Indexed annuities: Buying them for only the guarantees
By John L. Olsen, CLU, ChFC, AEP
Olsen & Marrion, LLC
My friend Stan "The Annuity Man" Haithcock argues that annuities should be purchased only for what they will do, not what they might do. In other words, we should evaluate them in terms of their guarantees. I agree wholeheartedly with that observation when the subject is immediate annuities or deferred income annuities ("longevity annuities"). But I believe that it's completely inappropriate when the subject is a deferred fixed annuity (either "index" or "declared rate").
Why? Two reasons:
1. In a scenario in which only the guaranteed values of a financial instrument will be realized (which is, I suppose, a pretty good operational definition of "worst case scenario"), how will the typical index annuity perform?
Do the math: The typical guarantee is 1.5 percent interest on 87.5 percent of premium. That will produce an annual return over 10 years of only 0.1537 percent per year. Do you know of any declared rate annuities, CDs, or bonds that can outperform 0.1537 percent per year on a guaranteed basis? I can think of many.
2. Deferred annuities that allow for the crediting of non-guaranteed interest have, historically, produced results significantly better than the guarantees. Don't believe me? Try to find an annual statement of a deferred annuity that has been in force for several years in which the accumulation value is not greater than the guaranteed value.
Now, this fact does not endorse those agents who illustrate the current interest rate as applicable for the next several decades. Historically, that practice has resulted in grossly overstated benefits. Even today, when interest rates are far lower than historical averages, the assumption that today's rates will persist into the future is problematic. This is particularly true of index life policies where the current interest rate formula is sometimes a participation rate of 100 percent with a cap rate of 12 percent or 13 percent. Index annuities may well produce, in future years, more interest than is currently being credited. (If bond prices rebound and equity index call options get less expensive, I would expect that result.)
But I wouldn't tell anyone to expect a given assumed future return. And I would never tell anyone that an indexed annuity is a good investment in a worst case scenario — because current guarantees are so low that it cannot be.
All that said, I hasten to add that Stan Haithcock is right about a lot of things he says. I just don't think that "buy annuities only for their guarantees" is one of them, unless you restrict that advice to SPIAs and DIAs.