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April 28, 2010

To: Office of Regulations and Interpretations

Employee Benefits Security Administration

U.S. Department of Labor, Room N‐5655

200 Constitution Avenue, N.W.

Washington D.C. 20210, USA

ATTENTION: Lifetime Income RFI ‐ RIN: 1210‐AB33

We the undersigned are all researchers in the fields of finance, actuarial science, insurance and

mathematics and have individually and collectively published over a dozen peer‐reviewed research

studies on the topic of annuities as it related to “lifetime income.” We would therefore like to take this

opportunity to respond to the Request for Information RIN 1210‐AB33, Request for Information

Regarding Lifetime Income Options for Participants and Beneficiaries in Retirement Plans issued on

February 2, 2010.

Given the extensive nature of the RFI and the rather narrow area of our expertise we have decided to

respond to only a subset of the questions. This document provides our responses to the questions for

which we feel best able to comment. We have also provided references to our relevant research at the

end of our submission.

[1.] From the standpoint of plan participants, what are the advantages and disadvantages for

participants of receiving some or all of their benefits in the form of lifetime payments?

The fundamental benefit of receiving lifetime income is that longevity risk is pooled across participants –

and thus income for surviving participants is subsidized by assets from participants who die, giving rise

to what actuaries call “mortality credits”.

This basic benefit increases as longevity risk increases. That is, for a given population, the greater the

uncertainty with respect to longevity – i.e., the greater the difference in time between the earliest and

latest expected death dates – the greater is the benefit from pooling longevity risk.  

The sharing or pooling of longevity risk is fundamentally the only reason that lifetime income has any

economic value or financial benefit to the retiree. Accordingly, in our view it is extremely important to

emphasize and make clear that (theoretically) if all members of a retirement group lived for the same or

very similar amounts of time – or conversely if everyone demanded guaranteed payments for 30 or 40

years regardless of survivorship status  ‐‐ there would be little if any benefit to lifetime income (i.e.,

annuitization). We believe that the concept of lifetime income is inseparable from pooling of longevity

risk.  

Of course the flip‐side or downside of longevity risk pooling is the need to make this pool irreversible to

avoid moral hazard (i.e., to ensure people who are on the verge of death do not remove themselves

from the pool).   

There are additional benefits to lifetime income which are not directly related to longevity risk. True

lifetime income provides a guaranteed long‐term yield, longer than any investment will give. Mortality
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credits, as mentioned above, ensure that the yield from lifetime income exceeds the yield from

comparable investments. Additionally, lifetime income typically is received automatically by the

recipient, which allows participants to put this part of their finances “on autopilot.” Finally, depending

on how the income is structured, the cash flow pattern can be adjusted to accommodate any desired

income profile, including cost of living adjustments and inflation protection.

The disadvantages of lifetime income options include the lack of flexibility (lifetime income typically

cannot be “cashed out” by the participant but instead involves total or near‐total loss of liquidity) and

the lack of inflation protection (although inflation‐indexed and cost‐of‐living‐indexed options are

available, they are relatively rare and expensive).  

[2.] ...Are there steps that the Agencies could or should take to overcome at least some of the concerns

that keep plan participants from requesting or electing lifetime income?

It should be noted that the lack of flexibility and inflation protection inherent in most lifetime income

plans (and as mentioned above) are legitimate reasons for people to opt against lifetime income options

and instead attempting to self‐annuitize.

However, people may opt against annuitization for other, not‐so‐legitimate reasons. We suspect that

the main reason people do not annuitize, or opt against lifetime income, is that they lack understanding

of annuities. People may feel they can get higher yields elsewhere, not taking into account the

guaranteed and long‐term nature of the annuity yield. Some – even many – potential annuitants may

feel that with annuities their money is being “stolen” from them when they die.

Accordingly, we feel that the most important steps the Agencies could take include doing a better job of

explaining the value of lifetime income and the risks of self‐annuitization. Perhaps the best place to start

is by ensuring the concept of longevity risk is better understood by the retiring public.

In addition, perhaps, instead of “annuitization,” a move could be made to adopt the term

“pensionization” – so that the odious A‐word is avoided.

