Annuities

[moda0306]

Anyone in here feel that they'd like to annuitize some of their wealth?  If I can confidently yield 7% instead of 3.5% (or whatever you think is safe) in income off of an asset, I'm thinking a portion of your portfolio in annuities is not a bad idea.

I love the PP, but I'd be afraid to count on taking 7% off the thing every year!

[Ad Orientem]

With interest rates and (official) inflation rates at or near historic lows I am not tempted by annuities. Not even a little.

[dualstow]

I would only buy an annuity if someone handed me $1 million in addition to what I already have.

[moda0306]

You could lock in your mortality by buying a Variable annuity today without locking in the interest rate assumption at annuitization.  At annuitization you could then use prevailing interest rates to lock in income.

Just a thought.

[WildAboutHarry]

I am getting close enough to retirement that I am considering how to make assets align with anticipated future spending.  It is fascinating for a number of reasons.  Tax optimization, social security strategies, required minimum distributions.  All fun stuff.  If you like complex Excel spreadsheets.

I am thinking that, depending on health, account balances, etc. that a single-premium immediate annuity for a portion of available assets at a later age (e.g. 80) might make sense.  And if I don't make it that far then I won't have to make that decision.

[moda0306]

Some insurance companies will let you lock in your mortality table for any amount of future investment within in annuity simply by investing the first $5,000 in a Variable Annuity.

So for $5,000 in something you may have not wanted to buy, you could be locking in a huge amount of money later on into a more preferential mortality table.  Sounds like something to consider.

I wonder if you can do a PP (or at leas the stock portion of it pretty easily) in a Variable Annuity...

[notsheigetz]

When I got a lump sum payout from a discontinued pension plan a couple of years ago I sat down with someone to discuss an annuity. The thing was so damn complicated the person presenting it to me had to finally admit he didn't understand it either but he'd have me sit down with somebody who could explain it better. I passed.

It didn't sound nearly as simple as a 7% guaranteed annual yield to me but assuming they can do that, I can't help but wonder how. Guaranteeing 7% feels like a risky business to me and they aren't FDIC insured so if they don't have good stock pickers and market timers what is going to happen to your annuity if they don't beat the market?

[craigr]

Annuities have a lot of options and risks. If someone were considering using them I would research the issue carefully and definitely use multiple providers to diversify against company risk. They may make sense for some investors, especially if they think they will not be able to mange their investments into old age and want to lock in an income stream.

[D1984]

Some insurance companies will let you lock in your mortality table for any amount of future investment within in annuity simply by investing the first $5,000 in a Variable Annuity.

So for $5,000 in something you may have not wanted to buy, you could be locking in a huge amount of money later on into a more preferential mortality table.  Sounds like something to consider.

I wonder if you can do a PP (or at leas the stock portion of it pretty easily) in a Variable Annuity...

Moda,

Two issues:

One, TIAA-CREF and Vanguard have no-load VAs but I don't think one could do a PP in them because although they have decent options for stocks (S&P 500 fund) and cash (fixed account or MM account...at least the TIAA one has this; not sure about Vanguard) neither has much of anything for LTTs or gold. Vanguard does offer a guaranteed distribution rider on its VA (TIAA may or may not; I haven't checked) but both of these VAs are in the main targeted as tax-sheltered accumulation products rather than income vehicles so I'd presume one would convert either of them to a SPIA for income which makes the rider almost pointless.

There may be some loaded (commissionable and with surrender charges) variable annuities that have decent options for the gold and LTT portion of the PP but I would typically avoid loaded/commissioned products (unless working with an hourly fee only advisor who rebates all commissions) out of principle so I don't know what's available in this area.

Two, when it comes down to income from annuities, wouldn't locking in a mortality rate when one is younger (and presumably healthier) defeat the purpose? My understanding (and I admit I could be wrong) was that locking in a preferred or preferred plus mortality rating was great for life insurance (cheaper COI) but would be exactly 180 degrees from what you wanted in an annuity.....for income purposes during the payout phase, wouldn't you want to seem to the company's underwriters that you had one foot in the grave and the other on a banana peel (the shorter the mortality table says that-actuarially speaking-you are likely to live the bigger mortality credits you get)? In other words, wouldn't you want to seem just the opposite healthwise when applying for an annuity as you would when applying for life insurance?

[D1984]

When I got a lump sum payout from a discontinued pension plan a couple of years ago I sat down with someone to discuss an annuity. The thing was so damn complicated the person presenting it to me had to finally admit he didn't understand it either but he'd have me sit down with somebody who could explain it better. I passed.

It didn't sound nearly as simple as a 7% guaranteed annual yield to me but assuming they can do that, I can't help but wonder how. Guaranteeing 7% feels like a risky business to me and they aren't FDIC insured so if they don't have good stock pickers and market timers what is going to happen to your annuity if they don't beat the market?

Notsheigetz,

Was this actually a guaranteed 7% annually on the cash account withdrawal amount (the amount-minus any applicable surrender charges-you could surrender the annuity and cash it out for) or just a guaranteed 7% on the "distribution amount" (a phantom amount that cannot actually be withdrawn but that a GLWB/GIB would be based on)? If the latter, it sounds like an FIA and something that you were smart to pass on. How long ago was this offered? I vaguely recall fixed annuities actually offering 7% on the actual cash account but that was back in 2000-2001...chances are if you saw a 7 or 8% offer any time recently it was on the GLWB/GIB "roll-up" amount that can't actually be withdrawn (or else it was only 7% for the first year and the six point font fine print on page five million or so of the contract said that the insurance company could lower it to 0.1% for the next nine years with no recourse on your part).

[moda0306]

D1984,

Life insurance tests for insurability and price accordingly... annuities do not.

So with life insurance, you would buy more than you need when you're young and healthy because you want to lock in a good health rating, mortality being (maybe) something you actually lose on if people live older.  However, you could lose on the health rating MUCH faster than your likely loss on mortality.

With an annuity, "locking in mortality" means that the insurance company thinks you'll die at 78 today, but decades later the mortality tables will have you dying at 84... This means you'll get a higher income at annuitization.  Of course, that's if people are living longer then.  Nice thing is, with some VA's, you get that option with a small initial investment.

[D1984]

D1984,

Life insurance tests for insurability and price accordingly... annuities do not.

So with life insurance, you would buy more than you need when you're young and healthy because you want to lock in a good health rating, mortality being (maybe) something you actually lose on if people live older.  However, you could lose on the health rating MUCH faster than your likely loss on mortality.

With an annuity, "locking in mortality" means that the insurance company thinks you'll die at 78 today, but decades later the mortality tables will have you dying at 84... This means you'll get a higher income at annuitization.  Of course, that's if people are living longer then.  Nice thing is, with some VA's, you get that option with a small initial investment.

Thanks for clearing that up. I would like to add that some annuities (SPIA's as far as I know although there may be some VAs that do this as well) are in fact priced according to mortality risk...Google "medically underitten annuity", medically rated annuity", or "impaired risk annuity"

Also, do you mean that someone could invest, say, $5,000 in one of these VAs and then if life expectancy DID go up dramatically they could deposit, say, another $250,000 into the annuity right before they annuitized (at the old mortality table rating)? If that is the case, isn't the insurance company playing a risky no-win game of "heads we lose, tails you win"? Surely the mortality guarantee only applies on the original deposited amount.

[AgAuMoney]

It didn't sound nearly as simple as a 7% guaranteed annual yield to me

An annuity never is.

The most simple have a fixed payment for term.  On those it is easy to figure out how much they will pay out, they will tell you how much it will cost, and you can figure the necessary rate of return.  The insurance company will be figuring a higher return, because usually they can aggressively invest your money and make the payments to you from current income.  The difference is their profit.  Margins are usually smaller for this type of annuity because it is so simple.  In fact, margins can appear to be negative, in that the payments you receive may include actual return of principal and not just investment return, but they will always plan to make some profit even it is just a percentage of your original purchase cost.

The next most simple is a deferral (deferred annuity).  All that does is add some investment growth before payments start.  All the rest of the calculations are the same as the previous.

The next most simple have a fixed payment for life.  They use their mortality estimate and your age when payments start to calculate a term.  The rest of the calculations are the same as previously.  If you expect to live longer than typical, you win.  If you die early, they win.

Then start adding complexity such as multiple payment in, dual life, different payments for second life, inflation or other growth in payments, variable payments, variable with some portion invested under your control, guaranteed minimum payout or term, a death benefit (life insurance rider), etc.  Each adds just a little bit of complexity until pretty soon the contract is almost incomprehensible.

[MachineGhost]

Annuities have a lot of options and risks. If someone were considering using them I would research the issue carefully and definitely use multiple providers to diversify against company risk. They may make sense for some investors, especially if they think they will not be able to mange their investments into old age and want to lock in an income stream.

And if you were going to all the trouble, then get a Swiss annuity.

[WildAboutHarry]

The most simple have a fixed payment for term.  On those it is easy to figure out how much they will pay out, they will tell you how much it will cost, and you can figure the necessary rate of return.  The insurance company will be figuring a higher return, because usually they can aggressively invest your money and make the payments to you from current income.  The difference is their profit.  Margins are usually smaller for this type of annuity because it is so simple.  In fact, margins can appear to be negative, in that the payments you receive may include actual return of principal and not just investment return, but they will always plan to make some profit even it is just a percentage of your original purchase cost.

Right, immediate annuities are very simple and relatively cheap (not aggressively sold, suggesting low costs).  These products simply share risk among a pool of annuitants.  Some annuitants collect a lot, some of them collect a little.  Theoretically they are actuarialy neutral, minus profit for the insurance company.

[moda0306]

D1984,

Life insurance tests for insurability and price accordingly... annuities do not.

So with life insurance, you would buy more than you need when you're young and healthy because you want to lock in a good health rating, mortality being (maybe) something you actually lose on if people live older.  However, you could lose on the health rating MUCH faster than your likely loss on mortality.

With an annuity, "locking in mortality" means that the insurance company thinks you'll die at 78 today, but decades later the mortality tables will have you dying at 84... This means you'll get a higher income at annuitization.  Of course, that's if people are living longer then.  Nice thing is, with some VA's, you get that option with a small initial investment.

Thanks for clearing that up. I would like to add that some annuities (SPIA's as far as I know although there may be some VAs that do this as well) are in fact priced according to mortality risk...Google "medically underitten annuity", medically rated annuity", or "impaired risk annuity"

Also, do you mean that someone could invest, say, $5,000 in one of these VAs and then if life expectancy DID go up dramatically they could deposit, say, another $250,000 into the annuity right before they annuitized (at the old mortality table rating)? If that is the case, isn't the insurance company playing a risky no-win game of "heads we lose, tails you win"? Surely the mortality guarantee only applies on the original deposited amount.

D,

Yeah that's exactly what you can do, and I am still trying to figure out what the catch is.  I've heard prudential recently froze add'l contributions to those accounts, so maybe they have a fail-safe mechanism that prevents things from going haywire.

I think most young people that could most likely take advantage of it are going to laugh at starting a VA... though smart people will see the opportunity and pounce on it.  I don't know why insurance companies would leave themselves exposed like that.

[D1984]

D1984,

Life insurance tests for insurability and price accordingly... annuities do not.

So with life insurance, you would buy more than you need when you're young and healthy because you want to lock in a good health rating, mortality being (maybe) something you actually lose on if people live older.  However, you could lose on the health rating MUCH faster than your likely loss on mortality.

With an annuity, "locking in mortality" means that the insurance company thinks you'll die at 78 today, but decades later the mortality tables will have you dying at 84... This means you'll get a higher income at annuitization.  Of course, that's if people are living longer then.  Nice thing is, with some VA's, you get that option with a small initial investment.

Thanks for clearing that up. I would like to add that some annuities (SPIA's as far as I know although there may be some VAs that do this as well) are in fact priced according to mortality risk...Google "medically underitten annuity", medically rated annuity", or "impaired risk annuity"

Also, do you mean that someone could invest, say, $5,000 in one of these VAs and then if life expectancy DID go up dramatically they could deposit, say, another $250,000 into the annuity right before they annuitized (at the old mortality table rating)? If that is the case, isn't the insurance company playing a risky no-win game of "heads we lose, tails you win"? Surely the mortality guarantee only applies on the original deposited amount.

D,

Yeah that's exactly what you can do, and I am still trying to figure out what the catch is.  I've heard prudential recently froze add'l contributions to those accounts, so maybe they have a fail-safe mechanism that prevents things from going haywire.

I think most young people that could most likely take advantage of it are going to laugh at starting a VA... though smart people will see the opportunity and pounce on it.  I don't know why insurance companies would leave themselves exposed like that.

Moda, several potential reasons an insurance company would do something seemingly dumb like this come to mind. The first is simple ignorance on the part of their customers/policyholders...the simple fact that most people aren't "clued in" enough to maximize their utility with such an annuity as you suggested and those (many) who don't use the annuity in such an unorthodox manner will make the company enough profit to subsidize those (few) who do; I can't think of an example from the insurance industry but a situation like this in another FIRE sector is the Amex Blue Cash Preferred...if everyone who had the card used it only for the 6% cash back on groceries (or even worse from Amex's standpoint, bought Visa gift cards at stores like Kroger so they could effectively get nearly 6% cash back on EVERYTHING) and always paid their balance in full it would likely make this American Express's most unprofitable card ever (even though it does charge an annual fee to offset some of its costs). But most people don't do what I just described; they use it for every kind of purchase (including the ones that only pay 1% cash back), not just groceries, and revolve a balance to boot. Amex makes 3-4% off the interchange fees and a nice chunk off the interest as well.

