PensionReforms' summary and comments
Life annuities are a good way to run down (decumulate) retirement assets in an orderly way.  They also let the annuitant buy 'insurance' against unexpectedly low investment returns and unexpectedly long life.  That all means relative certainty of income from retirement until death.  Where a 'continuation option' is available, the annuitant can also arrange for that protection to be built into the survivor's annuity.

Often, the tax-favoured nature of pension saving arrangements during the accumulation period means that the retirement benefit must be used to buy an annuity.  In the usual EET environment, the tax system collects partial recompense during retirement for the concessions allowed on capital contributions and investment income while saving.

Where annuities are a voluntary option, they aren't very popular.  That seems to be the case internationally (see here and here).  Part of the reason is on the supply side and is connected with the risks that annuity providers run over the long periods involved in annuities (including expenses).  The uncertainties must be priced into the product and that makes them look relatively bad value.  Another part is due to the absence in many jurisdictions of appropriate investments to underpin the annuity.  

On the demand side, there is also the loss of flexibility that prospective purchasers face in parting with what are usually large sums of money.  Most savers might prefer to control the investment strategy, even if they are unskilled.  There is also the bequest motive that might influence a retiree to want control of a lump sum.  Anyway, annuities are not particularly easy things to understand.

The rest of the reason, according to this report, is the way in which the annuity sale/purchase is presented to the prospective buyer - how the proposition is "framed".  It concludes that the apparent aversion to buying annuities is "not a fully rational phenomenon".  The report used an online survey of 1,342 individuals carried out in December 2007 to test what really seemed to be happening.

"We hypothesize that framing matters for annuitization decisions: in a consumption frame, annuities are viewed as valuable insurance, whereas in an investment frame, the annuity is a risky asset because the payoff depends on an uncertain date of death."

The report thinks the insurance aspects referred to (against long life and low investment returns) should be emphasised:
"Survey evidence is consistent with our hypothesis that framing matters: the vast majority of individuals prefer an annuity over alternative products when presented in a consumption frame, whereas the majority of individuals prefer non-annuitized products when presented in an investment frame.  To the extent that the investment frame is the dominant frame for consumers making financial planning decisions for retirement, this finding may help to explain why so few individuals annuitize."

So why might this be the case?  Why don't the sellers of annuities market their proposition with a focus on the protection elements of the transaction rather than the investment?

"We conjecture that the investment frame is the dominant frame in the market and in most younger customers' minds both because it is simpler, due to the focus on nearer-term and impersonal outcomes, and because little is lost by using this frame during the wealth accumulation stage of life."

Apparently, it may be difficult to change the retiree's perspective (from investment to insurance) for several possible reasons:
".resources are required to incorporate additional personalized information and thus convert consumers to a more complex frame; a given firm may not capture the return from raising a customer's interest in particular products in the consumption frame because the converted customer can purchase from another lower-cost seller; the compensation of sales staff (e.g., through commissions) may be oriented to products most consonant with investment frame and the compensation system may involve sales people outside the direct control of a given firm; invoking the consumption frame may undermine demand for the firm's other non-life-contingent products."

The report concludes by suggesting that these possibilities need investigation.

PensionReforms is unconvinced.  While the way an annuity product is presented must influence the way prospective buyers behave, we suspect this is likely to be at the margins when consumers are confronted with decisions about their own money (as opposed to the hypothetical situations used in the report's survey).  PensionReforms thinks there seem to be more fundamental issues at the heart of this issue.  It is undoubtedly the case that most have no real understanding of the relationship between the present value of an income stream and a lump sum so the education/information issue must be addressed.  That will probably best come from the government - or a government agency.

Then there is the issue of institutional mistrust that will not have been improved since the report's survey was carried out in December 2007.  That is particularly acute for annuities given the long time frames and the relative significance of a single decision at the start of retirement.

Governments have the capacity to help resolve some of the difficulties faced on the supply side of annuities.  For example, governments might issue proper inflation-linked bonds because, even if private annuity providers could eliminate unexpected longevity improvements, unexpected inflation is also a risk that only governments can control.  Asking them to help pay for that might help private annuity markets to be more efficient.  Another possibility is the direct involvement of governments in selling properly priced annuities - governments have potential social objectives that might be resolved in different ways in this difficult part of pensions markets.

PensionReforms suspects that it's time for governments to get involved in helping to broker a resolution of the annuitisation 'puzzle'.  They must lead the debate and perhaps, in PensionReform's view, even get directly involved in the outcomes.  Governments simply cannot stand back and watch private markets (and consumers) try to cope with all the risks associated with annuities.  Apart from anything else, the ultimate risks of long-term, high quality care at the end of a pensioner's life rest with society - that's if we care about looking after those who become unable to look after themselves, financially or physically.  And every unintended bequest, while nice for beneficiaries, also signals a market or individual failure.

In summary, PensionReforms suspects that it probably doesn't really matter how the annuity option is framed.  It's quite difficult to make a silk purse out of a sow's ear.  (File size 72 KB; 11 pp) 350