Annuities as an Investment

[2B]

I don't think you need to be an actuary to do the calculation.

So the math seems manageable. The tricky part is deciding which table to use. Should I use Total US Population? Or Total Male Population? or White Male Population? Should I adjust for the fact that I'm healthy today, and the mortality table includes people who are terminally ill today? Should I adjust for the expected improvement in mortality rates in the future? That seems more challenging to me.

Insurance companies employ legions of actuaries. They make really good money for mostly just plugging data into a formula. Insurance companies have created an industry out of making sure they make a good profit.

As has been stated many times before, the IRR is determined by how long someone continues to receive payments. Assuming you will live past your mortality table lifespan makes a SPIA look really good. It does not change the fact that among all the people purchasing the annuity half will die before that date. So ask yourself, do you feel lucky? If the answer is yes, buy the SPIA and stop repeating the same absurd thread over and over.

 

[FinanceDude]

All I have to add is that annuities are INSURANCE products, NOT INVESTMENT products..........

 

[samclem]

I'm not sure that you need to be an actuary OR need to know how to do math.
- The insurance company needs to make money on the annuities they sell. If they pay out more than they take in (initial purchase price + gains on that invested money) then they will not be profitable. The things they invest in are things individuals could also invest in. Therefore, on the face of it, unless there's some amazing hidden mechanism at work, we should go in with the assumption that the annuities will, overall, pay out less than you could expect to get yourself by investing in te same or similar things as the annuity companies. Somebody is paying for those skyscrapers and TV ads.

It is possible to make a case for annuities based on the longevity risk we face, or the value of a steady monthly income. Despite the spirited jousting on this board, this is clearly an individual issue, and some people sincerely believe these attributes of annuities are worth the overall decreased payout they will receive. That's fine, and I'm glad these products are available for consumers who want them.

I do not believe it is possible for anyone to show that they'll receive more absolute, inflation-adjusted, money from investing in an annuity than they would have received from a well-chosen, prudent mix on investment vehicles. Any proof that involves assuming a longevity in excess of the mortality tables is highly suspect.

According to a mortality table I consulted (http://www.cdc.gov/nchs/data/statab/lewk3_2003.pdf ) as of 2003 a 53 year old male in the US should expect to live 26 more years (that is, to age 79). If you assume that you'l live to 86, then the annuity will look better. If you assume you'll live to 100, the annuity looks GREAT! It turns out you can make the annuity IRR anything you want by creatively picking an age of death that meets your psychological criteria for self-proof.

Who is paying for those skyscrapers?

 

[haha]

So the math seems manageable. The tricky part is deciding which table to use. Should I use Total US Population? Or Total Male Population? or White Male Population? Should I adjust for the fact that I'm healthy today, and the mortality table includes people who are terminally ill today? Should I adjust for the expected improvement in mortality rates in the future? That seems more challenging to me.

That is why you need to be an actuary. That, and the fact that you would get paid for your work.

Ha

 

[Independent]

I'm not sure that you need to be an actuary OR need to know how to do math.
- The insurance company needs to make money on the annuities they sell. If they pay out more than they take in (initial purchase price + gains on that invested money) then they will not be profitable. The things they invest in are things individuals could also invest in. Therefore, on the face of it, unless there's some amazing hidden mechanism at work, we should go in with the assumption that the annuities will, overall, pay out less than you could expect to get yourself by investing in te same or similar things as the annuity companies. Somebody is paying for those skyscrapers and TV ads.

Who is paying for those skyscrapers?

This is exactly the way my dad explained it when I was a teenager. He was right then, and you are now. The topic at the time was deductible on car insurance.

As he went on to explain, because of the skyscrapers, you never want to buy insurance to cover an inconvenience. But, it can still make sense to buy insurance to cover a catastrophe. I know that I'm buying insurance today even though I understand the skyscrapers, and I think I'm a rational person.

When you're trying to decide whether or not to buy, it seems that you should at least know how much the insurance company is going to pay if the "bad thing" happens. In the case of an SPIA, that's not so obvious because of the long time frame. So Rockon's calculation is useful if the question is "What do I get if I live to an unusually old age?". It's not correct if the question is "What do people get on average from this?"

Your answer to the second question "Less than they put in (adjusted for the time value of money)" is enough of a response for a lot of people.

Ha's approach gives us "How much do they lose on average?". This can be a useful number if "living too long" looks like a serious financial problem, but not exactly a catastrophe.

 

[RockOn]

Wow, I just stopped by after a whole boatload of posts and can't believe my comment was so offensive. Rock - if you look back you will see that you started complaining about insults after my comment and Ha's suggestion that he also didn't understand the post. I was not trying to insult you -- heck, I am one of the relatively pro SPIA posters. I just didn't think your question made sense. You simply asked for confirmation that VG's annuity has a 6% IRR - no other information to determine what period you were talking about. The question didn't make sense. No insult in pointing that out.

