Annuities - A Troubled Solution in Search of a Problem

Years ago I'm sitting in a San Francisco coffee shop with my wife enjoying breakfast. Without trying to or really wanting to we can easily hear the conversation from a close-by table. It was two young couples. Both were well dressed, but one was decidedly more outgoing and charismatic. One might even describe them as smooth.

They were clearly on travelling together. Somehow their conversation turned to topics that drew my attention. It began innocently enough.

"Well, what are your plans?" or so went the inquiry. "Nobody wants to think about this stuff, but it is important." They were clearly talking about someone who wasn't there. 

"It is hard to know what to do."

"Look, we obviously can't know the future. But with this approach at least you have something to show for it..." Turning to her partner a little too on cue, "Remember Grandma’s experience..."

I don't remember too vividly the exact conversation--I honestly wasn't trying to listen.* It was not a simple case of a couple-friend giving friendly advice. This was a sales pitch. And they were selling the other couple on the idea of long-term care insurance, a type of annuity that has very strict terms regarding when it will be paid along with sharp limits on how much and long payment will occur. 

LTC insurance plans are not bad per se. They can work in practice; though they more frequently work in theory. While I didn't know all the relevant facts in this situation, and it was none of my business regardless, the conversation frustrated me. In fact I was offended. Why?

I was offended because they were using emotion to solve a math problem. Well, more precisely they were disguising an emotional pitch as if it were a math problem, pretending it was a math problem, and not doing or even hinting at any math! 

Presumably there would be some assumption-laden work-up presented at some point before signing on the dotted line. Let's charitably assume there was--that all we were witness to was the initial hook. Regardless, I resented both the approach and the fact that it appeared to be working.

It was a learning moment for me. As analytical as I want things to be, the truth is humans are emotion-driven beings. Many of our decisions are based on feelings. We seek social desirability and find comfort in confirmation. 

This is why confident people are charming. Especially it is so when they are selling us something. 

How you say it versus what you say--delivery versus content. They will remember how confident they were in you long after they have forgotten what you actually said. 

I remembered this story as I read this recent piece from Vanguard, Guaranteed Income: A Tricky Trade-Off. From the summary bullet points:

The math is clear. A certain income can leave retirees better prepared for an uncertain lifetime. But retirees’ reluctance to annuitize suggests that the irrevocable decision to exchange liquid wealth for guaranteed income is about more than math.**

It is not too much of an exaggeration to say that there are two types of people in the financial products industry: those who sell annuities and those who detest them. A derogatory but perhaps not unfair way of describing annuities is to say that they are never bought always sold. Another is that the primary beneficiary on a variable annuity is the sales person.

Annuities work extremely well in theory. They are straightforward instruments that spread risk and smooth income. 

In practice they are extremely complicated, notoriously misleading, and very expensive. There are exceptions. The regulations around them have improved the situation some, but I would argue strongly that this is a second-best solution behind simply allowing more competition in the industry in the first place. World-class fine dining in Napa Valley isn't because of world-class restaurant regulation. 

If you're paying attention, you'll have noticed a paradox. I started by showing that people often use emotion to sell a financial solution but then argued that emotion is keeping people from adopting those same financial solutions. But that really isn't a mystery. If people are reluctant to listen to the clear math supporting annuitizing future income, it stands to reason that emotion will be perhaps necessary to get them over the hump. 

*In fact they were so bad at attempting to be discrete that I can only assume we too were part of the sales audience.

**The Vanguard piece points to fear of regret and a strong bequest motive as the major obstacles to annuity adoption. I liked their analysis, but I don't think they sufficiently considered just how few good, honest annuity options there are. Hard to buy what isn't being sold--especially with fair options that do leave bequests. And it is harder and harder to sell them. Whether deserved or not (it is definitely deserved!), annuities have been given a bad name by all the many investment advisors who rail against them. 

Briefly Evaluating Biden’s First 100 Days

The short, short version is Gerald Ford doing a bad Jimmy Carter impersonation--with apologies to the very underrated Jimmy Carter.

I look forward to the point when the gesture politics will take a back seat to actual governing, and I hope they get religion on spending before reality forces a come to Jesus moment.

Let's do it by focusing on The Big Six.

• Drug Prohibition - Perhaps this summarizes where we are. I am shocked, SHOCKED!. We elected an OG drug prohibitionist and a bully cop, and we’re surprised that instead of legalization we got more of the same. (0/1)
• War - The administration seems to be content to continue Trump's policies on China, but the promised withdrawal from Afghanistan is potentially a significant improvement.  (0.5/2)
• Taxes - The plan so far is not too surprising, but it is still undesirable. The corporate tax increase is much much bigger once you account for the fact that Trumps reductions we’re paid for with reductions in loopholes. Going back to the prior rates without the loopholes is a big net increase on AN ENTITY THAT DOESN'T PAY TAXES! People pay taxes. When you tax corporations, the tax incidence falls on owners, employees, and customers. (0.5/3)
• Education - Biden specifically and the administration and Democratic Party generally cannot part ways from the teacher’s unions. Clearly the direction is for the government to vastly increase its role. They lost me at "12 years of [compulsory] schooling is not enough". (0.5/4)
• Immigration - Finally something we should be able to give a clear win on, but . . . it is hard to see these as anything more than better promises but very short actual results. Still, let's grade on a curve and hope for the best. (1.5/5)
• Housing Development - It appears there is hope that the Biden administration will lean toward YIMBY policies. As Republicans and many conservatives retrench deeply into antidevelopment rhetoric, the progressives may stumble into enlightenment simply by trying to be the opposite. (2.5/6)

Trade policy would be another important and interesting area given the place this issue held over the past administration. Sadly Biden hasn't changed in all these decades. He is still economically ignorant or simply a captured interest. And he looks like Trump 2.0 on China trade specifically.

Sigh***

Finding Common Ground

Lasting intellectual, legal, and cultural progress comes by working with ideological opponents rather than despite them. As good as it might make one feel to 'Yeah!' our team and 'Boo!' their team, those tribal behaviors set us back. 

That is why I am excited for the recent collaboration between strange bedfellows Ben Cohen & Jerry Greenfield and the Cato Institute scholars is Clark Neily & Jay Schweikert who are all working to end qualified immunity. 

See also Ben Cohen's book, Above the Law.

Zoning Laws Suffer From The Fixed Window Fallacy

The Fixed Window Fallacy is an error in reasoning whereby people believe they know or can know what is nice/preferred/optimal. This line of thought is based on unimaginative, linear-thinking and further held back by the Local Maximum Problem. 

It can be summarized as a thought process that goes: "We know what is best. We/they can afford what is desired (after all, it is usually for our/their own good). Therefore, we should make ourselves/them provide it." 

Both premises are false, and the conclusion is fallacious (non sequitur) as it ignores the critical questions: do we have a right to do this, and can we successfully do this? 
The only constant is change, and it comes in two types. 

1. Depreciation, which is the natural condition, difficult to counter, and mostly objective.
2. Appreciation, which is the abnormal condition, difficult to achieve, and highly subjective. 

Attempts to stop depreciation such as zoning laws are never done in a vacuum. They are not single events where good replaces bad, and we move on to the next decision. They are part of economic evolution where decisions made affect trend trajectories with uncertain net outcomes and unpredictable magnitudes. 

Similarly collective action attempts to realize appreciation such as subsidizes for development and master plans are fraught with captured interest risk bringing asymmetric outcomes adverse to the presumed collective goal. In other words the rent-seeking developers and their friends in power do what is good for them and costly for society. For those cases where everyone has the best of intentions, we still have the knowledge problem. When artificial outcomes are engineered by those who do not bear the full risk, bad ideas do not get properly punished and good ideas do not get properly rewarded. 

Back to zoning, trying to stop people from doing things they want to do is prohibition. People and markets work to thwart prohibitions in proportion to how much they desire that which is prohibited. The less morally sound the prohibition, the less compliant are those working against it and those third parties who have no dog in the fight. Fortunately the long-term trend is for less and less prohibition. Unfortunately working against a prohibition is costly as is the administration of a prohibition. 

Whether it is in icky markets (e.g., sex work, recreational drugs deemed illicit, kidney transplants, etc.) or in we-know-better markets (e.g., zoning), an underlying force supporting the prohibition is not in my backyard thinking. In fact I believe NIMBY is the last vestige of prohibition rationalization.

