Jack Marrion

The Investment Company Institute publishes weekly Flow Reports that show whether investors, overall, are buying or selling equity-traded, closed-end and mutual funds, and in what quantity. If you look back over the years you find that investors tend to buy more equity funds at market cycle peaks and sell more at market cycle bottoms–the classic “buy high-sell low” bad investing dance. The main reason this happens is due to a decision-making rule of thumb known as projection bias, whereby we take what is happening yesterday and today and think the trend will stay the same tomorrow.

This pattern of buy high-sell low was easily seen during the millennium bear market and the Crash of 2008, but if you look at equity fund flows for the last couple of years you see that there is not a clear direction. For a few months there will be buying, then there will be selling for the next few, then buying for a month, then net selling of equity funds the next month. The reason why is that even though the bull market continues, its rise has been very jagged and volatile. The result is that investors are unable to use their projection bias rule of thumb. Granted, it is a lousy rule of thumb, but it at least gave investors the illusion that they knew what they were doing.

A different rule of thumb from the securities world that has greater validity is to move into bonds from stocks when the future looks dire. This made a lot of sense over the last 35 years as interest rates fell and the value of existing bonds increased. In this falling rate environment it didn’t take genius to make money in bonds. If you look at flows since last winter you’ll notice that people have been steadily selling equity funds and, it appears, putting that money into bond funds. This isn’t a bad strategy if interest rates remain flat or decrease, but it may be bad if rates go up.

From 1946 to 1982 interest rates went up. If you had purchased $100,000 of long-term investment grade bonds in January 1946 and sold them in January 1956 you would have gotten back roughly $90,000, or 10 percent less. The reason for the loss is the value of your bonds was lower because interest rates moved up about one half of one percent over those ten years. Let’s say you turned around and did this all over again buying another $100,000 of long-term investment grade bonds in January 1956. If ten years later you again sold them, you’d have received around $80,000 in January 1966.* The reason for the 20 percent loss is because interest rates moved up about one and a half percent during the period. So, 0.5 percent rate increase equals 10 percent loss; 1.5 percent increase equals 20 percent loss. There are those at the Federal Reserve talking about an interest rate target that puts rates roughly two and a half percent higher than they are now. If that happens, how does that buy bonds rule of thumb look now?

There is an alternative to all this. You could simply buy fixed annuities and transfer the principal market risk to the annuity carrier. It’s not yet a rule of thumb, but it looks like it should be. 

*Standard & Poor’s High-Grade Corporate Bonds 1945-1982.

One thing that terrifies us in growing older is losing our mental powers; this fear is not helped when we are forgetful from time to time. The reality is we’ve been experiencing “senior moments”–forgetting things–our entire life, but we didn’t make a big deal out of forgetting an appointment, leaving the teakettle on or losing our car keys until we noticed we needed reading glasses and our joints were getting stiffer. It wasn’t until we realized that our bodies were aging that we started worrying about our minds. 

However, most of the time a senior moment doesn’t mean we’ve lost it, it just means our minds are busy with something else and our brain will come back to us with the answer shortly. Here are some ways to tell the difference between having a senior moment and actual dementia (FYI: Alzheimer’s disease is a form of dementia).

Senior Moment–forgetting someone’s name.
Dementia–forgetting your own name.

Senior Moment–misplacing your car keys
Dementia–looking at the car keys and wondering what they do.

Senior Moment–thinking it is Tuesday on Wednesday.
Dementia–thinking it’s 1964.

Senior Moment–walking into a room and forgetting why you went there.
Dementia–after boiling an egg forgetting how to open the egg.

Senior Moment–telling the grandkids the same fishing story you told them last year.
Dementia–telling the grandkids the same fishing story you told them 5 minutes ago.

Senior Moment–getting lost at the shopping mall.
Dementia–getting lost going from your bedroom to the living room.

Senior Moment–forgetting a word you know when writing a complete sentence.
Dementia–not being able to write a sentence.

