there is value to participants in having access to a liquid, lump-sum of wealth (e.g., for
uninsured health expenditures), then this logic would be inconsistent with then requiring
the individual to spend down this lump-sum too quickly.

Questions 29 - 32: Because | am not a legal expert, | will defer to others on the
specifics relating to fiduciary matters. However, | do wish to make two comments on
the goals of these efforts.

First, plan sponsors should not be penalized for trying to do the right thing. We
currently operate in a “backwards” environment in which plan sponsors who offer an
annuity to their participants are subject to more fiduciary risk than plan sponsors who
choose to leave their employees “on their own” by lump-summing them out of the plan.
The policy goal should be to ensure that employers are not discouraged from offering
annuities due to the actual or perceived fiduciary risk that employers take on if they
choose to offer these products.

Second, | understand the importance of ensuring that plan sponsors choose a
reasonably safe annuity provider, especially if participants are to be defaulted into an
annuity. However, it strikes me as unnecessarily burdensome on plan sponsors
(especially small plan sponsors) to require that each individual plan sponsor undertake
a full review of the long-term claims paying ability of an annuity provider. This would
also be socially inefficient in the sense that it would require tens of thousands of plan
sponsors to duplicate one another's efforts in an attempt to choose a qualified provider.
A desirable outcome would seem to be one in which plan sponsors are able to rely on
credible third-party assessments of the long-term claims paying ability of an annuity
provider.

Questions 33 — 35: A good case can be made that the ideal retirement system would
be one that is focused on the generation of secure, lifetime income during one’s
retirement years. The provision of secure lifetime income should not be treated as a
“post-retirement” issue: rather, it should be an integral part of plan design from the day
that a new participant enrolls in a plan. As such, it is vitally important that plan sponsors
have the flexibility to integrate the provision of annuities and other guaranteed income
products into the “accumulation phase” of a plan. There are many ways to do this,
including the use of annuity contracts during the accumulation phase (a practice which
is common in the 403(b) space, the integration of deferred annuity products in the menu
of portfolio options, the gradual conversion of non-annuitized assets into annuitized
assets over the participant’s lifecycle, and more. For example, one might imagine a life-
cycle fund that invests in a mix of both fixed and variable deferred annuity units in
addition to fixed and variable non-annuitized assets.

Such products have the potential to add enormous value to plan participants. As such,
it is vital that any public policy in this area be sufficiently flexible so as to encourage
innovative solutions.


innovation by the private sector. There has been tremendous innovation in this product
space just in the past 5 years, and there is every reason to suspect that innovation will
continue so long as it is not discouraged by policy.

Question 16: Any policy in this area should carefully consider the effect of annuitization
on surviving spouses. | believe it is imperative that any “default annuity” be one that
provides survivor benefits when the plan participant is married. For example, if 50% of
the account is subject to an annuitization default, then a “joint and 100% survivor” rule
might be appropriate. | discuss this issue more in this paper:

Jeffrey R. Brown. 2009. “Automatic Lifetime Income as a Path to Retirement Income
Security.” Policy paper written for the American Council of Life Insurers.
http://www.acli.com/NR/rdonlyres/E403B3C1-C827-44E5-8491-

B3C31491C3B6/21227/Automatic_ Lifetime _IncomePaper.pdf

Questions 17 — 20: As with any financial product, consumers need to be provided with
adequate disclosures to make an informed decision. Given the potentially “irreversible”
nature of some annuity contracts, it is particularly important in this context. Indeed,
some thought might be given (as | discuss in the previously cited paper) of providing a
temporary period of reversibility if individuals are to be defaulted into annuity contracts.

When disclosing information, however, | believe it is imperative that regulators not think
of annuity products as being “just another investment product.” It can be difficult —
indeed, it may even be counterproductive — to illustrate “fees” in terms of “basis points,”
given that payout differences can arise from a large number of sources, some of which
are true “fees” and some of which simply reflect the economic value of the product (e.g.,
the insurance against mortality risk, for example). In general, | believe that consumers
will be better served if disclosures are stated in terms of “monthly income differences” or
some other metric.

Questions 21 — 24: Elsewhere, | have supported the idea that quarterly benefit
statements be expressed in terms of monthly income rather than solely as account
balances (see, for example, the previously cited paper). Such an approach is a natural
extension of the academic work on “framing” that suggests that individuals are more
likely to understand the value of annuities when they are discussed in a context that
emphasizes needs rather than a context in which individuals think of annuities as
“investment” products.