An Addition to My The Big Five

I hate having to do this, but I feel it is necessary to add to my list of the low-hanging fruit of public policy where 90% solutions (improvements) on these issues are several orders of magnitude more important than 99% solutions on a thousand others. In my defense this was always filed under "partial list", and it continues to be. I just hate making a tag and then needing to update it. 

Keep in mind that I did issue addendums to the list shortly after first publication. This will take one of those and elevate it to the new big list.

The Big Six:

• Drug Prohibition (end it--allow adults to make their own choices)
• Education (privatize it--give the government an ever-smaller role)
• Immigration (open it up--allow people to freely move and freely interact with other people)
• Taxation (simplify and redirect it--efficiently tax the use of resources not the creation of resources)
• War (move away from it--make postures less bellicose and violence less of an option).
• ***AND*** Housing Development (greatly reduce the obstacles and restrictions so that the owners of capital can buy, build, and reconfigure real estate as they see fit)

First because of Kevin Erdmann's work and recently because of Bryan Caplan's current discussion and forthcoming work, I have become radicalized to make this addition to my reform agenda canon. 

Living in a historic district with all its well-intended nonsense, I see this issue close at hand. The HD seems to be a classic case of people being nostalgic for a past that didn’t actually exist. The effect is expense for homeowners, self-righteous satisfaction for busybodies, a jobs program for the rent-seeking suppliers and regulators, and general exclusion for those who don’t fit in or can’t afford to. 

Every day I see stark examples of the perfect being the enemy of the good. 

The Local Maximum Problem

Ever since being introduced to this concept, I’ve been intrigued by it and see examples of it more and more throughout life, business, and public policy. This is the problem that occurs when people get stuck in a situation that is the best near-term or near-possible outcome but is not the best possible yet reasonable long-term outcome. 

The analogy is to imagine four people playing a game that has them blindfolded and linked arm-in-arm in a square configuration. Each member of this team is responsible for one of the cardinal directions (north, south, east, and west). Their goal is to locate the highest point possible. They experiment by taking steps to see if a step in that direction is up or down. If the step is down, they don’t take it. If the step is up, they take it. They keep walking until none of the four can make a step that is in the upward direction. This point is the conclusion of their game by reaching the local maximum. However it is most likely not the highest point on the surface where they’re walking. They just can’t reach (or detect) a higher point by virtue of their own rules. 

I believe governments are particularly susceptible to this problem. The rewards for experimentation that drive one out of a local maximum are very dispersed or completely irrelevant to those bearing the costs of experimentation. This is more than just people not wanting their cheese moved or having their apple cart disrupted. This is the very legitimate concern that an ambitious idea is going to have significant negative outcomes or the potential rewards will not accrue to those bearing the risk. It is an acute combination of asymmetric risk-reward and principal-agent problems.

The many, many public and private failures in the COVID pandemic are vivid examples. Perhaps the most costly in the United States were the CDC and FDA's insistence on using their own developed testing (staying with the controllable and familiar) and as important if not more so the refusal to allow challenge trials to speed the vaccine development process. Sadly this list goes on and on from "pausing" the Johnson & Johnson vaccine to not approving AstraZeneca's. 

The position those in power have taken are understandable but completely inexcusable. And we have ourselves to blame as these mistakes are just the latest examples of how the FDA works against medical advancement and is a deep net cost to society. 

To be sure individuals, firms, and other organizations are also susceptible to the LMP. Notice, though, the degree to which these entities are somewhat or greatly better structured and incentivized to resist and correct it.  

As a general rule, the more insulated and protected an entity is from competition, the more vulnerable they are to a local maximum. Hence, traditional banks are more vulnerable than are start-up fintech firms. 

To whom a firm or organization is held responsive has strong implications for its fragility to local maximums. As a firm is more responsive to those who reap rewards proportional to risk taken, it will better prevent the LMP. Hence, non-profits (highly responsive to donors rather than customers) are more at risk than are profit-seeking firms (highly responsive to owners and customers). 