The reality is you’re probably okay. The vast majority of people meet their maker with their mental faculties intact. If you are concerned about your own or someone else’s possible dementia, your physician can conduct a couple of simple mental tests that will indicate whether there is a problem. Even if the test results are bad, it doesn’t necessarily mean dementia. Mental fogginess can also be caused by depression, a reaction to medications, or a brain chemistry malfunction that might be corrected with the right treatment. 

I would like to ask a favor. Every week I have lunch with a friend and, occasionally, he’ll think of one menu choice, say another, and have to correct himself. He’s always done this, but since his hair turned gray he now tells the 20-something server that he is having a senior moment. Here’s the thing. When a millennial hears the phrase “senior moment” they often assume the older person is advancing quickly into dementia and may not make it through the dessert. For the sake of your fellow gray heads, please don’t publicly announce your lapses, it makes the rest of us look bad. 

Annuities have an image problem. Multiple surveys say consumers want a retirement income that is guaranteed not to go down and will last a lifetime. Many consumers say they are willing to give up some growth if you take away market risk of loss. And yet many of these same consumers say they would never buy an annuity. The academics say this is due to consumers having difficulty in assessing the value of annuities or the marginal utility of the opportunity cost consequence. I think it’s because consumers don’t feel an emotional connection to what annuities are—but one can created.

The insurance industry often does a good job of creating emotional connections. Leaving your widow with funeral expenses and other debts may cause anxiety that you’re not a good provider, but low death benefit life insurance soothes that guilt and your widow will brag about the life insurance policy when the neighbors come over for coffee. Short-term disability insurance may be a good concept, but contemplating having an accident is not a happy topic; enter the Aflac duck. The Aflac duck shows the potential problem, that Aflac has the solution, and does it in a friendly, non-threatening way. Fixed annuities need to make an emotional connection and should also create a symbol.

This idea occurred to me last week when I was having breakfast at the neighborhood diner. I then decided to conduct a survey asking the other eight people in the diner two questions–Which animal is the friendliest? and Which animal would most likely protect you? In response to the first question, four people said a dog was the friendliest and one person each said cat and panda. To the second question all six said a dog would do the best job of protecting them (the other two patrons declined to participate). Science has spoken! A dog should be used as the symbol for fixed annuities. But which breed?

Rottweilers, dobermans and pit bulls rank high as symbols of protection, but are not regarded by all as friendly. Poodles and dachshunds may be friendly, but are not usually thought of as protectors. Then I had it. The fixed annuity symbol should be a collie. Not only are collies a friendly breed, but they were trained to protect the herd. In addition, every baby boomer in America watched Lassie on TV as a child and that television show’s values can easily be adapted to annuities–“What’s that Lassie? The bear market has caused Timmy’s retirement income to fall into a well?  Lassie, go save Timmy’s retirement!”

Picture the collie growling at the snake that is market risk and forcing the snake to retreat. Envision a glowing hearth with the owner and collie both smiling as they review the fixed annuity contract with the blizzard raging outside the window. Watch as the collie pulls the couple out of financial quicksand using a fixed annuity income safety line. The possibilities are endless, and all serve to reinforce the idea that annuities are something familiar, easy to understand, friendly and will protect you at all times.

I admit it is possible that another symbol might be better than a collie, but the industry needs to pick the right symbol—there are 9,000 likes (or hates to be accurate) on the Facebook page “I Hate Flo”. It’s hard to hate Lassie. 

Combining a heterogeneous mix of products into a bundled unit often reduces cognitive load and lessens the effects of mental accounting biases while price insensitivity increases. The fast food industry does this with great success. We tend to isolate decisions and not see the bigger picture, which often leads to not buying. To counter, the restaurant will offer a combination of burger, fries and drink for a set price. The burger/fries/drink combination causes us to see this as buying a meal rather than buying a burger.  Your cognitive load is lessened since you don’t need to make three decisions, but only one. The result is often not only a bigger sale, but a transaction that has done a better job of solving the consumer’s food need. 

The insurance industry has done this bundling of products to some extent. They show the overall discount the consumer receives if they buy both auto and homeowners insurance from the same carrier, or an annuity may group a number of benefits under a single rider fee. However, this bundling approach can be taken further.

