Philosopher and economist Adam Smith, whose statue is near St. Giles Cathedral in Edinburgh, Scotland, participated in an early group longevity pool.ewg3D/iStockPhoto / Getty Images
The Scottish Enlightenment offers lessons for advisors and investors about retirement income planning.
For his latest book, The Religious Roots of Longevity Risk Sharing: The Genesis of Annuity Funds in the Scottish Enlightenment and the Path to Modern Pension Management, Moshe Arye Milevsky researched how seniors supported themselves in old age before modern state and corporate pensions were implemented.
Mr. Milevsky, professor of finance at the Schulich School of Business at York University in Toronto and chief retirement architect at Guardian Capital, argues that 18th century consumers were relatively more financially literate than investors in the 21st century as it appears they weighed the few economic options available to them more carefully.
Today, the evidence suggests many consumers, and especially employees, stick to the recommended “default” option for their savings and pensions without considering if the choice makes sense for their circumstances.
Globe Advisor spoke with Mr. Milevsky recently.
How old are annuities?
Stand-alone pension annuities have been offered for millennia, but in 1745, the Scottish Presbyterian Church made the first successful attempt to pool them together and thus hedge longevity risk. The key idea with a life annuity is you’re in a large pool with diverse people, which means somebody is subsidizing somebody else, but we don’t know who until the very end.
One of your findings was that Scottish economist and philosopher Adam Smith was an early participant in a group annuity pool.
Yes, to me, that was the big surprise, stumbling on his name in the archival documents in Edinburgh. I was going through the names of hundreds of participants when I came across Professor Adam Smith at Glasgow University. Interestingly, he never married, which means the reversionary annuity for his non-existent wife was a bad investment. But as a youngster, he thought this was a good investment, so he allocated and invested the maximum allowed. This find led me to some of Smith’s insights on longevity risk and annuities. The Presbyterian church designed and launched the plan, but university professors such as Mr. Smith petitioned to join the annuity fund. It was that good.
What are some lessons from that very first successful longevity risk pool?
My view is that historical success wasn’t because they had brilliant mathematicians or actuaries on staff, or because they brought together a large enough group of individuals to diversify longevity risk. Rather, the key secret ingredient was management as well as communal and religious solidarity.
There was the shared outlook that everyone in the longevity risk pool was in this together. They knew and understood that in risk pools, some win and some lose. They all accepted it because they felt a sense of kinship with each other, a sense of camaraderie. The religious church structure generated that affinity.
That’s one of the important insights from this early history. When you extrapolate it to the 21st century, we’re losing much of that kinship in very large pension pools with millions of strangers. I think longevity risk pooling will collapse when participants realize in advance exactly who wins and who loses – and kinship is absent.
When, in your opinion, does an annuity make sense for an investor today?
If, for example, you’re a retired federal employee, a teacher or have a partner who is part of a defined-benefit pension plan, then you might not need more annuity income or longevity risk pooling. But if you have an RRSP, which is converted to a RRIF, or other taxable retirement fund and are trying to make it last for the rest of your life, you might want to participate in a longevity risk pool or buy a life annuity.
This interview has been edited and condensed.
– Deanne Gage, Globe Advisor reporter
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