by Tyler Cowen
on June 5, 2011 at 6:34 pm
in Uncategorized |
1. The Between Parentheses Reading List, highly original.
2. Why so few annuities?
3. Agriculture and TGS.
4. BELLS vs. PIGS.
I’ll tell you why so few annuities. It’s because the industry has a reputation for selling bad products to people with high pressure tactics.
We need a straightforward way for people to purchase an annuity, based on the actuariral break-even price + some reasonable profit for the company selling the product.
The article reads like a straw man to implicitly supporting annuities though it does note some legitimate issues regarding the complexity of these financial instruments. Thaler isn’t being intellectually honest and doesn’t mention any of the significant problems with annuities (high costs, inflation risks, etc.). Save your money and hire a fee only financial planned and put your money in a diversified portfolio. From a policy perspective, solvent pension plans are probably the best form of retirement benefits you can have, I’d just be surprised if they ever work without significant government intervention and oversight.
I second Robert’s comment. The other issue is that those of us approaching 65 were adults when the inflation of the 70’s made the annuities that people had signed up for 20 or 30 years before laughable. My father in law got less than $50 a month from his GI benefits election in 1945. When he signed up he thought it pay for groceries in his old age. Fortunately he had invested the $250,000 he inherited from his mother in the early 70’s in a diversified portfolio which grew sufficiently to provide a comfortable old age. The idea that people are too stupid to invest their money should be addressed by educating people to be financially literate, not by encouraging them to rely on others.
What Robert said – annuities are a classic lemon market. Most people only ever buy one annuity and they can’t afford to get it wrong. Even if you can manage to buy one that is good value (not excessive fees), where and how are they investing your money? And of course, due to the need for fees and profits, annuities must have a negative expected rate of return. Because of this, in the example given (between otherwise equal people one with a defined benefit pension, the other with a lump sum) if they have exactly equal value, the lump sum will buy a significantly lower monthly payment than the defined benefit pension, meaning a significantly lower standard of living in the early retirement years. Also, the existence of social security means that effectively those who live long enough to run out of money can rely on the state to bail them out. Better to gamble and have a high standard of living in your earlier years. Most people also intuitively understand that as you get older you spend a lot less in any event.
Defined benefit pension plans avoid a lot of this as they of course are managed by sophisticated investors with the experience and time to properly research. Firm generally can manage to keep fees as low as possible by spreading the cost over many persons, and not needing to employ agents or intermediarys. The employees managing the pension investments are usually members of the pension fund and the firm often backstops the pension fund if it looks like it will not have enough to cover the fund payout (and which itself is often backstopped by the Government in this see GM). So on a risk adjusted basis, even if the payout is the same, the pension is better than the annuity.
So no mystery then.
People don’t want to subsidize others in the event of their early deaths, they would rather the unspent funds went to their heirs- that is why so few purchase annuities. They may be underestimating their need for a guaranteed income (and an annuity can’t guarantee that in a real sense, anyway), but I bet that is a small factor. People view pensions differently because they simply don’t understand how closely annuities and pensions are related because one is usually purchased with a lump sum of money in hand while the other is purchased in increments through payroll deductions and foregone wages over a working life.
On # 2. Professor Thaler should study the experience of Chile’s pension system where people can choose between an annuity and a pension that is assessed every 12 months in accordance with the expected performance of the individual’s fund and some legal constraints (this is called “retiro programado”). Since the funds, the annuity and the “retiro programado” pension are indexed to the IPC, inflation is not a serious problem.
On # 3. As usual you rely on a NYT journalist to suggest that there is a serious problem with food production and prices. Maybe there is a serious problem but you will never know it from someone that starts with the claim that “Many of the failed harvests of the past decade were a consequence of weather disasters, like floods in the United States, drought in Australia and blistering heat waves in Europe and Russia.” The past decade? He should have said the past 10,000 years.
On # 4. I’m glad to read E. Hugh’s argument about how the different experiences of Eurozone countries challenge macro orthodoxy. In addition, his analysis shows how difficult it is to diagnose what in going on in each country, questioning the propensity of U.S. economists to ignore differences and highlight similarities.