A situation where bundling needs to happen far more is in retirement planning. Usually the consumer is presented with a series of isolated decisions…accept this investment portfolio, select a provider for savings and bank services, do this estate plan, and buy this annuity. The result is the consumer tends to not consider the overall effect of each decision and this can result in bad choices. Example: The consumer is asked to place $100,000 in an annuity that will generate $12,000 a year when he retires. The annuity also has a $10,000 surrender charge. The consumer does not buy the annuity because he fixates on the concern that he will need this $100,000 and thus lose 10 percent of his money when he cashes in the annuity. However, if the annuity decision is placed within a retirement planning bundle, where the consumer sees that in addition to the annuity he still has $200,000 in money market accounts and $700,000 in securities, the fear he will need the annuity money diminishes and the 10 percent potential cost of surrendering the annuity becomes a one percent unlikely cost when looking at all of the assets.

Annuity bundling can be used to create an “Income Now-Freedom Later” annuity unit where one annuity produces income immediately and the other(s) could generate an income in later years or be left for heirs if the income is not needed. An example of this would be combining an immediate annuity with a deferred guaranteed lifetime withdrawal benefit annuity (although aggregation rules shouldn’t apply in this example [IRC §72(e)(11)] a tax advisor should be consulted for individual situations).

Insurance bundling is being done where dental/vision/health policies are shown as a unit, but the marketing can be improved. Every request for life insurance on children could also include a quote for a “Protected Child” unit that provides life and dental coverage. A term life quote for an adult could also include a quote for a “Life and Death” bundle that includes life and disability insurance.

Bundling is usually done by the product manufacturer, but is often easily accomplished at the retail level where it can be personalized. An appointment to talk with one spouse about a deferred annuity could also include a single premium life illustration on how the death benefit could be used to replace Social Security income at the spouse’s death. If the agent knows the prospect is a supporter of a charity, a scheduled estate planning meeting could show how the “Legacy” life insurance bundle can pay estate taxes as well as support the charity.

Bundling is often done so the mix contains assets only or expenses only, but concept bundles permit interplay. A “Today and Tomorrow” unit could combine an asset move to a deferred lifetime income annuity with annual expense items of life insurance, disability and long term care premiums (of course, additional assets could be used to buy an immediate annuity to help pay those annual expenses).

Even if the annuity and insurance solutions are not packaged together as a bundle, the agent can help increase the probability of a successful purchase by helping the consumer see the bigger picture and the place the insurance solution occupies within the whole. A bundled approach lessens cognitive load and makes the decision process less complicated. 

Which ads are usually more effective? Those ads that present objective information about a product so that a consumer can update their views and make an informed decision, or ads that determine what the consumer currently believes and says their product is aligned with those beliefs? You can probably guess; it’s the ad that confirms what the consumer wants to believe that is more successful. And it doesn’t matter if what they believe is wrong—as long as the ad confirms what they already think it’ll help make a sale. Indeed, it is a waste of time to try to rationally show through marketing that what the person believes is incorrect when they are looking for confirmation—because they won’t accept it.

A prime example of this is during exuberant bull stock markets. Equity mutual funds advertise how high their returns are to a greater extent as more money flows in while the market keeps going up, thus helping to confirm why the consumer is buying.  But in a bear market, funds are unlikely to use return charts to provide a rational reason why the consumer should be buying when the price is low. 

A new study says our reaction is more nuanced that simply either seeking confirmation or logic, but that we tend to use logic for low-risk decisions and our “animal evolution” decision instincts for high-risk ones. Therefore, marketing approaches showing high returns for stock funds help to overwhelm the emotional risk avoidance feeling that investing in stocks can create. By contrast, a factual approach can be effective on a low-risk product. 

What this means is that if the consumer is looking to start a low-risk bank savings account, they are likely to analyze the ad or marketing materials for new data to update their beliefs and react negatively if they believe important information is missing. By contrast, if a consumer is looking to buy a growth mutual fund they want confirmation that the hunt and kill (picking the fund and purchase) is worth the risk and will ignore data that doesn’t talk about and reinforce the reward.

Where do fixed annuities fit? By design they are low-risk financial products, thus it would appear the correct marketing approach is to promote facts and ample disclosure. This approach is the correct one if the consumer is looking to buy fixed annuities. But what if the goal is to persuade the consumer not to buy the mutual fund, but to buy the fixed annuity instead? The marketing message then is to tell the consumer to listen to their risk avoidance voice.

It is a waste of time to preach the risk avoidance message during the raging bull market for the same reason that mutual funds don’t talk about returns in the pits of bear markets. But the fixed annuity message becomes stronger every day the bear market continues because the new belief being confirmed is that being involved in the stock markets without protection from market loss is a bad strategy. 

Today the consumer belief has a bearish outlook, based on looking at mutual fund outflows (www.ici.org/research/stats), and it explains why sales of fixed rate and fixed index annuities began the year strong. It also suggests that the best fixed annuity marketing approach today is facts and more facts. 

Reference:

R. Ferretti et al, A test of the Behavioral versus the Rational model of Persuasion in Financial Advertising, CEFIN Working Papers  No. 59, (May 2016).

Many of those in the financial world talk about the concept of retirement ruin. As commonly used, retirement ruin means running out of retirement income before one is dead. In the investment world it has come to be defined as odds that a pile of assets will produce a given percentage of income for a certain number of years. In practice, the advisor will enter details about the consumer’s assets, withdrawal percentage and number of years the income is needed into a software program, and a software program spits out an answer showing the probability that the assets will last. The pronouncement is made saying something like “There is a 90 percent probability of receiving this percentage payout for the next 30 years.” And yet, it is readily apparent that many of those relying on the probabilities produced by the model have given little thought to whether the basic assumptions are accurate or can even be supported. 

My main problem with the models is they use limited data and attempt to apply it to the future. A recent article by Professor Moshe Milevsky¹ does a great job of summarizing the fascination that many have with the concept of retirement ruin, even though they don’t have the “mathyness” to understand what they are looking at, and adds a third reason why this concept is misapplied.

1) Too few data points.
A Martian landing in Duluth on the first day of June and leaving after Labor Day would have over 100 data points for Twin Ports weather. The only conclusion you could reach from the data points is the average temperature in Duluth is 71 degrees and it never gets below 55 degrees. Many in academia and Wall Street act as if their extremely limited number of data points, representing less than a century of modern financial market history, can show all of the possible outcomes in the financial markets.

2) Beware Soothsayers & Prophets  
When it comes to computer predictions of retirement ruin, seldom has GIGO (garbage in-garbage out) seemed more appropriate. I’m unaware of any investment algorithms made in the 1990s that had predicted even a one percent probability of a three-year bear market followed by a 50 percent market crash within the same decade. I’m unaware of any past model that assumed an extended period of near zero T-bill rates.  

Addressing these financial engineers, Milesky states “Your black box is subliminally forecasting how interest rates, stock prices, inflation and mortality will evolve over the next 50 years and how they will co-vary with each other. Can you justify these assumptions to your clients? Do you even know these assumptions?”

3) Beware the standard deviation.  
Let’s say that Portfolio A and Portfolio B each have a 90 percent probability of being able to pay out an income for 30 years. Based on that fact alone we should be indifferent to using either one, if our goal is a 90 percent probability of getting 30 years worth of income. However, let’s say the worst case scenario for Portfolio A is that the income lasts 28 years and the worst case scenario for Portfolio B is that the income lasts 16 years. Are you still indifferent?

A large standard deviation (or a lopsided deviation where there’s a bunch of short year run-outs) means that if you are in that 10 percent ruin group that doesn’t make it to 30 years, the number of years short could be huge. However, I almost never see the variance of the suggested portfolios discussed. 

