make the decision and made them more likely to choose the [retirement income product]”.
Another explanation identified in the research is the lack of longevity awareness, the understanding and acknowledgment of the increasing average lifespan of people in society. Many calculators rely on average life expectancy for determining the retirement planning horizon. When helping people plan for retirement, it is important to ensure they understand life expectancy and their future lifespan to help them make better choices about retirement products.
A common theme throughout the research is that we need a better understanding of how people make decisions about retirement products. We know from behavioural economics that such decisions are not always based on cold, hard facts.
A key learning from behavioural economics is that how choices are described and presented influences the decision-making process. This phenomenon is known as framing, and several researchers have been exploring how framing might be used to increase the attractiveness of lifetime retirement income products. One conclusion is that lifetime retirement income products are more attractive when presented in a consumption rather than an investment frame.
Consumers have no trouble understanding how insurance protects their important possessions, such as their houses and cars, or ensures their dependents are looked after if they die. Lifetime retirement income products provide protection against longevity risk. That is, they provide longevity risk insurance.
Lifetime retirement income products are not for everyone, but the retirement income covenant requires superannuation funds to consider solutions for different cohorts of their members. Longevity risk protection will be relevant for some. Most accept there is no single silver bullet lifetime retirement income product.
Similarly, there is no single silver bullet way to discuss retirement income product decisions with members. Once we have developed the products to offer to members in retirement, we need to spend as much time on how we offer them. This includes how we present the product choices, help individuals think about longevity risk and how information is best presented. When helping members with their retirement planning, superannuation funds would do well to heed the advice of Moshe Milevsky, Professor of Finance at York University and widely acknowledged global annuity guru, to “balance emotion and math”.
It is a decade since David Bell, executive director of the Conexus Institute, called for “further work…on both rational and behavioural reasons, as well as the interaction between the two.” That call is more important than ever.