The second way they could be counting on to make a profit is a combination of lapse supported pricing and high fees/costs. If the fees on the separate accounts inside the annuity are hefty enough (no idea how much Pru charges or even what most loaded VAs charge but I'm seen loaded VULs with S&P 500 index funds with nearly 1.25% expense rations...on an index fund! ), the M&E charges (if applicable) are high enough, the surrender charges are steep enough, and enough people surrender early on (or 1035 to another annuity before they can annuitize at the preferential mortality rate) when the surrender charge is still in effect, this could more than offset the enhanced mortality credits paid to those who do as you described. The few who stick it out until annuitization are in effect subsidized by the ones who quit early. The best examples I've seen of this profitability tactic (call it "the quitters subsidize the stayers" ) by insurance companies are (judging based on how the products are currently priced vs what safe rates are available in the marketplace where insurers have to invest their money) are GULs to age 121 and ROP term...although some VULs (especially as regards M&E and surrender chages) use this form of "high-fees plus lapse supported pricing" as well.

The final answer to why they do it could just be that somebody (or several somebodies) at the actuarial and rate making divisions of the home office just goofed big time and underpriced their product by not fully considering how a sharp consumer could outwit them and use the annuity in ways they never intended. The clearest case of this I ever saw (and I'm going from memory here of what I saw on various online bulletin boards...I unfortunately never bought one of these for myself because it was too late when I heard about it) was Penn Mutual's PPP (Purchasing Power Protector) variable annuity. It charged around 2.93% per year if I remember correctly (2.93% sounds ridiculously steep for someone used to index funds or ETFs but it turned out to be a great deal for anyone who bought the annuity if they knew how to utilize it) to guarantee that (for income purposes) the available value would never be less than it was in the preceding policy anniversary (in other words, it "locked in" the value at each policy anniversary so if the value of the actual account fell sharply-like in 2008-the income account stayed at its previous 2007 contract anniversary levels) and promised that when the annuitant actually started taking income the income would be hiked each year for inflation. This was a pretty sweet deal by VA standards but the kicker was that unlike most VAs with an income guarantee (Vanguard's, for instance) that wouldn't let you put anything more than 60/40 or 50/50 into stocks vs bonds, the PPP let you allocate it any way you wanted...and they offered a small cap sub-account and an emerging markets sub-account. Oh, their brochure helpfully suggested 50/50 stocks and bonds, but if you wanted to you could elect to put everything 100% in risky, volatile equities and still receive the exact same income guarantee. Savvy investors soon enough figured out the implications of this ( "I can gamble on risky equities and if I lose someone else still has to make good on it and pay me my income" ), bought the annuity, and proceeded to put every bit of their contributions to it into the smallcap or EM subaccounts in order to maximize the value of the implied quasi-put option embedded in the income guarantee.

Needless to say, in 2010 Penn Mutual rather suddenly quit selling this annuity (at least as currently structured with the heads-you-win-tails-we-lose-guarantee) and no one's heard much about it since. They can't have made any money on the thing and probably lost quite a bit. Whoever came up with it and convinced Penn Mutual that it would be a good idea to offer such a product probably didn't get their yearly bonus, to say the least.

[AgAuMoney]

The second way they could be counting on to make a profit is a combination of lapse supported pricing and high fees/costs. If the fees on the separate accounts inside the annuity are hefty enough (no idea how much Pru charges or even what most loaded VAs charge but I'm seen loaded VULs with S&P 500 index funds with nearly 1.25% expense rations...on an index fund! ), the M&E charges (if applicable) are high enough, the surrender charges are steep enough, and enough people surrender early on (or 1035 to another annuity before they can annuitize at the preferential mortality rate) when the surrender charge is still in effect, this could more than offset the enhanced mortality credits paid to those who do as you described. The few who stick it out until annuitization are in effect subsidized by the ones who quit early.

I think the quitters are a big part of it.  I know they are with whole life life insurance.

It appears that actuarial mistakes were a big part of disability insurance pricing.  The last couple of years price increases have been huge and some companies have quit selling the policies because future liability looks to be significantly more than expected 10 years ago.

As for the 1.25% "high fees" on an S&P index fund....

My current employer's 401(k) is run by a large national insurance company (not Prudential).  Their S&P index option is charges 1.66%.  There is no cheaper option.  Their money market fund charges 1.91%, resulting in years of negative returns.

Needless to say, with no employer match I'm not putting any money there.