This Best's Review article discusses why, as public pension programs face challenges, converting assets into an annuity can help retirees transfer the risk of living longer.
Actuaries have long predicted that as large populations age, retirement savings would come under pressure — a so-called "pension time bomb." With some of the world's largest public and private pension systems in decline, this fuse now looks shorter than ever.
As retirees are left to invest and save on their own, they may find themselves unprepared to live comfortably in old age. Insurers, in theory, already offer a solution: guaranteed lifetime income products. By converting assets into an annuity, retirees can transfer the risk of living longer than expected to an insurer. Yet, the individual annuity market had only recently shown strength after years of weakness in a low-interest-rate climate. Pension risk transfer (PRT), a related product line, may provide clues.
Through PRT solutions, employers have been purchasing guaranteed lifetime income protection for their defined benefit pension plans at record rates in both the U.S. and the U.K. With PRT, the underlying life insurance product mirrors a guaranteed lifetime annuity but is bought by corporations for a group of retirees. Insurers can draw several important lessons from the PRT path to improve guaranteed lifetime annuities:
Retirees are often forced into binary decisions at retirement (e.g., withdraw a lump sum or buy an annuity), and often choose the default: the withdrawal of cash lump sum(s) in most markets. Backed by a coherent legal and regulatory framework, employers would be more likely to embed lifetime annuity products in their defined contribution plans, making the choice of an annuity more likely.
Previously, employers ensured retiree lifetime income, but now with defined contribution plans the risk has transferred to employees, with employers only providing the infrastructure for retirement savings vehicles that are otherwise independent.
Through tax or other corporate incentives, employers could be encouraged to change this dynamic and implement group lifetime income protection products as part of their defined contribution plans. The result could be transformative.
In the defined benefit market, the value of transferring retirement responsibilities to insurers is widely recognized, but individual behaviors remain entrenched. Encouraging informed retiree decisions is now a global focus. Research suggests that increased financial literacy, through simplified language in forms and websites and better access to qualified financial advice, could have a noticeable impact on retirement savings.
Various charitable and community service organizations, financial institutions and commercial banks, consumer groups, and governments have launched initiatives to break down barriers to consumer financial education in a bid to close the retirement savings gap.
With public and employer-sponsored pensions waning, individuals must increasingly shoulder the burden of saving for retirement.
The magnitude of the resulting protection gap will only become evident over decades — and at that point it will be too late. Insurers’ experience in the PRT market shows a path to increasing security and stability through guaranteed lifetime annuities.
View this video to learn more about RGA's PRT solutions:
