Any retirement planning must answer an impossible question: how long will live? If you overestimate your longevity, you can try unnecessarily. If you underestimate, you survive your savings.
It is not really a new problem - and yet, not a single financial product offers a satisfactory solution to this risk.
We believe that a new product - an issued by the Federal Government, pension adjusted for inflation - would allow people to deal with this problem, with the bonus to contribute to public funds. In doing good for individuals, the Federal Government could do well for itself.
The insurance industry sells an annuity of corrected for inflation which is part of the way to help people cope with the possibility of survive outliving their savings. In your years of work or retirement, you pay a premium to an insurance company in exchange for the promise that the company pay you a fixed annual income, adjusted for inflation, until you will die.
But in a world in which A.I.G. had an excellent rating, only a few days before it becomes a ward of the State, how someone - especially a teenager - know certainly insurance companies will be solvent of a half-century from now? Annuities are not guaranteed by the Federal Government. The sole reinforcement is systems based on the State and current protection limits are sometimes small. If an insurance company goes as, retirees may end up with nothing close to what has been promised.
The Federal Government can provide a product that solves this problem. People would no risk of default than that associated with the bonds and other obligations, supported by the United States.
Here's how it would work. Initially, the people who wanted to buy this insurance would be register through retirement savings plans already available to the public, such as a 401 plan called and could choose the annuity option instead of, or in addition, investments in shares, bonds or mutual funds.
How many payments would be may be based on a variety of factors, including government bonds interest rates; tables of mortality which, among other things, take into account that healthier people are more likely to buy annuities; and administrative costs. This new product will cost the Government a penny. In fact, the Treasury would be advantageous. It's only an additional move beyond bonds adjusted for inflation, which has already been by the Treasury. By allowing the Government take advantage of a new class of investors, the cost of borrowing on the whole Government would probably fall.
In addition, expanding the Government the basis of domestic investors, the plan would allow improper address on foreign lenders, who have today nearly half of all federal debts - about 10 times the proportion in 1970. It is true that the Government would be on the hook a technological breakthrough has caused an unexpected increase in life expectancy. But it is a risk that the Government is on already implicitly: i.e., a fairly dramatic increase could threaten the solvency of issuers private annuities and many pensioners who do not have pensions, creating pressure for the rescue of the Government of the insurers or individuals. Taking explicitly on the risk and the fair cost of this risk of price in annuities are a far better way.
There is also the fear that annuities issued by the Government would displace private annuity sales. On the contrary: they might stimulate growth in private pensions. Because the monthly payments adjusted for inflation on these annuities without risk would be low, many retirees may choose to supplement with more risky annuities, highest.
In addition, insurance companies could be authorized to pack annuities issued by the Government with their own products, create attractive combinations that mix of security and the potential for higher yields.
Our proposal is a winner for everyone. The Treasury could reduce borrowing costs and diversify its investors base while acknowledging and budgeting for the risk that it is already. Individuals could eliminate the risk of living too long. Looking at the promised rates of return on the pension, people will have a better sense of how much they need to save. Eunice Sanborns in the world, and all taxpayers, would rest a little easier at night.
Henry t. c. Hu is Professor at the University of Texas School of Law. Terrance Odean is Professor of finance at the University of California at Berkeley.
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