Client frame of mind plays role in purchase of annuities

The mind-set of clients presents a significant stumbling block to advisers who recommend annuities as a retirement-planning tool. While many investors are on a quest for steady income during their retirement, some freeze up at the thought of buying an annuity. Indeed, the idea of committing a big chunk of their retirement savings to a product that may not provide them with any immediate benefits is daunting and presents a challenge to advisers. Advisers need to make sure "clients are using the right mental frame when they buy an annuity," said Jason S. Scott, managing director of the Retiree Research Center at Financial Engines Inc. of Palo Alto, Calif. "The right mental frame is the full retirement picture, not just the gains and losses of the annuity." Many research groups, including Windsor, Conn.-based LIMRA International Inc., have pointed out that registered reps and advisers need to take a less product-oriented ap-proach in guiding their clients into and through retirement. Though many comprehensive planners have gotten that message, it's going to take a little more effort to get clients on the same page, according to a recent study released by Financial Engines, "Behavioral Obstacles in the Annuity Market." The article, written by Mr. Scott and Wei-Yin Hu, director of investment analysis and research at Financial Engines, was published in the November/December 2007 issue of the Financial Analysts Journal.

BEHAVIORAL QUIRKS

One of the most common views among retirees considering buying an annuity is the tendency to think of annuities as a gamble rather than as insurance against future loss. The perception that the purchase of an annuity represents a massive upfront loss, as opposed to a gain in the form of income after its assets are depleted, is also a big worry, according to the study. "The desirable thing is to help clients focus not on the cost and payout of the annuity but more on having income in retirement," Mr. Scott said. "It's better to portray annuities as normal insurance to cover longevity risk" as opposed to an upfront cost to the client for something they may not see for years. Would-be purchasers also tend to distort the probability of certain events, the study found. For example, a 65-year-old purchaser may overestimate the chances that they will die soon after buying the annuity. "With annuities in general, people are skeptical because they don't understand them," said Samuel Braun, a certified financial planner and director of investments for the Financial Strategy Network LLC in Chicago. "For them, sometimes the easiest thing to do is nothing."
Variable annuities make sense for clients who want to be involved in the markets but want a guarantee of some sort, Mr. Braun said. "I think you have to make the client understand that with these income products, you're not really annuitizing the money," he added. "The fear is the trade-off of an asset through annuitization." The only way to clear that up is to present the client with a simple cost-benefit analysis: They invest a certain amount of money that can go down or up, and they pay an added cost for an income guarantee, Mr. Braun noted. However, sometimes investors also overestimate the strength of their investment portfolios. "Some clients think they'll live entirely off the interest from their portfolios and won't ever have to dip into the principal," said Craig DuVarney, a certified financial planner in Concord, Mass., who works independently. "You're not going to make money 10 out of 10 years in your investment portfolio. If you have three slow years, you'll either stop eating or you're going to take from the principal."

SKEPTICISM IS GOOD

Ironically, these investors aren't that different from those who lose sleep over the possibility that their investments will flat-line and last only a decade, Mr. DuVarney said. "You have to get past those emotional barriers and show them they can live without having the money run out." Investors' wariness toward annuities isn't necessarily bad, especially if it helps them avoid purchasing an annuity out of fear, Mr. DuVarney said. "I'm not begrudging anyone for making a commission," said the adviser, who recommends variable annuities in the "right situation." "But clients are legitimately scared of going into the markets and then someone uses that to sell them an annuity," Mr. DuVarney said. Mr. Scott agrees, noting that advisers should work with clients' behavioral quirks to help them overcome their shortsightedness, not exploit it. "We want to help clients view annuities in a broader context and emphasize how they can help manage risk," he said. Darla Mercado can be reached at dmercado@crain.com.