Study Says Income Annuities Best to Address Longevity Risk

A new study suggests lifetime income annuities are the most cost-effective and least risky asset class for generating retirement income that will last for an individual’s lifetime.

In the academic study “Rational Decumulation,” David F. Babbel, Professor of Insurance and Risk Management and Professor of Finance at The Wharton School at the University of Pennsylvania and Craig Merrill, Professor of Finance and Insurance with Brigham Young University, found that income annuities can provide income for an entire lifetime for 25% -40% less than it would cost an individual to provide a similar level of guaranteed lifetime income through traditional investment vehicles. This is due, in part, to an insurer’s ability to spread risk across a group of policyholders, according to a press release on a report of the study.

The study concluded that using equities, fixed income, and other investment products like mutual funds, individuals face the risk of outliving their retirement savings and individuals are not annuitizing enough of their portfolios. By covering at least basic living expenses with income annuities, Babbel and Merrill suggest consumers would have the ability to take more investment risk with their remaining retirement asset portfolio.

Babbel and Merrill’s paper based on their study, “Investing Your Lump Sum at Retirement,” addresses concerns individuals have that prevent them from purchasing income annuities. Recent innovations, such as annual inflation adjustments, legacy benefits and access to capital in emergencies, have helped make the products a more desirable retirement savings investment option, the paper says.

The study was co-sponsored by the Wharton Financial Institutions Center at the University of Pennsylvania and New York Life Insurance Company.