Within a firm the dominant force becomes existing and entrenched stakeholders who are in comfortable, conventional positions. Hence, no one in marketing will ever suggest the firm experiment by not running ads. 

The degree to which a person faces public scrutiny or cannot capitalize on public adoration, the more they will rest once finding the local maximum. Hence, a public figure with a lot to lose/little to gain will tend to play it safe. 

Risk bearing requires compensation in the form of return, and this risk-return should be commensurate, symmetrical, and willfully accepted. Those are tough hurdles to achieve. All the more so when we are relying on force rather than persuasion. 

P.S. I believe Arnold Kling deserves credit for introducing me to this concept.

Winkler's Wager

Let me state upfront I know that for the most part (if at all) I am not breaking new ground here. 

Are we all basically agnostic? Or all basically believers? How much of the rejection of belief (disbelief) is just a rejection of the behavior and style and beliefs of individuals or institutions the nonbeliever (believer) finds amiss or reprehensible or simply unconvincing? 

Years ago in thinking about this topic and in preparation for this blog post specifically I polled two friends. These are each very thoughtful, highly intelligent people. One is correctly described as a strong believer in God. One is correctly described as a strong disbeliever. Separately I asked them simply "What is the probability God exists?" leaving it fairly open ended for their own interpretation. Both of these people know how probability works and why 100% and 0% are bad answers. 

The believer stated that he wanted to say 100%, knew that was technically impossible, knew that faith might be a reason to actually make it legitimate, but settled on 90% (all of this recollection conditional on if memory serves; it was 5 years ago). He gave a good explanation for his thinking to support the answer.

The disbeliever answered via email, so I have his response. After sleeping on it, he answered 20% with a thorough account of his reasoning. 

I don't want to make this about their specific answers. This was just an experiment regarding my prediction about what they would say and why they would say it. Why I completely understood what they said and why they said it (it basically matched my prediction as well), I do not feel fully compelled by either. 

Similarly, I ran this twitter poll recently:

Probability a supernatural being(s) (aka, God) exists?

— Steve Winkler (@swinkler78) March 6, 2021

Obviously, this was not a meaningful sample size. But that isn't the point as much as the split among the choices I presented gives some indication that I think resembles how people tend to think about this.

Faith = ???... belief in the face of doubt? That definition would imply that 100% and 0% are not legitimate answers. Doubt seems essential for faith to have meaning. And the existence of doubt pushes one toward the unsatisfactory middle point of 50/50.

I think this is more easily seen in the case of a believer. But it is true at the antithesis as well. Atheism (certainty there is no God) is a faith by the atheists' own definition--one cannot prove a negative (e.g., there is no God); therefore, atheism cannot be scientifically proven. 

Ask a believer and a disbeliever this question: What it would take for them to reverse their view? This leads me to believe all in this debate are "believers" ultimately. And yes I know the problems with this over simplicity.

To the point of many in the atheist community, a point Penn Jillette makes in this piece, no one is really agnostic. A person always will find a way to dismiss evidence or argument offered against the view they hold in their heart of hearts. 

I think this gets to the crux of the question. The right answer is perhaps +/-50% with faith in God or faith in not God (something beyond the material realm) pushing one off of this center point of pure agnosticism toward one of the two faiths. The existence of God is a non-falsifiable conjecture; therefore, using science or reasoning to "prove" either the existence or the nonexistence of God is futile and fallacious thinking. 

Can we at least point to arguments to guide our judgments on God's existence? It would seem this is quite hard beyond simply an exercise in persuasion for those already tempted to be on the same side of the argument--we can never change the minds of those on the other side. Yet, minds do change and in both directions. The links in the P.S. sections allude to this.

So much of this ageless debate is people talking past one another. Adjacent to this is the determinism versus free will debate. Usually there is confusion on the part of those arguing for free will between determinism and fatalism, and usually there is confusion on the part of those arguing for determinism between free will and randomness. 

Sam Harris makes a strong case for determinism but only on the back of a reductivism I don't think can be denied--yes, there are always causes . . . it is cause and effect all the way down. Yet this basically amounts to a tautology that avoids the important parts of the question. Can we hold ourselves and others responsible for actions taken? What does it mean to choose? To act? To fail to act? 