Another step the agency could take to encourage lifetime income would be to make it easier for plan

sponsors to offer pure longevity insurance in the form of deferred annuities that are accumulated slowly

over time, and provide a lifetime income benefit starting at some advanced age (say 85) assuming the

individual retiree is still alive. Thus, for example, a plan participant would be encouraged to allocate

0.05$ of every dollar they contribute (save, invest) into a longevity pool/fund that would entitle them to

a lifetime benefit of $1 starting at age 85. Obviously the pricing itself would depend on market

conditions and economic other factors, but the main idea is that for a very small amount of money –

paid over a long period of time with no survivor benefits – the retiree would protected against longevity

risk. This, of course, is the spirit of a Defined Benefit (DB) pension.

[7.] What product features have a significant impact on the cost of providing lifetime income or other

arrangements designed to provide a stream of income after retirement, such as features that provide

participants with the...option of accelerating distributions if needed?

Any options which provide other than straight lifetime income “water down” the mortality credits and

thus the overall strength and rationale for lifetime income options.  
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The ability to reverse, refund, cash‐out and receive payments even after death negatively impacts the

cost of lifetime income options by driving prices higher and monthly payout amounts lower.  

[12.] How should participants determine what portion (if any) of their account balance to annuitize?

Should the portion be based on basic or necessary expenses in retirement?

The optimal or “right” portion of a retirement account balance to annuitize will depend on the

participant’s bequest motive versus his or her desired for guaranteed lifetime income. At a basic level,

however, we believe that the absolutely required expenses in retirement should annuitized.  

The decision to annuitize any amounts above this basic bottom line depends on whether the participant

wants to maximize legacy or sustainability. Indeed, just like there is no universal risk/return point of the

efficient frontier that it optimal for everyone, the same applied to the tradeoff between bequest and

sustainability.

For every retiree, higher lifetime income comes at the cost of a lower expected bequest amount. This

tradeoff should be explained carefully, just like the tradeoff between risk and return in the accumulation

phase. Models that illustrate this specific tradeoff would be useful.

[13.] Should some form of lifetime income distribution option be required for defined contribution

plans...? If so, should that option be the default distribution option, and should it apply to the entire

balance?

As touched on above, it is difficult to justify full annuitization of a retirement account balance, especially

given the existence of pre‐existing annuities in the form of Social Security. We are not in favor of

mandatory full annuitization, but rather believe that every plan should be required to offer options

(possibly with a “safe harbor” provision) so that retirees have the ability to acquire lifetime income

products with group pricing, favorable rates and with the understanding that employers will explain the

mechanics to employees. We also believe that requiring full (or even 50%) annuitization would be

negatively viewed by many, if not most, plan participants, even if this was only a default option.

No matter what range of options is offered, we believe it would be worthwhile to require plans to

educate participants about their choices in a way that is similar to the education 401(k) investors are

provided about their investment options.  

[17.] What information (e.g. fees, risks, etc.) do plan participants need to make informed decisions

regarding whether to select lifetime income or other arrangements designed to provide a stream of

income after retirement?

Plan participants need two basic sets of information in order to make informed decisions:

First, they should be able to compare the income from a pure life‐only annuity to the income from

whatever other option(s) are available. Plan participants should be provided with expected payouts

from all available options. To this end some sort of “lifetime income index” would help participants and

plan sponsor gauge the relative value from various options.

Secondly, they need to be able to consider how long they are likely to live, and to do that, they should

have some idea of the state of their health. Models or tools which allow for discussion and appreciation

of longevity risk should be made available to plan participants.  
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[20.] To what extent should plans be encouraged to provide or promote education about the

advantages and disadvantages of lifetime annuities...?

We believe that educating prospective annuitants about the advantages and disadvantages of lifetime

annuities is very important and should be promoted and emphasized in all future discussions of this

issue.  

We further suggest that employers and plan promoters should be encouraged (“nudged”) to educate

prospective plan participants by the development of guidelines on how to fulfill this without incurring

any legal risk on the part of employers and plan sponsors.

[21] Should an individual benefit statement present the participant’s accrued benefits as a lifetime

income stream of payments in addition to presenting the benefits as an account balance?

Yes. Participants should be able to VALUE their holdings across two dimensions: expected monthly

lifetime income and current account balance. As interest rates change and mortality tables are revised

the lifetime income stream would change to reflect this, even if the account balance has remained

relatively constant.

[22] If the answer to question 21 is yes, how should a lifetime stream of income payments be

expressed on the benefit statement?

The most useful information would be monthly payments projected at a future retirement age. The plan

probably would need to employ an impartial (third party) service to ensure the numbers were fair and

appropriate (perhaps based on PBGC interest rates.)  