Annuities Are Not Perfect but…
If you buy an annuity guaranteeing a lifetime income you are protected from the retirement ruin…unless the insurance company making the guarantee fails. Although infrequent, annuity carriers have failed in the past, but fixed annuities have actual safeguards that don’t apply to those fantasy retirement ruin portfolio models. One safeguard is carrier financial strength, which is dynamically watched over and regulated by state insurance departments. A long period of low bond yields and rising longevity will be like watching the approach of a very slow moving train—the regulators have sufficient time to switch the train to a different track. Guaranty associations providing a minimum level of coverage are another safeguard, but it needs to be stated that if several annuity carriers go belly-up it could be years before an annuity owner would get their covered payment.

Even though the reality is that getting a life income from an annuity does not give you 100 percent protection from retirement ruin because we can’t predict the future, the annuity comes a whole lot closer to 100 percent than anything else out there. And you don’t need a degree in mathyness to understand that.  ïƒ¾

Footnote:
1. Moshe Milevsk, “It’s Time to Retire Ruin (Probabilities),” Financial Analysts Journal (March/April 2016): 8-12.

The author would like to thank Jeremy Alexander and Monika Hunsinger of Beacon Research for allowing access to their comprehensive store of annuity sales data and granting permission for a portion of this research to be shared.

Data for this article was drawn from the Beacon Research “Fixed Annuity Premium Study,” the only ongoing study to report and analyze U.S. fixed annuity sales at a product level. The study reports sales data provided quarterly by participating insurance companies as well as results reported in statutory filings and other publicly available sources. Beacon checks this data for general reasonableness, but does not perform independent audits. Beacon uses this data to estimate overall sales and sales by product type.

Beacon Research offers a suite of products to access industry leading annuity data mined from industry filings, researched from company websites, collected from annuity issuers and rigorously quality-checked by experienced data analysts and issuing companies.  Beacon Research provides the most comprehensive and accurate fixed and variable contract and sales data in the industry.  They can be contacted at 800-720-3504 or on the web at www.beaconresearch.net.

Overview
For calendar year 2015 estimated U.S. fixed annuity sales were $98.4 billion, up 7.5 percent from 2014. This was the best year for fixed annuity sales since 2009.  Sales steadily grew each quarter from $20.9 billion in the first to $28.2 billion in the fourth.

The greatest annual percentage category gain was 14 percent as fixed index annuity sales increased from $48.0 to $54.6 billion. Fixed rate annuity sales (including both market value adjusted (MVA) and non-MVA) were 2 percent higher than in 2014, closing out 2015 at $31.2 billion. Fixed income (deferred income annuities (DIA) and immediate income) slipped 4 percent from the previous year to end up at $12.5 billion.

Product Trends
Once again the Allianz 222 was the top selling fixed annuity in the nation, followed by New York Life Secure Term MVA Fixed Annuity; rounding out the top three was American Equity Bonus Gold. Five of the top ten selling fixed annuities were fixed index, three were fixed rate (non-MVA) with one fixed rate (MVA) and one fixed income (SPIA) completing the field.

The first quarter of the year is typically the weakest, and 2015 was no exception. The two stories here are that DIA and income annuities were down sharply for the first half of the year – a 15 percent decrease from the first half of 2014, but made up most of that loss with a strong final half of the year. The second story was the steady growth of fixed index annuities leading to another record with $16.1 billion purchased in the fourth quarter alone. To give that record some perspective, more fixed index annuities were purchased in the fourth quarter than were purchased in the entire last millennium. 

Interest Rate Trends
Overall interest rates were higher at the end than at the beginning. The Advantage Insurer Bond Yield Index had the overall average yield on new bonds purchased by insurers at the end of 2014 at 4.14 percent and at 4.74 percent at the end of December 2015. Going forward, interest rates are again heading down as uncertainty about the future direction of the stock market and global economy continue.

Higher bond yields translated into more favorable annuity rates. The average yield on five-year multiple year guaranteed annuities (MYGA) increased a quarter point going from 1.66 percent to 1.91percent by December. Although fixed index annuity interest caps also generally increased during the year, the driver for increased fixed index annuity sales was the new story offered by a flood of new volatility-controlled-index crediting methods.

