Blessed Assurance Too Often Rejected

On annuities and sales.

Guaranteed income solutions – annuities – can provide blessed assurance to retirees.

But they are too seldom utilized. That’s the initial subject of this week’s TBL, followed by my examination of our need for conviction.

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Blessed Assurance Too Often Rejected

Since at least 1965 and the seminal research of Menachem Yaari, overwhelmingly, economists have recognized that retirees should convert far more of their assets into income annuities at retirement than they do (see, e.g., here, here, here, here, and here). Nobel laureates Bill Sharpe and Robert Merton are among the strong advocates of guaranteed income solutions.

Income annuities hedge longevity risk simply and efficiently as risk pooling – which allows insurance carriers to fund each individual annuity based upon the annuitant’s expected life rather than his possible life – makes them 25–40 percent cheaper than do-it-yourself options (more here).

Retirees who purchase an income annuity assure themselves a higher level of consumption and guarantee it as well. As academics Shlomo Benartzi, Richard Thaler, and Alessandro Previtero pointed out in a paper that addressed the issue, “You increase your consumption and eliminate risk at the same time…. Who says there is no thing as a free lunch?”

However, the free lunch is often left uneaten. Why consumers so rarely eat is known as the “annuity puzzle.”

This puzzle is usually framed using Franco Modigliani’s famous formulation from his Nobel lecture.

“It is a well-known fact that annuity contracts, other than in the form of group insurance through pension systems, are extremely rare. Why this should be so is a subject of considerable current interest. It is still ill-understood.”

It was true then (in 1985) and remains true today. Income annuities remain widely unpopular (largely thought to be because they are a one-time irrevocable decision which allow no legacy distribution) yet would help to solve a variety of complex problems with which retirees struggle and which cannot be solved otherwise.

The key problem dealt with by income annuities is longevity risk. This risk is increasing steadily in that life expectancies continue generally to expand throughout the developed world (despite recent declines here in the U.S., not entirely due to the global pandemic) and is exacerbated because we are both retiring earlier and have less and less access to private pensions. Moreover, the distribution of longevity is wide.

A related problem faced by retirees who reject income annuities is the complexity that is added to their lives.

“Households who choose not to annuitize must learn a new skill, namely calculating the optimal drawdown rate over time. Given the complexity of this optimization problem, it is not surprising that retirees might err, either by under- or over-spending. These errors can easily be exacerbated by self-control problems if households have trouble sticking to their drawdown plans, either by spending too little or too much. By converting wealth into an annuity, individuals and households can simultaneously answer the conceptually difficult question of figuring out how much consumption is sustainable given the age and wealth of the consumer and provide a monthly income target to help implement the plan.”

In general, academics make the well-known case that greater reliance on income annuities would enable individuals to increase consumption, deal with uncertainty, and help people determine the right drawdown rate and timing of retirement.

That said, and despite record annuity sales, only a small percentage of defined contribution plan assets are used to purchase income annuities. As queried by academics Benartzi, Previtero, and Thaler: “the sum of this evidence makes a strong case that people should be making greater use of annuities, to increase their consumption level in retirement, deal with uncertainty, and help solve the cognitively difficult tasks of deciding how fast to draw down their wealth and when to start retirement. Why don’t they?”

A typical consumer perceives that he “is taking a considerable sum of money and putting it at risk – the risk being that the consumer will die young, making the purchase a bad deal.” Loss aversion comes into play here too. Since losing hurts about twice as much as winning feels good, the perceived monetary loss of dying early carries more weight than the possibility of monetary gain achieved by beating the actuarial tables, especially because a lump sum payment feels like a “sure thing.”

So-called “mental accounting” is another significant behavioral factor in this area, with investors reluctant to write a big check to purchase a series of small monthly checks, which seems like a bad deal to many. That’s because once we have something – and an account balance or a lump sum option makes us feel like we have something of real value – we are generally reluctant to give it up (loss aversion again).

Despite the strength of this research, some advisors and commentators hate annuities (see here, for example). Part of the problem is tribal. The insurance and investment sides of the financial services industry too seldom acknowledge that good financial planning usually requires both investment and insurance solutions.

There is also an issue with education and understanding. There are too many bad annuity products (just like there are too many bad investment products). Finding good ones and finding the best one for each particular circumstance can be daunting.

Finally, I suspect that the disconnect is also due in large part to the investment community’s unwillingness to promote guaranteed income options because it is not in the advisor’s financial interest to do so — because income annuities pay so little to advisors when they are sold and because the advisor loses control of the assets used to purchase it. It’s classic motivated reasoning.

In short, and sadly, when an advisor has a financial interest in a particular strategy over another, it is highly likely that the advisor will support the approach that is beneficial to the advisor.

As real fiduciary advice becomes the norm, and not just the standard, annuities will get the usage they — and the clients who utilize them — deserve.

