What might one market learn from the other?
Drawing close comparisons between markets could be overly simplistic, but given the similarity between the underlying insurance needs and insurance products, the structure and operation of the group lifetime annuity market do offer valuable lessons to the individual market. These lessons, if acted upon, could potentially increase the willingness of the at-retirement population to purchase guaranteed lifetime income protection.
Lesson #1: Advancing comprehensive legislation/regulation that targets individual retirement savings
A fundamental, yet often missing, requirement is a legal and regulatory framework that combines the accumulation and decumulation phases of retirement into a coherent whole. This should be an area of focus for policymakers. As noted earlier, individual savers, due to the discontinuity between (i) employer-sponsored DC retirement accounts, and (ii) the insurance and savings products that are available to the same individuals in their retired years, are often forced into binary decisions at retirement (e.g. withdraw a lump sum or purchase an annuity). These discrete decision points predispose individuals towards the “default option”, which in most markets is the withdrawal of cash lump sum(s).
To combat this discontinuity, employers could be allowed to embed lifetime annuity products in their defined contribution plans. With the appropriate structural changes, DC plan members should be able to purchase lifetime income protection either while they are saving for retirement or at retirement, all through their DC plans. This would necessitate close alignment and coherence between rules and regulations that govern DC plans and those that govern insurance products and how they are sold – much as is the case of DB plans and the group annuity market.
A promising development is recent legislation that was passed in the U.S. in 2022. The SECURE 2.0 Act aims to pave the way for insurer-carried annuity products to enter the realm of employer-sponsored DC plans such as 401(k)s.
Lesson #2: Giving a more prominent role to employers
Arguably the decommissioning of employer-sponsored DB plans has caused the pendulum to swing from one extreme to the other. Where once employers were fully on-the-risk for their retirees’ lifetime income security, the rise of DC plans has transferred the risks to retired employees, with employers only providing the infrastructure for retirement savings vehicles that are otherwise independent.
Building on the coherent legal and regulatory framework envisioned above, employers should be encouraged (perhaps through tax or other corporate incentives) to consider implementing group lifetime income protection products as part of their DC plans. This would be conceptually similar to group life or health insurance policies already commonly purchased by employers for their workforces and allow individuals to benefit from the collective bargaining power and diversification of the group but also allow employees to customize certain policy features for themselves.
Lesson #3: Combating behavioral biases
Perhaps the hardest nut to crack is figuring out if and how various stakeholders of the retirement income market (the state, employers, insurance companies, etc.) should counteract the tendencies of individual retirees to not purchase lifetime income protection products. In the DB market, the value of transferring retirement obligations to the insurance industry is widely recognized and publicized. As for changing individual attitudes, the solution is easy: individual retirees are not given a choice, the DB plan sponsor buys protection on their behalf.
A softer approach that is applicable to the DC space could be a group retirement income policy, as discussed above, that is purchased by a past or present employer but that offers individual, customizable features. Even softer still, employers may nudge savers toward desirable outcomes by selecting default options for their defined contribution funds. For instance, it is already common practice for DC contributions to be channeled into specific investment funds (such as target date funds) driven by the saver’s normal retirement date. It would not be much of a stretch to imagine a certain amount of an individual’s retirement account being, by default, directed toward the purchase of a guaranteed lifetime income option. Individuals, of course, can always opt out of the default settings.
At a minimum, however, improving customer financial awareness and the role of qualified financial advice should be emphasized. The U.S., the U.K., Japan, and other countries will have their own views based on cultural and political differences as to the right level of customer education. However, it is clear that actors in these markets can – and should – do more.
A vicious cycle to a virtuous one
Low sales volumes in a market discourage product development and result in products that are less attractive despite their potential for providing strong protection. This is keenly true in the individual lifetime annuity market. However, by pursuing initiatives to increase product take-up rates, this trend can be broken. Giving more prominence to employer choices on behalf of their employees, as opposed to individuals, would help broaden the mix of annuitants and thus reduce the anti-selection premium that is currently priced into most lifetime annuity products.
Similarly, any measure that increases the size of the market will help focus insurers’ attention on enhancing product offerings. Being able to rely on a larger inflow of annuity premiums allows insurers to invest at scale and in a manner that ultimately makes pricing more attractive. It is evident in the success of the DB group annuity market that once scale kicks in, pricing attractiveness gets a boost.
With flexible product design, insurers could also help ease retirees’ anxiety about handing over part of their life savings. For example, consider Single Premium Immediate Annuities (“SPIA’s”) in the U.S.
A common feature of SPIAs is a premium refund guarantee. If the annuitant dies in the first few years of policy issuance, the estate receives a refund of the premium adjusted for the annuity income already paid out. From the annuitant’s perspective, this product feature allays the fear of dying soon after the annuity commencement date and foregoing the value of the lifetime income guarantee. From the insurer’s perspective, this is a relatively inexpensive product feature to offer because the cumulative probability of the annuitant dying in the first few years of the policy is low. In other words, a win-win and a great example of the type of product development that serves the needs of the market at large.
Call to action – Closing the retirement income protection gap
With the gradual, most likely irreversible, decline in the role of the state and of employers in providing financial security to retirees, the onus is on individuals to make the right financial choice leading up to, and at, retirement. However, the average retiree across the three largest global retirement systems is alarmingly underprepared for the financial risks he or she will face in retirement. The lifetime income protection gap looms large and will only continue to grow unless current trends are broken or reversed – bridging it is a societal and financial imperative for most developed economies.
The life insurance industry could and should play a major role. Building upon an existing product suite and expertise, life insurers are better placed than anyone to partner with policymakers to advance a retirement income protection agenda, taking best practices and learnings from related markets and across geographies.
Make no mistake – catalyzing the individual lifetime income market represents a unique growth opportunity, too. Selling lifetime income protection products with an attainable market of close to $10 trillion and close to 100 million potential customers should be an enticing prospect.