Helping a friend

[Scuba]

In order to make your comparison valid, you would need to include hedging costs since her contract puts a floor on losses and what you are using doesn't... and those hedging costs would likely be very significant.



Also, from what you wrote this person would never have invested in SPY or QQQ without some or of floor... so since the floor was an important aspect of her investment decision then you need to proide for it in your analysis.

I would agree with you if there really was a floor, but from what I saw of how the gains and losses were calculated, losses count at full value and gains are capped.

At any rate, I cannot recommend that she stay in this “investment” knowing that if she had invested in the exact same ETF’s outside of this vehicle, she’d be over $130K better off in just 4 years. Her file didn’t have the 2018 statement in it but given recent volatility I’ll bet it’s more of the same so the gap will be even bigger.

If this were your friend or family member, would you recommend staying with this annuity?

 

[target2019]

Thanks, that is what I’m thinking too. I’m sure it’s legal as it was sold by a reputable company and the disclosures are documented. It’s just unfortunate that people with limited financial acumen buy these products, not really understanding the way they really work.

Yes, how could a 69-year old understand that document? I guess it is possible that someone else reviewed it for her and gave the thumbs up. Probably a matter for the son to know about and act upon. State authorities looking over these things may be interested, and I thought I'd mention that. It may be possible to make her whole. Maybe not. A specific commissioners office may be pro-consumer, and willing to look further into the matter.

In any event, good look with the matter.

 

[pb4uski]

Re-read the last two paragraphs of post #19.

I was helping a family friend with a annuity that they had that was much less onerous than your friend's annuity. Like your friend, it was money she had earmarked for her kids, but what was different was that she wanted some income from it. We move it to Wellesley and set up a monthly automatic redemption for the modest income that she needed.

 

[travelover]

Yes, how could a 69-year old understand that document? ............

The president is over 69 years old as are a number of the Supreme Court Justices and about half the Senate.

 

[REWahoo]

Yes, how could a 69-year old understand that document?

Apparently it will come as a surprise to you that a significant percentage of those of us who are over the age of 69 retain enough of our mental faculties that we can comprehend the fine print in these complex contractual agreements.

 

[pb4uski]

The president is over 69 years old as are a number of the Supreme Court Justices and about half the Senate.

That explains a lot. [emoji1]

Just kidding!

 

[youbet]

I would agree with you if there really was a floor, but from what I saw of how the gains and losses were calculated, losses count at full value and gains are capped.

Is that true in perpetuity? That is, does the protection of the "floor" come into play later, at maturity, with some guaranteed value? What does the contract specifically say about providing downside protection?

I'm pretty much in agreement with pb4uski's analysis (which was a very nice job!). The annuity is not a total disaster. Since your friend is very risk adverse and since it's likely you'll not be able to totally separate yourself from being thought of if the outcome of canceling the annuity and reinvesting is poor, I'd be very careful with recommendations. And, in fact, even explanations are going to be very risky for you depending on the outcome.

Is there a way you could bring a professional, fee for service advisor into this fray? With $300k at stake, a $1k fee (for example) to move the target from your forehead to his/hers would seem like money well spent. Remember that even if your analysis is dead on accurate and the probability of the move being successful very high, you'll likely never be recognized for success and will always be remembered for anything less than optimum outcome. You're really putting yourself in harms way IMHO.

 

[Scuba]

Is that true in perpetuity? That is, does the protection of the "floor" come into play later, at maturity, with some guaranteed value? What does the contract specifically say about providing downside protection?



I'm pretty much in agreement with pb4uski's analysis (which was a very nice job!). The annuity is not a total disaster. Since your friend is very risk adverse and since it's likely you'll not be able to totally separate yourself from being thought of if the outcome of canceling the annuity and reinvesting is poor, I'd be very careful with recommendations. And, in fact, even explanations are going to be very risky for you depending on the outcome.



Is there a way you could bring a professional, fee for service advisor into this fray? With $300k at stake, a $1k fee (for example) to move the target from your forehead to his/hers would seem like money well spent. Remember that even if your analysis is dead on accurate and the probability of the move being successful very high, you'll likely never be recognized for success and will always be remembered for anything less than optimum outcome.

Good idea, I will share my thoughts with her and suggest a professional consultation with a CFP to explore other options. Thanks.

 

[Ready]

A risk averse person who does not have a good understanding of finance and investments should not be purchasing an annuity from a sales person. There is no way they will ever understand the nuances of the contract so they will be buying it based on the sales pitch, which as others have stated, tend to sell the sizzle while leaving out meaningful details on the downsides.

