Annuities flavour of the month
An annuity payout is an option offered by few American employers. But it is the kind of benefit that employees are increasingly attracted to.The reason for this could be the recent stock market downturn that drastically cut the value of savings, or perhaps it is an awareness that we are all living longer and risk out-living our savings. Whatever the reason, insurance companies are trying to figure out how to satisfy the new demand.
A strong interest for “benefits paid as a guaranteed payment” emerges from the latest Watson Wyatt retirement attitude survey, conducted among 8,000 employees belonging both to defined benefit (DB) and defined contribution (DC) plans. “Economic theory holds that offering or not offering a pension plan affects the type of worker an employer attracts,” remark Watson Wyatt experts. “As such, an employer that offers only a 401(k) plan is likely to attract different workers than an employer that offers only a DB plan.” In other words, companies with DC plans are likely to attract people with higher risk tolerance, higher professional mobility and who are more willing to take financial decisions in their hands. However, employers with DB plans are more appealing to risk adverse people. But the theory is only partially corroborated by the survey.
The most important feature in a retirement plan is a “portable benefit” for both DC and DB members: on average 68.3% of employees prefer it, with DC-only employees slightly more in favour (72.4%) than their DB-only colleagues (62.5%). For all employees (including those covered by both a DC and a DB plan) a portable benefit gets the highest preferences: nearly seven out of 10 employees would rather be able to take their benefit with them if they leave their current employer than earn a higher payout by remaining with the same employer.
The difference between DC and DB members is clearer when discussing investment risks. In all, roughly 40% of responding employees say they prefer the employer to bear the investment risk, meaning they are willing to give up the opportunity for higher returns in exchange for a guaranteed benefit amount, reads the Watson Wyatt survey. However, 34% say they are willing to risk a disappointing investment outcome in exchange for the potential to earn higher returns on their retirement assets. The latter are more numerous among DC members (37.4% against 34.7% preferring not to risk and 28% with no preferences), while the majority of DB members (53.2%) prefer the employer bearing investment risks (24.8% have no preference and 22% are willing to bear risks).
Eagerness for a “guaranteed benefit” appears to be a common attitude when it concerns the payout of a retirement scheme, whether a DC or DB plan. Most people (54.5%) say they prefer a guaranteed monthly payment over a single lump sum. “This is surprising,” observe Watson Wyatt experts, “because anecdotal evidence seems to indicate that, when offered a choice between an annuity and a lump sum, most retirees choose the lump sum. Employees may have become more safety-conscious since the recent downturn in the financial markets, which hit many retirement accounts hard.” Beside a strong preference for portability and guaranteed monthly payment, the survey respondents consider ease of understanding very important in their “ideal” retirement plan (33.8%), as well as the ability to make pre-tax contributions (31.6%).
Wanting a guaranteed annuity payout and then choosing a lump sum is not a contradiction according to critics of today’s annuity products, which allegedly do not address market needs. The biggest problem is that annuities are not indexed to inflation, says David Wray, president of the Profit Sharing/401(k) Council of America. People who live longer could see the value of their monthly benefits drop to almost nothing, if they receive fixed dollar payments. And this issue will become hotter as the 77m baby boomers begin to retire in 2008 with longer life expectancy.
Currently only 17% of large companies with 401(k) plans offer an annuity payout, down from 31% in 1999, according to human resource consulting firm Hewitt Associates. Even when annuity options are available, the great majority of employees choose a lump sum, giving employers more reasons for ignoring those products.
To address demand, the insurance group MetLife is thinking of adding an inflation rider to its fixed annuity products. Hewitt Associates has just rolled out an annuity-purchasing platform in partnership with Hueler Companies, a Minneapolis-based firm that specialises in stable value investment products. Furthermore, nine insurance companies currently compete on the platform, called Income Solutions, and their products are available to 401(k) plan members at 40 US companies, one of which is IBM.