I'm truely sorry if I took your comment in the wrong way wrong, I've been a little overheated lately.

 

[RockOn]

So ask yourself, do you feel lucky? If the answer is yes, buy the SPIA and stop repeating the same absurd thread over and over.

I sure didn't mean to get this started again. If we could all just accept that annuities pay a reasonable rate of return (from about 4.5% to 7% depending on how long you live) which does include the loss of principle in the calculation, and are not huge ripoffs like some think, it would have been stopped long ago.

 

[RockOn]

All I have to add is that annuities are INSURANCE products, NOT INVESTMENT products..........

They are sold by insurance companies for sure, but why they are not investment products, I don't understand. Over time they will likely pay out a return in the range of CD's and bonds, are those not investment products?

 

[samclem]

I think the place to leave the discussion is this:

- Most people who buy annuities lose money compared to where they would have been if they'd invested the lump sum in a prudent set of investments. Therefore, they are a very poor investment if the criteria is "expected return on investment." Period.

- Even with this large shortcoming, annuities may be an appropriate vehicle for an individual who:
-- Needs a gauranteed base income that does not vary (again, even if this base income is significantly less on average than he would have been able to obtain on his own).
-- Has reason to believe he/she will live longer than the actuaries at the insurance company believe he will live.
-- Is not bothered by the fact that the annuity depends entirely on the promise and ability of a single company to remain solvent and to perform for as long as he/she lives.

 

[samclem]

They are sold by insurance companies for sure, but why they are not investment products, I don't understand. Over time they will likely pay out a return in the range of CD's and bonds, are those not investment products?

For the very reasons we keep telling you. In addition, they can only be offered by insurance companies. They are an insurance product. If I recall correctly, that exact phrase is required wording in the literature they hand out. They stink as investments. They may be appropriate as insurance.

 

[RockOn]

When you're trying to decide whether or not to buy, it seems that you should at least know how much the insurance company is going to pay if the "bad thing" happens. In the case of an SPIA, that's not so obvious because of the long time frame. So Rockon's calculation is useful if the question is "What do I get if I live to an unusually old age?". It's not correct if the question is "What do people get on average from this?"

Your answer to the second question "Less than they put in (adjusted for the time value of money)" is enough of a response for a lot of people.

Ha's approach gives us "How much do they lose on average?". This can be a useful number if "living too long" looks like a serious financial problem, but not exactly a catastrophe.

I'd like to pursue this a little more.

I agree that the biggest question is will the insurance company pay off. History has never shown a loss. That doesn't mean it can't happen but it's safer than a few things out there.

I don't understand the "what do people get on average" comment. If there has never been a default in history, it seems to me they get exactly what they deserve based on how long they actually live. If I die early, I understand I lost out, but at least I am dead. If I live to 100, I robbed the bank.

I don't think 86 is an unusually old age, maybe you do. Since I don't think 86 is unusual, I look at the 6% IRR. What age do you base your calculations on when you do financial planning? I think that has merit.

I sure don't understand your "Less than they put in" (adjusted for the time value of money) comment. They pay over out time (if the insurer stays solvent) as much as CD's and bonds do. Does the "less than they put in" apply to CD's and bonds also?

On the last comment, why is a 4.5% to 7% IRR at all tied to the comment "how much do they lose on average"? Are you comparing an annuity to a 50/50 portfolio or something? I don't understand that.

 

[REWahoo]

I'd like to pursue this a little more.

I think I see a pattern here...

 

[unclemick]

They are sold by insurance companies for sure, but why they are not investment products, I don't understand. Over time they will likely pay out a return in the range of CD's and bonds, are those not investment products?

Hmmm - for a forum that could/can go on and on and on about recyling dryer sheets, I have learned to move on another topic. Especially when they insist on poking fun.

I thought my dividend stock ladders in 2004 was a 'barn burner of an idea' but after the razzing I took - I threw in the towel.

Sometimes some folks just can't see the shear brilliance of things!

heh heh heh - now where did I put that Curmudgeon Certificate? .

 

[RockOn]

I think the place to leave the discussion is this:

- Most people who buy annuities lose money compared to where they would have been if they'd invested the lump sum in a prudent set of investments. Therefore, they are a very poor investment if the criteria is "expected return on investment." Period.

That is the best response I have heard. Period. Still, some of us may not have the risk tolerance you have, why be so negative about options we may have?

- Even with this large shortcoming, annuities may be an appropriate vehicle for an individual who:
-- Needs a gauranteed base income that does not vary (again, even if this base income is significantly less on average than he would have been able to obtain on his own).
-- Has reason to believe he/she will live longer than the actuaries at the insurance company believe he will live.
-- Is not bothered by the fact that the annuity depends entirely on the promise and ability of a single company to remain solvent and to perform for as long as he/she lives.

Amen to that

Thanks

 

[samclem]

 

[RockOn]

For the very reasons we keep telling you. In addition, they can only be offered by insurance companies. They are an insurance product. If I recall correctly, that exact phrase is required wording in the literature they hand out. They stink as investments. They may be appropriate as insurance.

You are correct that they are insurance products. I still think they are investments though, if I buy one I would consider it an investment and would compare it to other investments that I could make with the money.

I don't think they stink if they send me a decent check every month like a Defined Benefit plan would, but we can agree to disagree about that.

 

[RockOn]

I think I see a pattern here...

I know, but let's get it over with. I don't want to bring it up again.

 

[rs0460a]

Just for the heck of it, I did an IRR computation on an SPIA which I purchased last year (age 59), guaranteed for 28 years (payments continue if I/DW live beyond age 87).

For the 28 year period, the rate of return comes out to 4.79%. However, if either of us live an additional 2 years, the return goes up to 5.08%.

Longetivity means a lot on your computation. Again, since we know we (or our estate) will get a payment to a certain date, we know what the minimum return is. If we live longer, who knows? I guess I/DW can do the computation on our deathbead if we live more than 28 years.

For me, this means that you really can't compute what a SPIA actually returns. "Good practice" means you make your decision based upon the minimum (would have to compute IRR from all vendors/plans) but understand that there is a chance that you will actually do better.

Actually, slightly less than 5% returns are not bad (when compared to the current market returns). However, with the inflation rate sure to rise, you will take a hit (unless you live to 100+ ... )

- Ron

 

[RockOn]

Hmmm - for a forum that could/can go on and on and on about recyling dryer sheets, I have learned to move on another topic. Especially when they insist on poking fun.

I thought my dividend stock ladders in 2004 was a 'barn burner of an idea' but after the razzing I took - I threw in the towel.

Sometimes some folks just can't see the shear brilliance of things!

heh heh heh - now where did I put that Curmudgeon Certificate? .

I am about to throw in the towel on this too. I'd still like to clear up a few things though. I might buy a SPIA in the future. 1/2 of my nest egg in a COLA'd annuity would lock in my retirement plan without volatility, that would be sweet. As long as the insurer keeps paying me of course.

 

[RockOn]

Just for the heck of it, I did an IRR computation on an SPIA which I purchased last year (age 59), guaranteed for 28 years (payments continue if I/DW live beyond age 87).

For the 28 year period, the rate of return comes out to 4.79%. However, if either of us live an additional 2 years, the return goes up to 5.08%.

Longetivity means a lot on your computation. Again, since we know we (or our estate) will get a payment to a certain date, we know what the minimum return is. If we live longer, who knows? I guess I/DW can do the computation on our deathbead if we live more than 28 years.

For me, this means that you really can't compute what a SPIA actually returns. "Good practice" means you make your decision based upon the minimum (would have to compute IRR from all vendors/plans) but understand that there is a chance that you will actually do better.

Actually, slightly less than 5% returns are not bad (when compared to the current market returns). However, with the inflation rate sure to rise, you will take a hit (unless you live to 100+ ... )

- Ron

Around 5%, that's in the ballpark. Vanguard pays a little more, I don't know if you tried that. When I did it awhile back I got 5.94%. I'd have to go back an remember if I used an inflation adjusted annuity or not. I used from age 53 to 86, 33 years. A few others confirmed my numbers at the time. I also used a single life, unlike you. I am pretty sure it comes out to ~6% either way at Vanguard but didn't try all the options, just a few.

Still it is not the 2 or 3% horrible investment that has been put forth by some who I believe refuse to take an honest look at it.

I also think 5% or 6% isn't really all that bad. Millions of people buy only CD's, they are getting less that that on average I bet. Also annuities have no reinvestment risk (the risk rates could be low when rolling it over) and no volatility. The amount of the monthly check is fully predictable.

 

[RockOn]

For me, this means that you really can't compute what a SPIA actually returns. "Good practice" means you make your decision based upon the minimum (would have to compute IRR from all vendors/plans) but understand that there is a chance that you will actually do better.


- Ron

I argee you have to make assumptions and cannot calculate the actual return ahead of time. My risky assumption is I'll live to 86 (and the insurer will not go insolvent). I think assumptions are a reasonable thing to do though, we almost all assume something like 85 or 90 with our financial plans.

 

[haha]

I am about to throw in the towel on this too. I'd still like to clear up a few things though.

Have you looked into home remedies for OCD?

 

[RockOn]

Have you looked into home remedies for OCD?

No

 

[huskerblue]

As long as the insurer keeps paying me of course.

In my book, there's the rub. You can talk about being made whole with a government bailout if there is a default but that is making a HUGE leap of faith. I will not tied up a big piece of my retirement nestegg in one company - ever - period. I will consider tying up a small portion if the numbers work right at the time.

 

[harley]

I agree that the biggest question is will the insurance company pay off. History has never shown a loss. That doesn't mean it can't happen but it's safer than a few things out there.

Hasn't happened yet in the US - Q&A: Equitable Life | Money | guardian.co.uk

Harley