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Complexity, Conviction, and Nuance

Meredith Willson’s The Music Man is perhaps the great American musical. It tells the story of con man and “every time a bullseye salesman” Harold Hill, who poses as a boys’ band organizer and conductor to sell band instruments and uniforms “where people are as green as the money.” Once he has the money, he forgets about organizing the band and teaching music and skips town with the cash. “Professor” Hill, played with such aplomb by Robert Preston in both the Broadway production and in the movie, is so persuasive that it’s downright scary. 

As the expression goes, he could sell ice cubes to Eskimos.

However, in the investment business, proper disclosure requires that strategies and products be communicated fairly.  Since investment management is highly complex and very difficult — there are no “sure things” — nuance and careful analysis is imperative. 

But nuance and careful analysis don’t sell.   

As noted above, consumers too often don’t want guaranteed income solutions in retirement.

They need to be sold.¹

All of us in the financial services business know people like Harold Hill. They are often very successful financially. They are not so often successful in doing right by their clients. However, good persuasive skills are not antithetical to good financial planning and money management. 

Let’s examine a bit of what makes the persuasive masters so extremely good at what they do. A persuasive master keeps it simple, is strong in his presentation, uses surprise to her advantage, and makes his clients and prospects feel special.  Doing each of these things is no guaranty that you won’t lose business to a Harold Hill, but it will surely help.

1. Simple

It’s an old cliché but it’s true: if it’s easy to follow it’s easy to swallow. Simpler is better. Sharper is better. Shorter is better.

Abraham Lincoln’s Gettysburg Address is one of the great examples of oratory in human history. Yet it was Edward Everett who was the featured speaker before the crowd of 15,000 at the dedication of the Soldiers’ National Cemetery in Gettysburg, Pennsylvania, on the afternoon of Thursday, November 19, 1863. He delivered a two-hour oration of 13,607 words before Lincoln’s few moments of dedicatory remarks that consisted of a mere 266 words. Everett was deeply impressed by the concise speech and later wrote to Lincoln, noting that “I should be glad if I could flatter myself that I came as near to the central idea of the occasion, in two hours, as you did in two minutes.” Indeed, Senator Charles Sumner was correct to call Lincoln’s speech a “monumental act.”

Lincoln was clearly in error to claim that “the world will little note, nor long remember what we say here.” The master persuaders keep it simple.

2. Strong

Nike has been very successful for a long time with the slogan, Just Do It. It’s simple and clear. It’s also strong and confident. Nike doesn’t say, “Think About It.”

Research by Hilke Plassmann, among others, demonstrates that people associate confidence with competence. The research involved wine and the Stanford wine tasting group. Plassmann and her colleagues discovered that the expert wine tasters, when tasting the very same wine, systematically reported superior taste for wine that came out of a $90 bottle as opposed to wine that came from a $10 bottle. The price tag seemed to have a real physiological influence on the taster’s taste experience.

My wife is a teacher and had a related experience tutoring children in the summer. Early on she charged only a nominal sum, because she wanted to be fair to the children’s parents and to encourage them to keep their children engaged in learning over the summer. She was particularly circumspect with respect to parents for whom paying wasn’t always easy. However, she soon realized that her work was being significantly undervalued. The children weren’t well prepared, weren’t getting adequate support from home, and the parents often cancelled. However, when she raised her prices significantly, things got much better in all of these areas.

We can conclude that strength — confident, assertive sales skills based upon products and services that are believed in utterly — is crucial to sales success. Thus, any attempt to influence without conviction is bound to fail. 

3. Surprise

Defying expectations is crucial to effective persuasion. It is a fairly common practice among servers in restaurants is to give their customers an unexpected gift in the form of candy when delivering the check. Two experiments were conducted by a group of researchers led by David Strohmitz to evaluate the impact of this gesture on the tip percentages received by servers. The first experiment found that customers who received a small piece of chocolate along with the check tipped 3.3 percent more than customers who received no candy. Surprise helped. The unexpected gift resulted in the customer acting with reciprocity and increasing the tip amount. 

The second experiment found that tips varied with the amount of the candy given to the diners. More candy — a bigger surprise — meant bigger tips to the tune of a 14.1 percent increase. But the manner in which the candy was offered mattered too. When the waiter left a piece of candy with the check, started to walk away, and then turned around and left an additional piece, tips increased 23 percent. 

Surprise coupled with making the customer feel “extra special” makes a huge difference.

4. Special

The best persuaders are able to convey to their audience that they care and have their best interests at heart. In Blink: The Power of Thinking Without Thinking, Malcolm Gladwell noted that a doctor’s risk of being sued for malpractice has very little to do with how many mistakes he makes. Interestingly, there are highly skilled doctors who get sued a lot and doctors who make lots of mistakes and never get sued.

