Weighing Retirement Income Options

In a MetLife white paper, Joseph W. Jordan, Dan Weinberger and Joel L. Franks explore the applications of consumer behavior to financial decisions. Key research highlighted here explores how consumer behavior principles can be applied to promoting retirement income products. As producers focus on discussing wealth distribution strategies with clients at the threshold of retirement, what is the most compelling way to present information on retirement income products? How can a complicated subject be made engaging and informative to help guide them to make better informed buying decisions? Some compelling findings are summarized below:

Values and Emotions are Integral In Financial Decisions

Numerous studies have called out the financial services industry for too often focusing on  left brain processes including facts and logic  while neglecting  the role that right brain processes – emotions, language and imagery – play in the buying process. Findings in behavioral finance research tell us that integrating logic with emotion facilitate better financial decision making as well as stimulate the sale of financial products.

1. Emotional engagement leads to more sales: A 2009 LIMRA research report compared a “fact-find and analyze” sales approach with a sales approach focusing on clients’ feelings supported by facts, including soft questions like “how do you feel about the investments you have?” The results: a 29% higher likelihood to buy.

2. Emotional engagement leads to more informed choices: Neurologist Antonio Damasio’s book Descartes’ Error: Emotion, Reason, and the Human Brain holds that rationality in fact requires emotional input. He studied people who were able to reason without the benefit of emotional content due to suffering damage to the area of their brains that generates emotions. In the absence of emotion, their decision making was seriously impaired. The conclusion: emotions, feelings and intuition are required to make better quality choices.  Findings such as this suggest that approaches that integrate both these modes of decision making are more effective.

3. Meaning (vs. money) is particularly important in evaluating retirement strategies: In a recent MetLife study (Discovering What Matters: Balancing Money, Medicine and Meaning, MetLife’s Mature Market Institute, January 2009), clients were asked what held the most importance — money, medicine, meaning or place? The findings were that at all ages “meaning” ranks highest, and increases in importance with age.  “Meaning” is  a reflection of what is emotionally important to us.

Applications to Retirement Income Planning

The implications of the above these findings are that we need to engage clients in discussions about retirement income in away that enables them to become emotionally engaged and active, to enable them to better evaluate their financial risks and make better decisions .MetLife’s White paper highlights three behavioral frameworks that can be employed to more effectively approach, engage and inform clients regarding their retirement income decision.

1. Framing

How we frame questions to investors will affect their choices, so a 2008 study by the National Bureau of Economic Research investigated the role of framing lifetime income solutions.  The study divided participants into two groups and asked them to select among various retirement income payout options for distribution of a hypothetical $100,000 principle amount.

  • One half of the participants received explanations of  the pay out options that focused on the asset value and rate of return.
  • The other half received explanations focusing on the amount of income and duration of payments.

72% of those presented the payout options in terms of income and duration chose the lifetime annuity (which provides the highest income for the longest duration (lifetime.) However, when presented the same set of choices in terms of asset value and rate of return, only 21% chose the lifetime annuity option. These results were duplicated in a subsequent 2010 MetLife study.

Implications: 

  • Income framing effectively conveyed the idea that the life annuity is a valuable form of insurance guaranteeing lifetime income.
  • Investment framing focused more attention on risk owing to the uncertainty of living long enough to achieve the best results.

2. Losses loom larger than gains

Numerous behavioral finance studies, including the 2010 MetLife study, and a study by Nobel Prize laureate  Daniel Kahneman, notable for his work on the psychology of judgement, decision making and behavioral finance, show the interesting finding that feeling that one is not losing his assets is more important than generating income.   

Daniel Kahneman and Amos Tversky’s Prospect Theory: Analysis of Decision Under Risk (1979) for example finds that people tend to be irrationally risk tolerant in protecting capital and that losses have a higher emotional influence even if the gains equate to the same value.

Implications:

  • Losses loom larger than gains in financial decisions.
  • Help clients picture retirement planning not in terms of asset value (which they fear losing) but on the potential to enjoy a “lifestyle sustaining retirement income.” 

3. Experiential Bias

As people gain knowledge and experience, their decisions we are increasingly influenced by past experience. This can cause people
to ignore changing data and new facts, and the effect is amplified as people age.

This is shown in an August 2008 Federal Reserve Bank of Chicago study that examined consumers’ decision-making performance on several financial oriented decisions. The findings were that when we are younger we tend to have more “cognitive capital” – ie. we are more receptive to analytical information, and employ it when making financial decisions. As we age (age 53 is the age of peak performance) we tend to lose cognitive capital and we rely on long-standing experience to make decisions. Clients considering retirement income decisions risk relying on irrelevant experience related solely to accumulation rather than distribution.

The Implications:

  • Retirement income clients require rigorous analysis, yet risk relying more on irrelevant long-standing financial experience.
  • Effective retirement income planning requires us to effectively discuss and address their long-standing opinions.

Suggestions for Framing the Discussion

Some suggestions for more effective planning include:

  • Make fact finding  personal: Draw out and address the client’s personal experiences relating to financial risks.
  • Emphasize their feelings: Draw out how they “feel” – not just how they“think,” and address feelings with the proper solutions.
  • Emphasize income and benefits: rather than asset value and return. Drive awareness about the retirement income to help clients make informed decisions.

I would like to thank MetLife, and especially Joel L. Franks, who has been active in discussing the impact of behavioral finance throughout the organization for sharing this information.

Snap principle of applying behavioral finance to retirement income planning:

Find ways to connect with clients in ways that effectively support the important long-term decisions they need to make.

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