If your friends is not comfortable investing at all in equities because they may lose value, they should be purchasing the best bank CD they can find. That's as low risk as they are going to get.

 

[travelover]

..........If your friends is not comfortable investing at all in equities because they may lose value, they should be purchasing the best bank CD they can find. That's as low risk as they are going to get.

Well sure, but how does that make an annuity salesman rich?

 

[pb4uski]

Is that true in perpetuity? That is, does the protection of the "floor" come into play later, at maturity, with some guaranteed value? What does the contract specifically say about providing downside protection?.....

That might well be it... many of these contracts have different account values and you get the higher one.. 3% growth on 90% of premium for equity indexed SPDAs was the common floor back in the late 90s.

 

[mystang52]

I may get flamed for this, but I think OP's friend just needs simplicity in her financial life. I don't think it's a bad idea to just suck it up and redeem the annuity and put it in Wellesley, or some other simpler financial instrument.
The gains she may have missed out on can't be recouped now, so they're just "sunken costs." This annuity sure seems to be deceptive and a major rip-off, legal or not. I wouldn't trust keeping my money there.

 

[Scuba]

I may get flamed for this, but I think OP's friend just needs simplicity in her financial life. I don't think it's a bad idea to just suck it up and redeem the annuity and put it in Wellesley, or some other simpler financial instrument.
The gains she may have missed out on can't be recouped now, so they're just "sunken costs." This annuity sure seems to be deceptive and a major rip-off, legal or not. I wouldn't trust keeping my money there.

I agree with your perspective, and others here have also recommended that. I do like the idea of her talking with a CFP or fee only FA to get their recommendation so all of the responsibility for recommending an alternative isn’t on me. Also not a bad idea for her to speak with her son, the ultimate beneficiary, to see how he invests his long-term money.

Great advice on this thread, thanks to all. I just got her 2018 statement but haven’t had time yet to analyze it. However at a quick glance, the earnings gap widened in 2018.

 

[Clone]

Just be careful that some other shiny shoes salesman doesn't present her with a product that is guaranteed to make money with no risk of losing money!

 

[Scuba]

I've completed my analysis including her 2018 statement. Her IRR is 3.39% annually, better than a CD or money market, but significantly worse than the underlying investments. Most years she was 50/50 in monthly S&P 500 and monthly NASDAQ. The problem is that this annuity caps monthly appreciation at 2%, but does not limit monthly losses. So, there were months that had double digit losses that counted fully against her, but the double digit gains did not benefit her because she was capped at 2%.

The annual cap is 3.75%, if she had been invested in the S&P and NASDAQ annual instead of monthly sum. It seems to me that if she decides to stay with this annuity, it would be better to invest in the annual options instead of the monthly given that volatility is much greater on a monthly basis. However I am not clear what the maximum loss can be on an annual basis - that will be one of my questions for the agent.

I also did an analysis to figure out where she would be if she had just invested in an S&P 500 index fund or ETF. Even assuming average S&P 500 ETF fees of 0.44%, and a conservative 2% for dividend income, her stash would be worth $452K now. Her annuity's "guaranteed value" is $195K less, "accumulated value" is $128K less and even her "enhanced value" which includes the bonus is $48K less than it would be from just investing in S&P 500. Her beneficiary would also have more flexibility inheriting an S&P 500 investment in an IRA vs an annuity.

I can't see any reason why she should stay in this vehicle, even with a surrender charge her beneficiary would be way better off if this cash were invested in the market. I like the idea of asking her son for input and suggesting the two of them decide, and get professional advice if they so desire.

Anything else I'm missing? Thanks again to all who took time to respond!

 

[OldShooter]

I'll defer to others with more expertise, like @pb4uski who IIRC used to be in the business but I will comment on one important point. You ask:

... - If the cash surrender value net of surrender charges is about what she put into this, do you think she'd be better off just cashing this out now? ...

This is an example of what is called the "sunk cost fallacy." Sunk costs are costs already incurred that are not recoverable. They should be ignored when making decisions on future actions because they do not and cannot affect the future. Whether the initial cost was $10K, $300K, or $1M, it doesn't matter. Your task is simply to look at the prospective numbers for each option that exists and to pick the best one. More here: https://en.wikipedia.org/wiki/Sunk_cost

 

[pb4uski]

I've completed my analysis including her 2018 statement. Her IRR is 3.39% annually, better than a CD or money market, but significantly worse than the underlying investments. ...

I also did an analysis to figure out where she would be if she had just invested in an S&P 500 index fund or ETF. Even assuming average S&P 500 ETF fees of 0.44%, and a conservative 2% for dividend income, her stash would be worth $452K now. Her annuity's "guaranteed value" is $195K less, "accumulated value" is $128K less and even her "enhanced value" which includes the bonus is $48K less than it would be from just investing in S&P 500. ....