Best Selling Products By Channel
The top ten selling products in the independent channel space are all fixed index annuities. In the bank channel, fixed rate annuities had the edge. In both the wirehouse and independent broker-dealer space fixed index annuities had seven out of ten slots. This contrasted sharply with the large regional broker/dealer channel where index products did not crack the top ten; in this channel fixed income annuity products were the mainstay, supported by fixed rate (MVA).

Distribution Trends
In 2015 captive and independent agents were responsible for 53.2 percent of total fixed annuity sales. Also in 2015 banks did 24.7 percent of sales with wirehouses and broker/dealers contributing 20.6 percent—up over two percent from 2014—and direct sales were at 1.6 percent. 

Independent agent sales became even more concentrated with almost nine in ten happening in the fixed index annuity channel; seven out of ten fixed annuity sales in the independent broker/dealer channel occurred in index annuities as well as four out of ten bank sales. 

The Forecast
I made the right call on bond rates moving up and was too chicken to make any other prediction last year. My fowl mood continues on declining to make predictions; there are too many unknowns.

As I write this interest rates have headed down since the start of the year and the stock market has moved up, but where they go from here I have no idea. The uncertainty out there should continue to drive people to fixed annuities, but there are no guarantees this will happen.

This spring the Department of Labor announced dramatic revisions to fiduciary standards associated with qualified accounts that will have profound effects on fixed annuity distribution. Although none of the revisions go into effect until the spring of 2017, I am concerned that this mandate will cause a drop in 2016 sales as producers spend more time worrying and less time selling. 

Over the last two years the number of closed customer complaints reported by the National Association of Insurance Commissioners (NAIC) concerning annuities has nearly doubled, increasing from 342 complaints in 2013 to 603 in 2014 to 656 in 2015. Although overall fixed and variable sales have modestly increased from around $230 billion in 2013 to $236 billion in 2015 (based on looking at the various sales reporting services), it still shows that there was one complaint for every $672 million of sales in 2013 and one closed complaint for every $361 million in 2015 – and the smaller the number, the greater the number of complaints by comparison.

The NAIC gathers closed details of customer complaints from the state insurance departments and tallies them. These are the numbers of annual complaints coded “annuity” or “group annuity” and would include both fixed and variable. The totals should not be viewed as 100 percent accurate because some complaints are miscoded, but the numbers do provide evidence that complaints are up.

Why are complaints higher? It’s unclear to me. Nothing exceptionally or particularly bad in the annuity world has occurred since 2012. It’s true that guaranteed lifetime withdrawal benefit income roll-up (increasing benefit) rates have declined on both variable and fixed index annuities, but in-force annuities were not affected. Markets have not crashed, which could have caused bad feelings, nor have interest rates spiked, which could have caused existing owners to question significantly lower renewal rates when compared to new money rates on fixed annuities. It’s true there are new indices in the fixed index annuity space, but they haven’t been around long enough to potentially give a consumer anything to complain about. In short, I can’t find a performance or product related reason for the increase in complaints.    

Some of the complaints are a little strange. In past years there has been a pattern of some carriers having consistently higher complaints than others – relative to premium received – but last year some carriers that had histories of zero or near zero complaints were hit with multiple complaints. In addition, some of the new complaints are directed at carriers that haven’t marketed annuities in years. 

Having 656 annuity complaints is not a good thing, but it helps if you keep things in perspective. Last year FINRA reported 3,250 complaints against its members, the top ten complaints alone to the SEC totaled 4,686 and bank complaints were over 25,000 – not including complaints against mortgage lenders and credit card issuers. Finally, there were over 82,000 complaints against property and casualty insurers and let’s not even get started on complaints in the health insurance arena. All of these totals are available on the applicable regulator’s website.  

It’s also good to note that of the over 2 million consumers that bought an annuity last year, or the several million that purchased over the last several years, that 99.98 percent did not feel the need to complain. In fact, when one looks at the volume of investment and annuity goods and services and compares that with the number of advisors, registered representatives and agents out there, you find that well over 99 percent of consumers never feel the need to file a complaint against an investment or annuity professional.*

None of this minimizes the reality that annuity complaints have gone up. However, if bad agents are causing the problem, insurance departments are working to get rid of them – in over a hundred cases last year agents were referred for disciplinary action. Hopefully, the no-consumer-complaint percentage will go up to 99.99 percent in 2016.