I am a dualist on the issue. When I play pool, my choice of where to aim the cue ball and how to hit it are my free will, the resulting actions of the balls on the table are pure determinism. The determinist would entreat, "Is it not just a higher order of underlying causes that lead you to 'chose freely' how to strike the cue'?" My answer is "Yes, of course, and that isn't interesting for the matter at hand." Daniel Dennett says it better. 

Similarly, believers in God and disbelievers in God tend to talk past one another. They mischaracterize the other side's position and misunderstand what the other side means. This is not helped by how poorly the believers tend to understand their own position or how dismissively the disbelievers tend to assume past the implications of their own position. Believers wish to put God in a box and disbelievers live out the story of the Apostle Thomas. Taken to logical ends most believers' understanding of God can be disproven and most disbelievers' reasoning forces them to reject all knowledge and facts about the world. Experiments to this end: 

1. Ask a believer to convince you that their belief is genuine as opposed to something that makes them feel good.
2. Ask a disbeliever to explain why their expectation that their car will get them to work tomorrow morning is not predicated on faith or many small faiths they themselves cannot prove. 

Each will often struggle: In the first case because it is hard for a believer to identify a reason for faith beyond a desire for faith; In the second case because most people do not know how an automobile works and the existence of the future is continually theoretical--I'll prove tomorrow exists . . . tomorrow.

We should not depend on the ill-equipped be the strawmen foils for our favored positions. 

Consider my work as a practitioner within the investment management profession. My most sophisticated client would find the way I explain my job to my young children and the way my young children understand what I do to be quite unimpressive and perhaps even unattractive. That doesn't invalidate the philosophies I hold or the method I employ or the track record I've achieved professionally. Likewise part of what I do and any successes or failures associated with it might be simply due to luck. My efforts and explanations are at least to some degree counterproductive, irrelevant, and orthogonal to their associated outcomes. My shortcomings, imperfections, and activities themselves within financial money management neither prove nor deny the existence of financial money management.

Perhaps the most challenging part for believers is to separate God from being simply a personification of truth, love, and perfection. 

Perhaps the most challenging part for disbelievers is to build a foundation of truth (moral, mathematical, and physical) without the identification of God as this foundation. 

Both sides accuse the other of shortcuts for the sake of certitude. Both sides make the mistake of looking to religious texts as scientific works. If you do this, you are gravely missing the point. Newtonian/Einsteinian physics can't speak to ethics or morality. Likewise, the Bible, et al. are not going to serve your quest for scientific truth. 

Along the journey of building this post over the past few years these fellow travelers were helpful: 

Tyler Cowen considered similar questions, Ross Douthat weighed in quite awesomely, and Think Again – a Big Think Podcast (125. Reza Aslan (author) – Deus Ex Hominem. 

Related: A little footnote on the population of "atheists", What is Robin Hanson's kind of atheist?, and Philosopher John Gray discussed the Seven Types of Atheism with Russ Roberts on EconTalk. 

Here is another very good, related conversation.

From this comes this insightful item: “Religion has nothing to fear from science, and science need not be afraid of religion. Religion claims to interpret the word of God, and science to reveal the laws of God. The interpreters may blunder, but truths are immutable, eternal and never in conflict.” If I could be so bold, I would like to add a corollary. Faith and religion are very poor at discovering and developing legislation to govern society and scientific facts to explain the universe and world around us. Faith and religion are very well-suited for the discovery of righteous first principles and guideposts for how to love and live among one another. Likewise science cannot teach us right from wrong but can teach us true from false.

P.S. Is God math?

And

https://fakenous.net/?p=1863

https://fakenous.net/?p=1649

https://fakenous.net/?p=1909

https://fakenous.net/?p=1929

https://fakenous.net/?p=1937

P.P.S. How should a Christian Bayesian react to the Mayans, et al? Should they heavily discount the evidence and slightly shift their prior or slightly discount the evidence and heavily shift their prior? Is this question a risk of confirmation bias?

P.P.P.S. I avoided the heresy of an adjacent issue: that perhaps believers of all types (Christians, Muslims, Buddhists, ... Mathematicians?, Universists? ("let the Universe decide..."), et al.) are all yearning and seeking to follow the same ultimate God.