One of the hottest selling financial products in the last few years is annuities. They come in several shapes, forms and sizes. Variable index annuities are the style most often pushed on seniors. The typical pitch is a “guaranteed return” of about 7% per year. The indexing is typically tied to the return of the stock market with enough formulas to make a mathematics PHD sigh a few times.One common characteristic of all annuities is that they are backed by insurance companies. In the unlikely event that the insurance company goes belly up, the salesman will quickly tell you that the annuity payouts are guaranteed to some dollar amount by state insurance funds. This is all true. Many annuity pushers will tell you that “no annuity has ever NOT paid out per the contract.” This is where it starts to get a little fuzzy.For purposes of this post, we will define old timers as anyone over 40 years old. If you are an old timer, you might remember a high flying insurance company called Executive Life. They were the largest life insurer in California in the 1980’s. At the time, their main selling point was above market returns. Unfortunately, their investment portfolio mostly consisted of junk bonds. They were closely tied to Michael Milken and his firm, Drexel Burnham Lambert. In the early 1990’s, many of the junk bonds got into trouble. This in turn had a negative impact on the First Executive portfolio.First Executive was declared insolvent in April 1991 and was taken over by the California insurance commissioner. This is why I suggested anyone younger than about 40, likely would not have heard about them.So you are saying: Yoda, who the heck cares about an insurance company that went belly up 21 years ago?And the answer is anyone that owns or is considering buying an annuity. Fast forward to today (4/16/12) when a New York judge approved the liquidation plan. I would NOT have believed it possible to take this long, but never underestimate the turtle crawling speed of the US legal system.A New York judge on Monday approved a plan to liquidate the long-insolvent Executive Life Insurance Co of New York and pay out most of the money owed to beneficiaries under the company's life insurance policies.The plan proposed by Benjamin Lawsky, New York's superintendent of financial services, would pay out the remainder of about $900 million in Executive Life's estate, as well as another $730 million in contributions from state life insurance guaranty associations. Insurers also agreed to chip in about $70 million.Lawsky's plan won approval by Nassau County Supreme Court Justice John Galasso, over the objection of a variety of Executive Life payees.Galasso said it would allow for about 85 percent of the roughly 10,000 payees to receive full payouts on the present value of their annuity benefits.I am NOT suggesting that any insurance company today is heading towards insolvency like Executive Life. However, several of the large insurance companies were in serious trouble like the TBTF banks in the credit crisis. Like the TBTF, they all survived, but I would NOT be optimistic about their outlook. Life insurers are being killed by the low returns across the bond front. On a broader scale, I strongly dislike both the indexed annuities plus how they are pushed onto seniors. They are good products for a low percentage of situations, far less than how they are sold.BOTTOM LINE is next time an annuity salesman tells you that annuities are guaranteed by state insurance funds, ask him to give you a history lesson on Executive Life. Link to Reuter’s article:http://www.reuters.com/article/2012/04/16/executivelife-idUS...Thanks,Yodaorange
Yoda,Thanks for a story...among others...that needs telling.The REIT board has had lengthy discussions on the subject of "longevity insurance" which is recommended by some pretty sophisticated board posters. Is this not the same "product"? I have a fully paid policy issues by Northwestern Mutual that I bought 18 years ago when I had a profit sharing plan balance from JP Morgan as I was departing for Salomon Bros. in London. Seemed like a low risk garage in which to park $200K. It now has a cash value of $500K and in the event of my going over the cliff would net the beneficiaries cash of $770K. With all of my investment sins in the interim, I'm thinking that bunch of cash...which I could access as well isn't a bad thing, though it's certainly not central to my retiremant planning. So I guess the products of this general family can be ok, but it depends on two variables: How is it funded? and Who is the obligor? Northwestern in very conservative, and I am a part owner as it's a mutual. And the funding is govs as opposed to an annuity based n the performance of a basket of equities of various stripes. Am I right in concluding that the devil is in the details?jz
BOTTOM LINE is next time an annuity salesman tells you that annuities are guaranteed by state insurance funds, ask him to give you a history lesson on Executive Life.You can add Mutual Benefit Life to the listMutual Benefit Life was seized by the New Jersey Department of Banking and Insurance on July 16, 1991 after losses in an overheated real estate market led to a run by policyholders. At the time, the collapse was the largest ever of an American insurer. Effective June 14, 2001, Mutual Benefit was liquidated and dissolved.http://en.wikipedia.org/wiki/Mutual_Benefit_Life_Insurance_C...I have mentioned before that my Aunt, a retired school teacher, had one of their annuities as part of her pension. Fortunatly, for her, the NEA stepped up and handled the transfer of her assets to an annuity at Prudential. As far as I know, she did not take a big loss, but she was wondering, for a couple years, whether she would.In the unlikely event that the insurance company goes belly up, the salesman will quickly tell you that the annuity payouts are guaranteed to some dollar amount by state insurance funds. This is all true. At present, many insurance products are regulated at the state level. Recall the proposals during the health insurance debate about selling insurance across state lines, without the oversight of the state where the insurance purchaser lives, in the name of "increasing competition"? If that type of proposal were to pass, all the insurance companies would shortly be domiciled in whichever state had the weakest regulation and/or most lax enforcement. Multiple insurance company failures in that single state would probably break the state reserve fund. ...several of the large insurance companies were in serious trouble like the TBTF banks in the credit crisis. The Hartford, for one, received TARP bailout money.Whatever we do, I figure that it's just a matter of time before bought government does something that will result in vast amounts of "our" money being put into annuities.Steve
Even ignoring the financial strength of the insurance company issuing the annuity and the underlying investments, the vast majority of annuities carry obscenely high sales charges and expenses. There are a few no-load, low expense annuities out there, but they are few and far between.
The question I always ask myself is "how do they do that?".I I can figure it out, I can usually "roll my own" without paying vig to a third party manager. If I can't figure it out because it just doesn't make sense, then I avoid it. If it is backed, then I'm interested in the risks of who guarantys it.So far, I have not figured that annuities have much efficacy for most people (though they do give some a sense of comfort).Jeff
the vast majority of annuities carry obscenely high sales charges and expenses. There are a few no-load, low expense annuities out there, but they are few and far between.I agree, which is why I put the profit sharing proceeds into a fully paid policy instead of a managed annuity product. My goal was to remove the money from my attention span and let it do it's little thing, which it has done. I have more than enough to do managing family money now that I'm retired and before I no time for any of this. They're good for some people who are happy giving up all control. But Looking at the managed annuity products I see in portfolios, I would avoid them.jz
The question I always ask myself is "how do they do that?".I I can figure it out, I can usually "roll my own" without paying vig to a third party manager. If I can't figure it out because it just doesn't make sense, then I avoid it. If it is backed, then I'm interested in the risks of who guarantys it.So far, I have not figured that annuities have much efficacy for most people (though they do give some a sense of comfort).JeffI think that most investors would be better off with a strategy of investing for income so that they never have to sell. For example, let's say that your portfolio consisted of 100% of the S&P 500 index, which you purchased at the end of 1999, when the market was at stratospheric levels. All you did was spend your dividends. In 2011, your dividends would have been about 56% higher than in 1999, a compound rate of increase of about 3.76% per year. Not bad considering the economic weakness we have experienced.People who continually stress out about what the market is doing typically make stupid mistakes and buy high and then sell low. Few people can disconnect themselves emotionally from the market.My father is no Wall Street wizard, but he has an old school common sense about him. He invests in blue chip dividend-paying stocks, highly rated bonds, REITS, rental properties, etc. All things that pay income so that he can afford to be patient about if or when he wants to sell, and he minimizes capital gains tax. He HATES to sell and incur capital gains tax.And yes, I realize that few people are going to have the assets to just invest in the S&P 500 index and collect dividends. The point is to minimize your reliance on the market for your financial wellbeing. You can do this by focusing on the income generated by the asset rather than what you can get for selling your assets.
Hi Jeff,The question I always ask myself is "how do they do that?".How they do it, in principal, is fairly easy;a) buy a high quality safe yield portfolio with a portion of the client's principal to "replenish" the account back to 100% each year. Example, a 6% yield port requires roughly $94k (and a pizza) out of an original $100k to replenish back to a full $100k each year. The insurers (through high quality corporate bonds, and commercial real estate loans,) are currently getting annual yields in the range of 6.4% to 8%-ish.b) They take the cash they didn't use ($6,000 in the above example) in the discounted yield purchase, and they buy a bull call option spread on a given (or a blend) of market indicies. The spread is typically long a strike at the money (or at the index price point on the initiating day of the contract,) and short a strike price as far into the forward profit of the index as that $6,000 will buy them. In other words, the long position might cost them $8,000, and they can recoup $2,000 by selling the short strike at 10% or 12% or 15% or more forward on the index.#b gives them a direct participation in that index's movement at the day of expiration (which they can either then close/sell to collect, or roll forward to ride.)It can certainly be done on a DIY basis, relative to an indexed annuity. The major downsides to the DIY basis are;A) YOU have to structure it yourself,B) You are unlikely to get anywhere near the safe-leg yield they get, for the same costs they pay,C) You are very unlikely to get as efficient of an option spread in the index, as you'll have to buy the retail standardized options on teh exchanges (where the insurers use banks as counterparties that sell them custom written option spreads to mathematically fit exactly the spread they want, at the lowest possible trade costs & slippage,)D) If not done in a qualified account, you'll have to pay the immediate taxes as applicable.Fixed indexed annuities are *not* really great instruments for growth, IMO... but they're certainly safer than unprotected security positions, and definitely generate a net value growth better than equivalent banking products (MMAs, CDs, etc.)Cheers,Dave DonhoffLeverage Planner
MadCap said wisely,The point is to minimize your reliance on the market for your financial wellbeing. You can do this by focusing on the income generated by the asset rather than what you can get for selling your assets.If you do it, you can also have the pronouncements of the CNBC crowd and other financial commentators as a frequent source of amusement rather than ulcers.jz
On top of the carrier risk, stupidly high commissions, and huge amounts of inflexibility, I cannot imagine why anyone buys an equity indexed annuity because you can roll your own in about 5 minutes with any brokerage account. Details of doing so are here: http://lifeinvestmentseverything.blogspot.com/2012/01/rollin...
I cannot imagine why anyone buys an equity indexed annuity because you can roll your own in about 5 minutes with any brokerage account.For the vast majority of my former coworkers, 5 minutes' effort is more than they are willing to spend on investments. They would rather play the lottery.Steve
H.R. 4529 (111th): Roadmap for America’s Future Act of 2010TITLE IV--SOCIAL SECURITY REFORM‘SEC. 258. PERSONAL SOCIAL SECURITY SAVINGS ANNUITY AND OTHER DISTRIBUTIONS.‘(f) Date of Final Distribution- All amounts credited to the personal social security savings account of an individual shall be distributed, by means of the purchase of annuities or otherwise in a manner consistent with the requirements of this section, not later than 5 years after the date the individual attains retirement age (as defined in section 216(l)). The Board shall provide by regulation for means of distribution necessary to ensure compliance with the requirements of this subsection.http://www.govtrack.us/congress/bills/111/hr4529/textSteve
The typical pitch is a “guaranteed return” of about 7% per year.No annuity that I have ever heard of makes this claim.I have heard of many that provide guaranteed income or withdrawals at a lower percentage than 7% but "return" relates to account value - and they simply do not do that.the salesman will quickly tell you that the annuity payouts are guaranteed to some dollar amount by state insurance funds.It is illegal in most, if not all states to tell a person that they are backed by the state fund. A person may ask if such is true but licensed individuals may not offer up this information as a means to induce a sale.Many annuity pushers will tell you that “no annuity has ever NOT paid out per the contractAnother prohibited practice.On a broader scale, I strongly dislike both the indexed annuities plus how they are pushed onto seniors. They are good products for a low percentage of situations, far less than how they are sold.I agree. I have seen few that I thought were a good deal. There are a few variable annuities (non-indexed) that are worthy considerations for that same low percentage of situations.BOTTOM LINE is next time an annuity salesman tells you that annuities are guaranteed by state insurance funds...Ask them if selling based on such is prohibited in their state (pretty sure this is an industry rule and not just a state rule).
The question I always ask myself is "how do they do that?".In most cases, they do the same way as any other form of insurance - they socialize the risk across many different investors in the form of the additional fees.2008 really tested this for many insurance companies. If you were getting ready to start taking income from your 401k at 5-6%, you could take it to a number of VAs and get that income amount guaranteed regardless of market performance. For those that bought such in late 2007, they made a killing. They get their 5-6% (per contract) even though their account lost 30-40% in value (assuming they were mostly in mutual funds). That income stream on the initial amount is usually paid the rest of your life (again, per contract).The insurance company took on the risk of the income payment. They recover those losses from everyone else that did not start taking income (just like a home owner pays for the fire on their neighbor's house by paying their insurance policy).Some companies that went through this have told people that their contract is/was so good, that they will not allow any new money to be added under that guaranteed income stream. New contracts for new customers pay less in most cases now. Old contracts must continue to pay the same higher benefit though.
>>The typical pitch is a “guaranteed return” of about 7% per year.<<No annuity that I have ever heard of makes this claim.Sure they do. The trick is in the fine print. My Mom got snared by Jackson National, with a high "guaranteed rate of return", which, the fine print revealed, was only guaranteed for the first two years, after which, the ROI plunged.That was the second time, that I know of, that she was snookered by an insurance salesman. Years ago, she bought a life insurance policy thesalesman described as a "20 year pay life". As the 20th year approched, she said something about not needing to pay on it anymore. I looked at the "schedule of premiums" on the back page of the policy, and pointed out there was no end date for payments. I called Prudential and confirmed that there was no such thing as an end date for paying, not at 20 years like the salesman said, or at any other time. Turns out this "great deal" of a policy was little better than term insurance, just more expensive.Notice that the SS "reform" legislation I linked to also describes how the "privatized account" money was to be invested: common stocks, bonds and insurance, before being rolled over to an annuity at retirement.Steve
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