Footnote:
If you include annuity complaints from FINRA and the SEC you still get the 99.98 percent no complaint percentage. The complaint percentage for representatives and advisors is based on total volume and number involved.

A recently published study that involved 4000 people concluded that while aging generally has a negative effect on making decisions, the decline in the ability to make optimal economic decisions is a “distinct phenomenon” from other forms of age related cognitive decline. This might mean that our ability to make economic decisions declines sooner than our ability to make other types of decisions.   

When it comes to making decisions the working memory, also known as fluid intelligence, is called upon because it holds the different bits of new information you need to process. Both the amount of new information you can hold and the speed at which you can process it begin to decline about when you enter adulthood. The reason we can still function at age 40 is, as we age, we also pick up knowledge, also known as crystallized intelligence, which means we don’t need as much new information. The end result is the quality of our decisions improves until, usually, sometime in our sixties or seventies – depending on the individual – when the quality declines. 

A new study says that our ability to make financial decisions declines differently than our ability to make other decisions, and perhaps at a quicker pace. This news follows other studies that say seniors generally made good decisions regarding retirement and that their decisions were often better than juniors. Although the results of the new and the older studies seem to be contradictory, that is not necessarily so, because what it may mean is financial decision-making follows a different path of decline and not that the person is unable to make good decisions. 

Even though cognitive functions decline this doesn’t mean a 75 year old automatically makes worse decisions than a 25 year old, but it does mean the 75 year old may not make the optimal decisions they might have made at age 55. However, most decisions do not need to be optimal; they simply need to be good enough. This study is in no way saying that aging causes people to make bad decisions. 

What this new study does is question the belief held up to now that the mental or cognitive decline was the same across the decision spectrum. In other words, we thought that whether the older person was trying to decide which hotel to stay at, which car to lease or which annuity to buy, that their decision making resources would operate at the same level for these different  decisions, but this new study suggests that may not be true. 

If this study is correct, what do we do? A knee-jerk reaction might be for regulations to limit the economic choices of the aged or to require government guardians to make the choices for seniors. A less intrusive policy is to encourage the use of financial solutions that do not require ongoing decision-making – such as using life income annuities rather than managing withdrawals from a portfolio. However, until we know whether this specific decline is happening and why, there can’t be any solutions—because we haven’t identified the nature of the decline or tested different remedies to combat or minimize its effects.

While we’re waiting for the results of additional research, we can still practice the key elements that allow all of us to make better decisions:

• Allow sufficient time for the new information to be processed;

• Minimize distractions;

• Probe for understanding by asking the decider to tell you what you just told them (and not simply asking “do you understand”);

• And don’t make decisions when you are tired. 

Aging does not mean bad decisions. The vast majority of people reach the end with the ability to still make good decisions, but it does require a little more effort as you go along.

Footnote:
Kariv, S. & D. Silverman. 2015. “Sources of Lower Financial Decision-making Ability at Older Ages.” University of Michigan Retirement Research Center Working Paper, WP 2015-335.  http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp335.pdf

A little while back most people had figured out they wouldn’t win the Powerball lottery jackpot and ticket sales were declining. A Powerball ticket is a low cost mental vacation where the real payback is the enjoyment of thinking about what you’d do if you won.  But buyers were tired of the small vacations they were imaging from tiny $20 to $40 million jackpots. They were also tired of almost never winning even a small prize. Powerball needed a reboot.

Last fall Powerball increased the range of white balls from 59 to 69 and dropped the range of Powerballs from 35 to 26. The end result was a buyer was more likely to at least win $4 (guess the Powerball) and the odds of anyone winning the jackpot dropped from one in 175 million to one in 292 million. Because it became more difficult to win the jackpots got bigger, and as the jackpots got bigger the mental vacation fantasy rocketed, creating a bandwagon effect that led to a billion and a half dollar lottery with a billion tickets purchased. The reboot worked.  