Monthly payments should be shown from as a single life annuity, a joint and last survivor annuity, and

possibly also with a guaranteed period (say 10 years). In fact, providing estimates for the last two

options is likely more important than providing single life annuity estimates, as most people do not

choose the straight life annuity.  

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In conclusion, we appreciate the opportunity to respond to this RFI. Please feel free to contact us

(collectively or individually) at The IFID Centre, 222 College Street, Toronto, Ontario, M5T 3J1.

Moshe A. Milevsky, Ph.D., Associate Professor of Finance, York University, Toronto

Kristen Moore, Ph.D., Associate Professor of Mathematics, University of Michigan

S. David Promislow, Ph.D., Professor Emeritus of Mathematics, York University, Toronto

Virginia Young, Ph.D., Professor of Mathematics, University of Mathematics

   
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References:

[R1] “Do Markets Like Frozen DB Pension Plans? An Event Study” (M.A. Milevsky with K. Song), Journal

of Risk and Insurance, forthcoming 2010

[R2] “Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Life Annuities”

(M.A. Milevsky with V. Young, D. Promislow and E. Bayraktar), Journal of Economic Dynamics and

Control, Vol. 33(3), March 2009, pg. 676‐691.

[R3] “Portfolio Choice with Puts: Evidence from Variable Annuities” (M.A. Milevsky with V. Kyrychenko),

Financial Analysts Journal, May/June 2008, Volume 64(2), pg. 1‐30

[R4] “Asset Allocation and Annuitization” (M.A. Milevsky with V.R. Young), Journal of Economic

Dynamics and Control, Volume 31, Issue 9, September 2007, Pg. 3138‐3177. Erratum published in Vol.

32(11), pg. 3743‐4744.

[R5] “The Timing of Annuitization, Investment Dominance and Mortality Risk” (M.A. Milevsky with V.R.

Young), Insurance: Mathematics and Economics, January 2007, Vol. 40(1), pg. 135‐144.

[R6] “Asset Allocation and Annuity Purchase Strategies to Minimize the Probability of Financial Ruin”

(M.A. Milevsky with V.R. Young and K. Moore), Mathematical Finance, October 2006 Vol. 16(4), pg. 647‐

671.

[R7] “Financial Valuation of Guaranteed Minimum Withdrawal Benefits” (M.A. Milevsky with T.

Salisbury), Insurance: Mathematics and Economics, February 2006, Vol. 38(1), pg. 21‐38.

[R8] “Advanced Life Delayed Annuities: Pure Longevity Insurance with Deductibles” (M.A. Milevsky),

North American Actuarial Journal, October 2005, Vol. 9(4), pg. 109‐122.

[R9] “Florida’s Pension Election: From DB to DC and Back” (M.A. Milevsky with S. D. Promislow), Journal

of Risk and Insurance, 2004 Vol. 74(3), pg. 381‐404.

[R10] “Asset Allocation and the Liquidity Premium for Illiquid Annuities” (M.A. Milevsky with S. Browne,

and T. S. Salisbury), Journal of Risk and Insurance, 2003 Vol. 70(3), pg. 509‐526.

[R11]  “Variable Annuities vs. Mutual Funds: A Monte Carlo Analysis of the Options”, (M.A. Milevsky with

K. Panyagometh), Financial Services Review, Vol. 10, 2002, pg. 145‐162.

[R12] “Asset Allocation in Variable Annuities: A Note”, (M.A. Milevsky with N. Charupat), Insurance:

Mathematics and Economics, Vol. 30(2), April 2002, pg. 199‐210.

[R13] “Mortality Derivatives and the Option to Annuitize”, (M.A. Milevsky with S.D. Promislow),

Insurance: Mathematics and Economics, Vol. 29, December 2001, pg. 299‐318

[R14] “Optimal Annuitization Policies: Analysis of the Options” (M.A. Milevsky), North American

Actuarial Journal, Vol. 5(1), January 2001, pg. 57‐69.
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[R15] “Self‐Annuitization and Ruin in Retirement”, (M.A. Milevsky with C. Robinson), North American

Actuarial Journal, Vol. 4(4), October 2000, pg. 112‐129.

[R16] “Optimal Asset Allocation Towards the End of the Life Cycle: To Annuitize or Not to Annuitize?”

(M.A. Milevsky), Journal of Risk and Insurance,  Vol. 65(3), September 1998, pg. 401‐426.