In the microeconomics literature, the
focal point is the price paid by consumers, and what matters
is the number of sellers to which consumers have access. If
there are many, the market is competitive, and the price
will be as low as production costs allow. If there is only
one seller, the market is in the hands of a monopolist who
sets a price that maximizes its revenues, which is always
substantially higher than the competitive price. Other
market structures, duopoly and oligopoly, fall in-between.
Federal anti-trust policy reflects this same focus
on the number of sellers and the probable impact on the
prices paid by consumers. When two firms seek permission to
merge, the authorities ask whether the number of firms
remaining is enough to assure continued competition.
When retirees fashion retirement plans, in
contrast, the regulations designed to protect them have
nothing to do with prices. The focus is entirely on assuring
that the retiree understands the instrument and associated
options being offered, and has made a rational decision.
This mandatory education is the major thrust of the
counseling required on HECM reverse mortgages by HUD, and
the suitability disclosures required on annuities by state
insurance regulators.
The rationale in both cases is that reverse
mortgages and annuities are extremely complicated
instruments that many retirees have difficulty
understanding, which is certainly true. The problem is that
retirees who have been required to educate themselves about
the options available on these instruments at best acquire
only limited capacity to judge which options best meet their
needs. The problems abound when multiple objectives are
involved, as is the case with annuities and reverse
mortgages.
Furthermore, the mandatory education typically
occurs after the mortgage lender or insurer has been
selected, which means that the prices they charge are not
part of the decision process. The Implicit assumption is
that the goal of preventing a bad selection based on
ignorance is more important than assuring competitive
prices.
Our position is that both objectives are attainable
using the following 5 step procedure for any given retiree:
-
Merge the annuity and the reverse mortgage into a combination instrument.
-
Identify the retiree characteristics that affect the decision process.
-
Define alternative scenarios of reverse mortgage and annuity options from which the retiree will make a selection.
-
Establish criteria for assessing the relative value of the different scenarios.
-
Find the individual lender and insurer providing the best price for the scenarios selected.
Step 1: Merging Reverse Mortgage and
Annuity
The rationale is that the combination works best as
parts of an integrated retirement plan. Within the plan, the
reverse mortgage is used both to fund the annuity and as a
source of spendable funds during the annuity deferment
period. Annuity payments begin at the end of that period.
Reverse mortgage/annuity combinations can have different
annuity deferment periods, and different ways of funding the
retiree during that period. All combinations are seamless in
that the last payment to the retiree from the reverse
mortgage matches the first annuity payment.
Step 2: Relevant Retiree Features
An illustrative retirement plan is geared for one
retiree. This is an example of the information required:
-
Age: 63
-
Sex: Male
-
Financial Assets: $1 million
-
Percent of Assets in Equities: 0%
-
House Value: $700,000
-
Mortgage Balance: $0
-
Other Income Sources: $0
Step 3: Retiree/Advisor Defines
Alternative Scenarios For Comparison
Each of the 6 scenarios shown below, as well as many others not shown, is a potential retirement plan for the retiree shown:
|
Scenario 1 |
Scenario 2 |
Scenario 3 |
Scenario 4 |
Scenario 5 |
Scenario 6 |
|
9% Expected
Return on Assets |
9% Expected
Return on Assets |
9% Expected
Return on Assets |
5% Expected
Return on Assets |
5% Expected
Return on Assets |
5% Expected
Return on Assets |
|
Worst Case
Return -3% |
Worst Case
Return 0% |
Worst Case
Return 3% |
Worst Case
Return 1% |
Worst Case
Return 2% |
Worst Case
Return 3% |
|
Set-Aside
$100,000 |
Set-Aside
$100,000 |
Set-Aside
$100,000 |
Set-Aside $0 |
Set-Aside $0 |
Set-Aside $0 |
|
Payment Draws
Fixed |
Draws
Rise 2%/year |
Draws
Inverse-U |
Payment Draws
Fixed |
Draws
Rise 2%/year |
Draws
Inverse-U |
|
Annuity Deferred
5 Years |
Annuity Deferred
10 Years |
Annuity Deferred
15 Years |
Annuity Deferred
5 Years |
Annuity Deferred
10 Years |
Annuity Deferred
15 Years |
|
No Annuity Rider |
Cash Refund
Rider |
Return of
Premium Rider |
No Annuity Rider |
Cash Refund
Rider |
Return of
Premium Rider |
|
No HECM Option |
HECM Credit Line |
HECM Term
Payment |
No HECM Option |
HECM Credit Line |
HECM Term
Payment |
Step 4: Criteria For Assessing
Scenarios
The retiree will select from among the scenarios
based on two criteria: projected future spendable funds, and
projected future estate values, over the retiree’s remaining
life in both cases. These criteria are deployed in Step 5
below.
Step 5: Select the Annuity
Provider and the Reverse Mortgage Lender Whose Price Quotes
Are the Best For the Scenario Selected
If scenario 5 is selected by the retiree, the next
step is to find the annuity provider and lender offering the
best terms. The information system on which this article is
based, which we call the Retirement Funds Integrator (RFI),
includes networks of 9 reverse mortgage lenders and 11
insurers who price any of the scenarios we deploy. The
networks allow us to select not only the best prices for a
particular scenario, but also the worst prices, which the
unwary retiree may find herself paying.
This is illustrated by the chart, which shows an
enormous difference in spendable funds between the best and
the worst prices but very little difference in estate
values. If anything, the chart understates the difference in
spendable funds because the firms in the networks know they
are being shopped.
Concluding Comment
The 5-step process described above was designed for
expository convenience but it can be conveniently collapsed
into 4 steps. RFI merges steps 3 and 5 so that the outputs
of each scenario are calculated with the best prices
available for the scenario. The upshot is that finding the
most advantageous scenario for the retiree, and finding the
most advantageous pricing for that scenario, are combined
into a single process.