Question 28: The required minimum distribution rules should be modified so that when
an individual chooses to partially annuitize their DC account balance, they participant
receives “credit” for the annual value of the annuitized distributions in every subsequent
period. Indeed, | would strongly suggest that if a default annuity program were to be
adopted that applied to 50% of the account balance, consideration be given to reducing,
or even waiving, the required minimum distribution on the remaining account balance.
After all, if the logic for not requiring annuitization of the full account balance is that


Summary:

My brief responses above barely “scratch the surface” on these topics. | would again
reiterate my willingness to discuss these any or all of these issues in more detail with
any interested party within the U.S. executive or legislative branch. | can be reached at
217-333-3322 or by email at brownjr@illinois.edu.

Thank you for the opportunity to share my thoughts on this important subject.

Sincerely,

Jeffrey R. Brown, Ph.D.

Contact Information:

Prof. Jeffrey R. Brown
University of Illinois
515 East Gregory Drive
Champaign, IL 61820
brownjr@illinois.edu


Response to “Request for Information Regarding Lifetime Income Options for
Participants and Beneficiaries in Retirement Plans”
RIN 1210-AB33

by
Prof. Jeffrey R. Brown, Ph.D.
William G. Karnes Professor of Finance, University of Illinois
Director, Center for Business and Public Policy, University of Illinois

February 23, 2010

| write in response to the request for information regarding lifetime income options for
participants and beneficiaries in defined contribution retirement plans. As background, |
have spent most of the past 15 years focused on research, policy and practice in the
area of retirement income security. | have published a wide range of articles — including
academic research papers as well as policy briefs — on annuities and other lifetime
income products. In addition to my faculty position at the University of Illinois, | serve as
associate director of the NBER Retirement Research Center. | have also worked on
issues related to retirement income security through a range of policy roles, including
serving as a senior economist at the White House Council of Economic Advisers (2001-
2002), as a staff member for the President’s Commission to Strengthen Social Security
(2001), and as a Presidential appointee to the bipartisan Social Security Advisory Board
(2006-2008). Because of my expertise in this area, | have been a consultant and/or
speaker for a large number of insurance companies and other providers of retirement
income products. | also serve as a trustee for TIAA, the largest private provider of
annuity income in the United States. While these various roles have exposed me to the
issue of retirement income security from a variety of perspectives, | should stress that
the comments | am providing in this response are mine alone, and do not necessarily
reflect the views of any of the institutions or organizations with which | currently have, or
have had in the past, an affiliation or relationship.

| applaud the Departments of Labor and Treasury for requesting information on this
important issue. As | have written extensively elsewhere, the U.S. retirement system’s
reliance on 401(k) plans and other defined contribution (DC) plans has provided a
reasonably effective means of accumulating assets for retirement. However, the current
system is woefully inadequate when it comes to providing participants with secure
retirement income. The near-exclusive focus on asset accumulation pervades the
entire retirement system, whether it is the disparity between the large number of
investment choices that the typical plan offers in the accumulation stage versus the very
limited payout options available in the same plan, or whether it is the manner in which
we communicate with employees (in terms of account balances rather than in terms of
sustainable monthly income). In order to change the retirement landscape to one in
which plan participants have adequate opportunities to convert their wealth into
guaranteed retirement income, a concerted effort is required to re-align public policy,
plan design, and participant behavior.



In total, your request for information raised 39 distinct questions. | will not attempt to
answer them all here. | will, however, refer you to existing research papers that relate
to many of these questions. | am also offering to make myself available to discuss
any/all of these questions with the relevant staff at Treasury and Labor, as well as any
other interested parties within the U.S. government.

Question 1: To briefly summarize the voluminous literature on the value of
annuitization, life annuity products are the single most efficient (i.e., least cost) way of
providing a guaranteed level of retirement income (due to the “mortality premium” that
they can provide, and annuities are a valuable form of insurance against outliving one’s
resources. The primary disadvantages of traditional annuity products are that one gives
up the right to wealth upon death (this is the source of the mortality premium), and that
standard annuity products impose liquidity constraints upon individuals because it is
difficult to borrow against future annuity income streams.

