"Including the word ‘annuity’ in the choice reduces consumers’ preference for the annuity to 50%."
Offer someone a glass of dihydrogen oxide and they might feel anxious, perhaps even repelled. Give them a glass of water and they’ll willingly quench their thirst.
They are, of course, the same thing. What we name things DOES matter. How we think or feel about something is influenced by what it’s called. Jeff Bezos first registered Amazon under the name Cadabra, until it was pointed out that people misheard it as 'Cadaver’!
There is a glaring example of the importance of naming in the retirement market. The use of the word ‘annuity’. Since pension freedoms, more people are choosing drawdown over annuities. Drawdown sales are nearly three times the level of annuity sales. This could be the result of people making an informed decision. I suspect it has more to do with heuristics and other behavioural traits.
Heuristics are mental shortcuts people use to make decisions quickly without a careful consideration of the facts. This process is underpinned by ‘availability bias’. George Osborne’s remark that ‘no one will have to buy an annuity’ is a classic example of ‘availability bias’: The tendency to rely on information that comes readily to mind when making decisions. And once we’ve made up our mind, ‘confirmation bias’ suggests we tend to filter any subsequent information to reinforce our original belief.
Let’s consider the evidence. A 2021 US Morningstar study of over 1,000 people found that participants were more willing to use a portion of their retirement money to purchase a ‘guaranteed stream of income’ rather than an ‘annuity’. A 2014 FCA study reached a similar conclusion. Without calling it an ‘annuity’, 66% of consumers preferred an annuity to a savings account. In contrast, including the word ‘annuity’ in the choice reduces consumers’ preference for the annuity to 50%.
More recently, a UK survey published in January 2023 found that two in five (44%) pre-retirees said they wanted a guaranteed income for the rest of their lives. However, just half of that number said they either wanted or are considering annuities.
Economists call this the ‘annuities puzzle’. There’s no rational explanation for choosing a solution that doesn’t guarantee a lifetime income, and where investment returns are uncertain, compared with a product that does guarantee an income that is fixed or increasing for life.
So why does this matter? It matters because the amounts being withdrawn from drawdown appear unsustainable. The prospect of people running out of money is very real. This isn’t a problem UK retirees have ever faced. State pensions, defined benefits and annuities – all guaranteed an income for life. Even drawdown, when introduced in the mid 90s, came with important safeguards on how much could be withdrawn and effectively a requirement to annuitise at 75.
And let’s be clear. This isn’t about concealing or suppressing the word ‘annuity’. It’s about presenting its features in such a way that the client can assess the attractiveness of the solution objectively, without any pre-conceptions. The research suggests this will lead to higher numbers of people choosing this option.
And choosing a guaranteed income for life will often be the right approach. Many people prefer to focus on enjoying their retirement, rather than worry about their investments. A 2018 study found that people who have annuitised are less likely to suffer from depression or feel sad compared with those who choose drawdown.
There’s also growing evidence that using a guaranteed income for life as an asset class within a drawdown portfolio can boost performance: Reducing volatility, improving the sustainability of income and even increasing the overall value on death over the long term in many cases.
And lest we forget, annuity rates are higher than they have been for many years. A 65 year old can now get over £7,000 pa for each £100,000 purchase price. This doesn’t allow for inflation, but even including escalation at 3% pa would still generate around £5,300 at the moment. This may not provide a complete hedge against inflation, though between 1989 and April 2022, the average annual rate of inflation was only 2.5%.
For these reasons, it’s imperative that people judge guaranteed lifetime income products on their merits, without contaminating their assessment by introducing a label or tag that impairs their objectivity. Advisers have a key role in educating their clients and eradicating misconceptions.
Not leading with the word ‘annuity’ has to be part of any solution.
