Life insurance and immediate annuities face a problem in probability perception. Most people, at most ages, think they’re going to live long enough to not need life insurance, but not so long that they will need a life income annuity. In both instances most people are wrong, but it’s tough to deal with perceptions. However, there are several ways to try to offset the effect of misperceptions. Here are two:
Make the Risk Vivid
People usually want to buy life insurance after their doctor says they have a terminal illness, but by then it’s too late. If a person is shown that a risk is real he is more likely to insure against it. An “obituary book,” filled with obituaries of people who died before their time, reminds the individual that bad things happen. If you’re talking about using annuities to fight longevity risk, ask the individual: “Did any of your relatives make it to age 90?” This often starts a memory cascade reminding them of Uncle Phil who made it to age 92, Aunt Fran who lived until age 96, and Uncle Bob, who is still around at age 98. Now, when you talk about how a life income annuity cannot be outlived, the audience will be more receptive.
Another way to increase vividness is to focus on risk aversion. There is roughly a one in 600 probability that a 39-year-old will not see age 40. So ask the person: “Say there were 599 white chips and one black chip in a covered bowl. If you pull out a white chip you get $200—the cost of an insurance premium; if you pull the black chip you die, and your family gets nothing. Will you take this bet?”
A third way is to bring a possible future into the present. It goes something like this: “It’s one month from today and your family is looking at your casket because you didn’t see that drunk driver. Does your family have enough money to survive without you?” or “You beat the odds and you’re still alive at age 85, but you ran out of money and your only alternative is the county old age home. Is there anything you wish you had done differently 30 years ago?”
Make the Cost of Insuring the Risk an Easy Choice
If scientists today pronounced that the effects of climate change could be completely prevented if every adult had at least one beer a day, I’m guessing there would be less discussion about the reality of the issue, because the cost of prevention would be so easy. If an individual feels he is likely to die before age 80 and doesn’t think he’ll need longevity protection—and many people under age 65 believe this to be true (according to the University of Michigan Health and Retirement Study)—you can offer inexpensive uncertainty insurance. Explain that for a cost of 0.85 percent a year on their annuity value they keep open the option of getting a guaranteed lifetime withdrawal benefit.
Or you ask if the prospective life insurance buyer has any goals for his family. The response might be providing college educations for the children. The return question is, “Will they still be able to go to college if you’re dead?” That leads into the “for the price of a latte a week you can insure your kids’ college is paid for” presentation.
Since the odds of dying before our later years is slim and the idea of being alive at age 85 or 90 is almost inconceivable, many people tend to underestimate the odds that it will happen to them. A couple of ways to deal with this are to change the misperception by making the risk more vivid or to leave the misperception alone and show how low the cost is to provide uncertainty (also known as “if you’re wrong”) insurance.
