Does pessimism really suppress annuity sales?

A prospect’s pessimism about their life span is usually seen as a high hurdle in an annuity sale, but lowering the dour outlook has less impact than raising the objective facts about longevity, according to a recent study.

Researchers were taking a crack at the “annuity puzzle” that has vexed the insurance industry since annuities were invented: Why, if people prefer having a regular pension payout, do they not buy an annuity, essentially a private pension, with their retirement funds?

According to the Boston College Center for Retirement Research study What Matters for Annuity Demand: Objective Life Expectancy or Subjective Survival Pessimism?, “Since 1965, academics have argued that, under a broad set of assumptions, individuals should annuitize a large part of their assets. For nearly as long, it has also been documented that annuitization rates fall short of what seem to be optimal levels, a fact known as the ‘annuity puzzle.’”

Explanations for the reluctance usually revolve around what could be called the “sucker principle,” basically that if someone buys an annuity and dies early, they just gave all the remaining money to the insurance company rather than their family. (Of course, people can opt for a death benefit or some other return of principal angle, but those do come with a cost.)

But really, what is the sucker principle? It’s pessimism that the person is not going to live long into old age. That is the subjective survival pessimism weighing heavily against an annuity purchase, according to the study’s authors Karolos Arapakis and Gal Wettstein.

“Of the many possible explanations for the annuity puzzle, irrational pessimism on the part of potential consumers regarding future life expectancy is appealing,” according to the report.

“Naturally, no one can learn about their own life expectancy from personal experience. Further, the decision to buy an annuity is itself usually made once and for all, a situation in which individuals never get the chance to learn from their own mistakes — and so mistakes can persist.”

But is pessimism really the reason? And would objective mortality data be an antidote to it? These were a few of the questions the researchers wanted to answer.

How pessimistic are we?

The authors used data from the University of Michigan Health and Retirement Study, which has been a nationally representative, biennial longitudinal survey of adults in the United States since 1992.

It turns out that we earn our optimism rather than sink into pessimism as we age. People are darker about their longevity between ages 55 and 70 and brighter between 70 and 85. Even though women tend to outlive men, they were nevertheless more pessimistic about their longevity.

Subjective guesses are in fact shorter than the best objective life expectancies, but not by much.
“On average, subjective life expectancy is lower than objective life expectancy by 1.6 years for the 55-59 age group, and 1.2 years for the 60-65 age group,” according to the report. “For the 55-59 age group, males are less pessimistic than females, understating their life expectancies by 0.9 years versus 2.5 years. For the 60-65 age group, the difference between men and women holds steady at 0.5 years versus 2 years.

Not a simple evaluation

It’s not as simple as that for evaluating the impact of objective life expectancy versus pessimism.

To drill into the data, the researchers used a regression model that controls for objective life expectancy, pessimism and the information that insurers use to price annuities.

They found that objective life expectancy and pessimism affect the choice to buy an annuity. But a one-year rise in objective life expectancy increased the probability of holding an annuity by 0.20 percentage points, while a one-year decline in pessimism increases the probability of holding an annuity by only 0.023 percentage points.

“Taken at face value, the results are consistent with objective life expectancy having a much stronger effect on the decision of whether to buy an annuity than pessimism,” according to the paper.

When the model included health factors, pessimism weighed heavier but not in blocking a purchase, rather in the amount that is annuitized.

“These results are more in line with past research,” according to the study, “as pessimism seems to remain important in the extensive margin decision of how much to annuitize, even as controls for objective factors such as health and demographics render objective life expectancy moot.”

Does pessimism get a bad rap?

The analysis suggested that the assumption that pessimism is the key hurdle to purchase of annuities and the amount to annuitize might be overestimated and that an objective life expectancy might be more important.

Also, pessimism is not necessarily bad in the process. In fact, pessimism about other factors in life, such as the stock market, can be an inherent but unseen factor.

“Pessimism about life expectancy may be correlated with pessimism about other variables that affect annuity purchases,” according to the report.

“These variables include pessimism about medical expenditures and pessimism about market risk. Hence, our results on the importance of subjective life expectancies may capture an overall measure of pessimism rather than a causal effect.”

Steven A. Morelli is a contributing editor for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at steve@innemail.com.