Everyone from the financial print media to television's financial "talking heads" have criticized annuities in general and fixed annuities in particular have been criticized as unsuitable accumulation vehicles. They have been derided as tepid and inflexible income vehicles or ignored outright. Indeed, "broker bias" against insurance products isn't hard to find; its maxims go something like this:
- Why would a consumer put their money into an insurance product that is regulated by disparate group of insurance commissioners when they could bask in the universal regulatory safety of the SEC and FINRA? (Cue laugh track here.)
- Insurance salesmen are a shady lot. They don't have the education or training of the average broker, and all they're interested in is high commissions. They can't be trusted. (Unlike those choir boys over at Goldman Sachs.)
- The market always comes back. It's an historical fact. (Except when it doesn't.)
- Annuities are mostly illiquid, and leave you with inflexible withdrawal options that only benefit the insurance company and its agents. (As opposed to those 12b1 fees, which are apparently given to charity.)
- Annuities are too complicated for clients to understand. (Those Monte Carlo simulations are much easier to grasp, especially for retirees.)
On the broker bias scale of misinformation, there's points of view to support a reasonable argument, and then there are outright transparent, prejudiced attacks. Considering the ubiquitous Jim Cramer's histrionic bias against annuity products, one can understand how the media-consuming public is often misinformed. Here's what he has to say:
Here's a puzzle for you -- the answer to which could make or break your financial future. What kind of business takes your money, gives you a guaranteed minimum return and then invests the money in complex derivative securities or crummy real estate investments? Wait, there's more. What kind of business takes your money and gives you a guaranteed level of performance, a stop out, plus some upside in the S&P 500, and then not only fails to hedge, but invests in the very same crummy, toxic properties? If you guessed the annuities market, go to the front of the line. Unfortunately, these days, the front of the line in the annuities market heads right off a cliff.1
Well, guess what, Jim? The top financial scholars in the country have analyzed the retirement puzzle and have considered both the accumulation and the distribution phases, and have universally concluded that annuities are an essential component of virtually every retirement plan.
This is significant, precisely because these studies have exposed broker bias as silly and self-serving; worse yet, such biases ignore the looming retirement crisis as more than 75 million baby boomers approach their retirement years. While no study espouses annuities as the only solution for the accumulation years, the studies are strikingly concurrent in their conclusion that annuities are crucial in the distribution phase, especially considering the looming problem of longevity risk. As this 2008 Ernst & Young study shows, the gathering storm in retirement income demand is real and frightening:
- Six out of 10 middle-class new retirees can expect to outlive their financial assets, if they attempt to maintain their current pre-retirement standard of living
- Almost three-quarters of middle-income households seven years from retirement can expect to outlive their financial assets if they attempt to maintain their standard of living
- Households without an employer pension plan to supplement Social Security and other savings are much more likely to outlive their assets than those that have a pension
- Married couples are more likely to outlive their financial assets, due to their longer joint life spans, than single households
- Near retirees would have to reduce their standard of living by 37 percent to reduce the likelihood of outliving their assets to only a five percent failure rate. This reduction would be less severe for single women (28 percent) and single males (30 percent) than for married couples (39 percent)
- New retirees would have to reduce their standard of living by 24 percent to reduce the likelihood of outliving their assets to only a five percent failure rate. This reduction would be less severe for single women (14 percent) and single males (16 percent) than for married couples (26 percent)
- (Conclusion) If the typical middle-income household without a defined benefit pension wants to reduce the risk of outliving their assets, they would have to reduce their post-retirement standard of living significantly below their pre-retirement standard of living.
Households approaching retirement face an environment where the possibility of living to age 90 or 100 and the volatility of inflation and investment returns put them at high risk of outliving their assets. This study shows that the presence of a significant guaranteed lifetime income stream beyond Social Security can help. Increased focus on both increased retirement savings and the importance of a guaranteed lifetime income stream will reduce the retirement vulnerability of retirees in the future.2
Note the bold section: "significant guaranteed lifetime income stream." Your average broker might suggest a mix of conservative bond funds, money market instruments, and blue chip equity funds to provide income and maintain pace with inflation. Alas, that strategy tends to ignore the importance of guaranteed income and protection against losses of any kind, especially in the distribution phase.
The scholarship from these and other centers of thought over the "lost decade" of the 2000s has not been beholden to such biases -- either against annuity products or in favor of equities -- and has come to some interesting conclusions:
- "Lifetime income annuities may not be the perfect financial instrument for retirement, but when compared under the rigorous analytical apparatus of economic science to other available choices for retirement income, where risks and returns are carefully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck."3 -- David F. Babbel, The Wharton School, University of Pennsylvania
- "From the peak of the stock market on October 9, 2007 -- roughly the time of the 2007 SCF -- until the end of the second quarter of 2009, the Dow Jones Industrial Average was down 40 percent, the Stan¬dard & Poor's 41 percent, and the broadest gauge of market activity -- the Dow Jones Wilshire 5000 -- 40 percent (see Figure 6). This steep decline (in equities) has impor¬tant implications for American households because of the dramatic shift in the nature of pension cover¬age and the expansion in the ownership of equities... The combined effect of declining asset values, declin¬ing interest rates, and the continuing rise in Social Security's Full Retirement Age increases the NRRI (households at risk of outliving their income) for 2009 to 51 percent."4 -- Alicia H. Munnell, Anthony Webb, and Francesca Golub-Sass, Center for Retirement Research at Boston College
- "Tomorrow's retirees will need access to an additional, reliable source of guaranteed retirement income. Financial products are available to help ensure that an individual can have adequate income at advanced ages, even if she lives to age 100 and beyond. In particular, life annuities provide a guaranteed source of monthly income that cannot be outlived."5 -- Jeffrey R. Brown, Professor, University of Illinois, Americans for Secure Retirement
Such dry and reasoned analyses are not the stuff of cable television entertainment. The truth rarely is. But the facts are clear: When the biases are stripped away and the study is objective, annuities stand as an essential factor in any reasonable retirement strategy.
1Jim Cramer, Cramer: Is Your Annuity Safe? www.mainstreet.com, February 26, 2009.
2Ernst & Young, LLP, Retirement Vulnerability of New Retirees: The Likelihood of Outliving Their Assets, July 2008.
3David F. Babbel, Lifetime Income for Women: A Financial Economist's Perspective, Wharton Financial Institutions Center, August 12, 2008.
4Alicia H. Munnell, Anthony Webb, and Francesca Golub-Sass, The National Retirement Risk Index: After the Crash, Center for Retirement Research at Boston College, October 2009.
5Jeffrey R. Brown, The New Retirement Challenge, Americans for Secure Retirement, September, 2004.
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