For more discussion on these issues, see Jeffrey R. Brown. “Understanding the Role of
Annuities in Retirement Planning.” NBER WP 13537 www.nber.org/papers/w13537

Most of the academic literature in this area suggests that the right balance of these
issues involves a high (but not 100%) level of annuitization. Indeed, because there are
some risks best addressed by annuitization (e.g., longevity risk), and other risks best
addressed by having liquid wealth (e.g., uninsurable shocks to one’s expenditure
needs), the optimal allocation of the typical DC plan should invoive partial annuitization
(i.e., neither zero nor full). For more discussion of the theoretical aspects of this issue,
see: Tom Davidoff, Jeffrey R. Brown, and Peter A. Diamond. “Annuities and Individual
Welfare,” The American Economic Review, Vol 95, No. 5,

Question 2: | have written extensively on these topics and | would encourage you to
read one or more of my reviews of the literature for a fuller explanation of what the
literature has to say on these topics — see, for example:

Jeffrey R. Brown. “Understanding the Role of Annuities in Retirement Planning.” NBER
Working paper 13537. www.nber.org/papers/w13537

Jeffrey R. Brown. “Financial Education and Annuities.” Policy brief written for the
OECD. www.cecd.org/dataoecd/38/0/44509379.pdf

To briefly summarize this extensive literature, there are three basic facts worth
considering. First, there are a variety of “rational” reasons that individuals may not wish
to annuitize all of their retirement wealth, including factors such as bequest motives,
standard pricing loads (arising from adverse selection or administrative costs), lack of
inflation protection, illiquidity, and more. Second, even after accounting for these
factors, most (although not all) economic and financial models still suggest that people,
on average, are annuitizing /ess than is optimal. Third, an emerging literature in
behavioral economics provides compelling evidence that the observed lack of demand
for annuities is not fully rational and indeed may be sensitive to plan design and the


manner in which products are “framed.” For example, in research that | conducted with

several co-authors, we found that simply using “consumption” oriented language instead
of the more commonly used “investment” oriented language can result in approximately

a 50 percentage point difference in the fraction of the population that believes annuities

compare favorably to other financial products.

For more information, see: Jeffrey R. Brown, Jeffrey Kling, Sendhil Mullainathan and
Marian Wrobel. “Why Don’t People Insure Late Life Consumption? A Framing
Explanation of the Under-Annuitization Puzzle.” American Economic Review, 98(2):
304-309. May 2008.

Questions 3 — 10: The key fact worth noting here is that only a small fraction of 401(k)
plans offer guaranteed lifetime income options inside the plan. While it is true that
individuals have access to a broad range of annuity products in the retail space if they
wish to access them through IRA rollovers, it should not be surprising that individuals
fail to do so. | discuss this more completely in this paper:

Jeffrey R. Brown. 2009. “Automatic Lifetime Income as a Path to Retirement Income
Security.” Policy paper written for the American Council of Life Insurers.

http://www.acli.com/NR/rdonlyres/E403B3C1-C827-44E5-8491-
B3C31491C3B6/21227/Automatic_Lifetime_IncomePaper.pdf

In this same paper, | provide a lengthy discussion of why it is important the plan sponsor
have a role to play in this process.

| believe it is very important to clarify the concept of “cost” in question 7. For example, it
is certainly true that providing inflation-indexed benefits or survivor benefits requires that
an individual pay more for the same initial dollar value of monthly benefits. However, to
refer to these products as more “costly” would be a mistake because it fails to consider
several factors. First, economists often use the concept of a “money's worth ratio” to
evaluate pricing loads because this concept considers the expected lifetime benefits
relative to the expected lifetime premiums paid. Second, even the “money's worth”
concept is incomplete because it fails to consider the risk-reducing value (i.e., the
insurance value) of the product.

Questions 11-14: | have an entire policy paper that explains why an “automatic annuity”
is a worthwhile policy idea. This paper also discusses how such a plan might be
designed. It also recommends that 50% of account balances be subject to this
automatic annuitization requirement and explains the rationale for this choice. This

paper can be found at: http:/Avww.acli.com/NR/rdonlyres/E403B3C 1-C827-44E5-8491-
B3C31491C3B6/21227/Automatic_Lifetime_IncomePaper.pdf

Question 15: There are theoretical advantages to combining annuities with other
investment and insurance products. In general, it is my view that any legislation or
regulation in this area should be sufficiently flexible so as to encourage continued