On # 2. My quest is (and was, when I was comparing options for a retiring relative) if people aren’t buying enough annuities, why isn’t the price lower? Is it a somewhat perverse financial market that because there aren’t enough contributors the price has to be higher? The company I figured might be subsidizing the lump sum option in order to limit their risk with annuity payments.
On #3: Persistence Pays: U.S. Agricultural Productivity Growth and the Benefits from Public R&D Spending by Alston et al is well worth a read.
On annuities I think the first three comments all make good points.
Another is the question, which Thaler alludes to only briefly, of the viability of the insurance company selling the annuity. That risk is important, and I don’t doubt that many potential annuity buyers are quite sensitive to it.
The world could certainly use another Norman Borlaug. But linking variations in food production over the last few years to a .1 degree per decade climate shift is pretty silly, not least because it ignores the long history of warming being associated with better agricultural conditions, all the way from the Natufians to the LIA. I mean, really now. Shortages are probably driven at least partly by the fact agriculture is so much more productive on a per-acre basis; I would bet those improvements also raise the volatility of ag production since you’re spreading the same land-related risk (such as due to flooding) over a greater harvest.
Annuities are to the old what buying whole life is to the young: a chance to pay high fees to a company that may not be there when you need it.
People who buy annuities privately live longer than the average (adverse selection) so It is not as good of an investment as ones you get from an employer where payments are based on average live expectancies.
Regarding the link about agriculture: I am a commercial farmer and have personally seen a roughly doubling of the output on our farm in the past 15 years thanks to improved technology in seeds and equipment as well as the integration of livestock into our crop farm to add value to the byproducts and residues. At the same time we have suffered tremendous increases in costs of energy, fertilizer, machinery, etc. Inflation is alive and well down on the farm if we were forced to sell at 2006 prices this year it would be financially devastating. I don’t see much relief in food prices In the near term but I have great confidence that innovation can meet the food demands of the future if government meddling doesn’t take away the proper incentives.
Since you are a commercial farmer and you mentioned government meddling; what’s your take on farm subsidies?
Still citing the guy who insisted that there was no way for Estonia to have any recovery? Maybe missed the data – Estonia is again an economic miracle, 8% yoy growth in Q1, the highest in the EU. And population is also rising for the first time since the post-communist transition.
P.S. There is no such thing as BELLS.
And all they had to do was massively cut their government spending!
I roll my eyes every time I hear someone saying that we need to spend more to get out of recession, when we find that if a country responds to a recession with massive spending cuts, the recession is much shorter.
This reminds me of the late 40’s and early 50’s when Keynesian economists were screaming that all the spending cuts would cause a second great depression… only to see one of the largest booms ever.
When I retired I annuitized my 403(b) stash (TIAA), without even thinking about the decision very much–it seemed to be a classic no-brainer. The only reason for hesitating at all was the inability to get straight answers from my doctors about my life expectancy. They seem to learn in med school that you should tell patients that they are going to live practically forever, no matter their medical condition. I also looked into buying an annuity with some of my other savings. I didn’t, mostly because of the large difference in cost. Why TIAA gives you so much more for the same amount of money is the question I’m left with. Anybody know?
Usually in this situation the answer is “risk.”
Just as “Life Insurance should be called “Death Insurance”, so Annuities should be called “Life Insurance”. I suppose that faced with those old age choices and in good health, I’d buy two annuities,: one in Swiss Francs and one in Norwegian Kroner.
Second thought – a bit too exposed to The Ice returning? Is there a tropical currency that’s any good? Singapore dollars? The Aussie?
Agree with comments above (one of my research areas is unethical and criminal targeting of the elderly).
After selling an overpriced and undervalued annuity, the salesmen will come back in five years and try to flip you into something worse.
There are legit annuity companies, if you can sort the wheat from the chaff.
Note to Self: When starting my own country, make sure to start it with a vowel. That will ensure I make it into more acronyms of important countries.
Because the market is pricing in a massive inflation rise in the future, but not quiet yet… So, people are buying non-intrest assets.
This shows which they last very much lengthier and thus saving you income which could otherwise are actually utilized to purchase new ones.5
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