On the other hand, the overwhelming numbers of people who suffer an injury due to the negligence of a doctor never file a malpractice suit at all. Simply put, patients don’t file lawsuits because they’ve been harmed by shoddy medical care. Patients file lawsuits because of the way they have been treated on a very personal level. When a patient has a major problem, the doctor has to take the time to explain what happened, and to answer the patient’s questions. The doctors who don’t are the ones who get sued.

Gladwell also described how medical researcher Wendy Levinson recorded hundreds of conversations between a group of physicians and their patients. Roughly half of the doctors had never been sued while the other half had been sued at least twice. Levinson found that just on the basis of those conversations, she could find clear differences between the two groups.

Those who had never been sued spent more than three minutes longer with each patient than those who had been sued did (18.3 minutes versus 15 minutes). They were more likely to make “orienting” comments, such as, “First I’ll examine you, and then we will talk the problem over,” or, “I will leave time for your questions.” Doing so helped patients get a sense of what the visit is supposed to accomplish and when they ought to ask questions. They were more likely to engage in active listening, saying such things as, “Go on, tell me more about that,” and they were far more likely to laugh and be funny during the visit.

Interestingly, there was no difference in the amount or quality of information they gave their patients; they didn’t provide more details about medication or the patient’s condition. The difference was entirely in how they talked to their patients.

In fact, psychologist Nalini Ambady used Levinson’s tapes and had judges rate the doctors’ speech tone for such qualities as warmth, hostility, dominance, and anxiousness. She found that by using only those ratings, she could predict which doctors got sued and which ones didn’t. 

The judges knew nothing about the skill level of the doctors. They didn’t know how experienced they were, what kind of training they had, or what kind of procedures they intended to do. They didn’t even know what the doctors were saying to their patients. All they were using for their prediction was their analysis of the tone of voice. In fact, it was even more basic than that: if the surgeon’s voice was judged to sound dominant, the surgeon tended to be in the sued group. If the voice sounded less dominant and more concerned, the surgeon tended to be in the not-sued group. 

That’s partly why, for financial advisors, regular client contact and regular reviews — especially when the news isn’t good — are so important.

The doctors who were successful conveyed their concern to their patients. Their patients weren’t talked down to or dealt with abruptly. They were handled with great care. They were made to feel special.

This final, simple example is an excellent portrait of how powerful the concept of caring and attention can be to customer satisfaction. Wharton marketing professor Xavier Drèze and Joseph C. Nunes, of the University of Southern California’s Marshall School of Business, handed out loyalty cards at a car wash requiring eight visits for a free wash. Some of the cards simply had eight blank circles to be X’ed out, while others had ten circles with the first two circles already filled in – this appeared to be an added bonus, even though both sets of cards required the same eight visits for the free car wash. Drèze and Nunes learned that customers who got the card with the “head start” were much more likely to participate in the program and earned the free car wash sooner. Getting a perceived special benefit led to more sales. 

Treating people well helps to protect experts from being sued, but it also means doing more business. 

Balancing these objectives with full and fair disclosure isn’t always easy. As I have pointed out before, people crave certainty, even if the investment universe doesn’t offer it. But since some in our business will promise certain (or near-certain) success, those of us who insist upon substantive disclosure and nuanced analysis are at a competitive disadvantage. Even data-driven explanations for why another’s rose-colored promises aren’t likely to hold up seem insufficient, especially in difficult times and markets. 

In the end, everything is sales. We might as well make the most of it.

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Totally Worth It

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Benediction

Stan Walker and the Levites are amazing (pardon the pun).

To those of us prone to wander, to those who are broken, to those who flee and fight in fear – which is every last lost one of us – there is a faith that offers hope. And may love have the last word. Now and forever.

Amen.

Thanks for reading.

Issue 152 (May 5, 2023)

1. Critics of the financial services industry frequently remind consumers (often with good reason) that financial products are typically “sold” rather than “bought” and implore them not to fall into that trap. The concept here is that financial products are “sold” — pushed upon a consuming public that doesn’t understand them or perhaps even want or need them. Instead, the alleged basis for their continued vibrancy and ongoing sales is that advisors get paid big bucks to sell them.

However, the idea that because people don’t naturally flock to buy something on their own means that it’s dangerous and bad simply doesn’t hold up. 

What is good for you and things that have enduring and intrinsic value are sometimes a tough sell. But they are still good and good for you. On the other hand, we often crave what’s bad for us.

Parents have a tough time selling healthy food to their kids (and a tough time following their own advice). Local symphonies are struggling to stay afloat while Justin Beiber could support several many times over. And porn is a multi-billion-dollar business. Sometimes the stuff we want would be better avoided and the really good stuff needs to be sold. 

As Steve Jobs famously said, “A lot of times, people don’t know what they want until you show it to them.”

Ultimately, a financial advisor’s job is to provide clients what they need — not just what they want. There are plenty of “advisors” who will give their clients what they want.  Sometimes doing what’s best for them — providing them with what they truly need, by being a true fiduciary — takes a great sales job. And that’s not a bad thing at all.