Ongoing LIMRA reports say that American families are vastly under-insured. From a rational perspective many of the families needing the insurance understand this. However, they also believe the odds of their families collecting on that insurance premium “ticket” are very low. The other aspect is the “prize” typically isn’t life changing. Even a million dollar death benefit doesn’t seem like a windfall when the person earns the equivalent in, say, a decade. Here’s how thinking like the lottery helps.

Millennials especially don’t really think they’re going to die, but if they die they mentally overweight the odds of having a headline death¹. By that I mean they don’t think they’ll be killed in a regular car crash or by the flu, but that they’ll be killed by a terrorist bomb at the mall or an airplane crash or in a Sharknado tempest. The implication is a life insurance policy that costs $102 and pays off $100 million if they are killed by a volcanic eruption in Des Moines or a tsunami in Wichita, but pays $100,000 for an ordinary death, will more likely be purchased than one with a $100 premium that pays $100,000 for death by any cause.

The other concept that should increase sales is refunding premium if they don’t die. From a behavioral viewpoint, charging a $16.67 monthly premium for that $100,000 death benefit and giving the buyer a check or giftcard back for $100 at the end of the year should result in more sales than simply charging $8.33 per month. This is similar to the strategy that several auto insurers have adopted.

I’m kidding about insuring the risk that Des Moines turns into Pompeii (then again I never thought Oklahoma would have 2,200 earthquakes last year), but it strongly appears that adding a rider offering a huge payout on an extremely unlikely, but colorful, cause of death will motivate younger buyers to also get the basic insurance protection their families need. It will also increase purchases of life insurance—with and without the Sharknado rider—if the buyer is overcharged at the beginning of the premium year and then refunded the overcharge at the end.

The first two ideas are derived from the response to the Powerball tweaking and involve understanding decision making under ambiguity as well as a bit of game theory. The next one utilizes mental accounting and framing decision-making biases.

Most Americans give to at least one charity and I’m guessing that many would give more if they felt they could. Aspirational life insurance encourages the purchase of insurance by providing an “extra” death benefit that is paid to a charity (or other designated party) with the much larger “base” death benefit going to main beneficiaries. The insurance premium already reflects the cost for the extra insurance, so the aspirational insurance is perceived as part of the whole, rather than an add-on or rider that can be separated out.

For example, the insurance need might be $500,000. Based on your conversation you discovered that the consumer is a strong supporter of the XYZ Charity, gives $50 a month, and wishes he or she could do more. The aspirational insurance presentation shows that upon death the consumer’s family would receive $500,000 and the charity gets $50,000. Coincidentally, the monthly premium of $50 is the same as they are spending for the charity. The consumer’s perception is they needed the life insurance anyway and now they have it, but they have now become a major donor of their charity and it didn’t feel like it cost them anything. Indeed, since the future donation of $50,000 is already set in place they could even use the $50 spent on the charity to fund the life insurance, meaning the life insurance feels like it is free. 

Of course, the consumer is aware they could make their family the beneficiary of the extra insurance and leave them $550,000, or back out the extra insurance so the premium drops to maybe $47 a month, but they probably won’t. 

A life insurance purchase runs contrary to the way most people make ambiguous decisions because it forces us to accept a certain loss (the premium) and gamble on a big return—dying soon. Lotteries force the same mindset, but they overcome the resistance by offering huge prizes, and the possibility of reducing or eliminating the loss. More life insurance should be purchased if the core benefit is retained, but a bit of fantasy added, as well as providing small wins that feel like the cost is reduced. Aspirational life insurance makes the consumer feel that they are helping to change the world and protect their family at the same time. Redesigning insurance means consumers may become active buyers and disprove the old adage life insurance has to be sold.

Footnote:
1. R. Heimer, K. Myrseth & R. Schoenle. 2015. YOLO: Mortality Beliefs and Household Finance Puzzles. Federal Reserve Bank of Cleveland, working paper no. 15-21.