I can't see any reason why she should stay in this vehicle, even with a surrender charge her beneficiary would be way better off if this cash were invested in the market. I like the idea of asking her son for input and suggesting the two of them decide, and get professional advice if they so desire.

Anything else I'm missing? Thanks again to all who took time to respond!

Is the 3.39% IRR using the cash surrender value as the terminal value or the accumulated value (before surrender charge)? If the 3.39% is based on the CSV, then what is the IRR with the accumulated value as the terminal value?

Have you figured out what the floor is for this annuity? Usually it was 3% interest on 90% of the initial deposit (adjusted for withdrawals of course).

Given that your friend is risk averse and as I understand it would not be comfortable investing in stocks.... I'm not sure if comparing the performance of this contract to having invested in the S&P 500 is useful at all.

 

[Scuba]

Is the 3.39% IRR using the cash surrender value as the terminal value or the accumulated value (before surrender charge)? If the 3.39% is based on the CSV, then what is the IRR with the accumulated value as the terminal value?



Have you figured out what the floor is for this annuity? Usually it was 3% interest on 90% of the initial deposit (adjusted for withdrawals of course).



Given that your friend is risk averse and as I understand it would not be comfortable investing in stocks.... I'm not sure if comparing the performance of this contract to having invested in the S&P 500 is useful at all.

The IRR is based on the accumulated value. The floor is something I’m not quite sure of. Her statements show a guaranteed contract value but I’m not clear on how it’s calculated. That is something I can inquire about when we see her agent.

The reasons I’ve compared performance to the S&P 500 is that that is the investment she’s been choosing, along with NASDAQ, each year as her underlying investments, so I’m trying to show her what her account value would have been if she had simply invested in the S&P outside the annuity. Also, since she says this is long-term money for her son to inherit, she may feel more comfortable taking more risk with this once someone shows her the performance of this instrument vs the market and how much she is potentially leaving on the table.

I’m having a hard time understanding how this particular annuity is protecting her from risk when monthly double digit market declines count against her accumulated value, but the following monthly double digit increases only benefit her to a small extent because of the cap on credit for appreciation. I understand that the annuity company needs to make their profit, but the way I’m seeing it, if she had just invested in the S&P 500 outside of the annuity and still taken out the same withdrawals, she’d be $128K better off. Her accumulated value is only $2K more than when she started. Doesn’t really feel like an equitable arrangement. I’m certainly no expert in this area, but the more I’ve examined the detail of the numbers, the bigger ripoff it seems to be.

Maybe I am just not understanding and appropriately valuing the downside protection provided. I definitely need to ask about the specifics of that. Perhaps an illustration of how this would have performed in 2008-2010 would help me see it in a more positive light?

 

[Scrapr]

I think the bombshell question is to ask why the agent put your friend in the product that has unlimited losses but caps out with 2% gains......then shut up

I would prep your friend that you are looking for a good answer when you ask this and she should stay quiet as well

There may be an uncomfortable pause

 

[pb4uski]

.... Maybe I am just not understanding and appropriately valuing the downside protection provided. I definitely need to ask about the specifics of that. Perhaps an illustration of how this would have performed in 2008-2010 would help me see it in a more positive light?

Yes, understanding the downside protection is key.

Back in the 90s, these products typically had non-forfeiture values based on 90% of premium accrued at 3% per annum, adjusted for withdrawals. The 90% broadly reflects the premium received net of acquisition costs (arguably 10% of premium might be generous on the acquisition costs). The 3% may be lower these days, perhaps 2%. So $100 would have a floor of $120 after 10 years [($100*90%)*(1+3%)^10]... or a floor IRR of 1.92%.

The nature of the guarantee was that at worst you would get your money back and a little something.... and at best you would get credits commensurate with the performance of the underlying index subject to caps and participation percentages. The caps and participation percentages were how the carrier managed their profit... and 200 bps of margin was a typical profit target.

If she is comfortable assuming equity risk then she would probably be better off with a conservative equity fund... like a value fund.

 

[Hermit]

..... The reasons I’ve compared performance to the S&P 500 is that that is the investment she’s been choosing, along with NASDAQ, each year as her underlying investments, so I’m trying to show her what her account value would have been if she had simply invested in the S&P outside the annuity. Also, since she says this is long-term money for her son to inherit, she may feel more comfortable taking more risk with this once someone shows her the performance of this instrument vs the market and how much she is potentially leaving on the table.....

I think you are doing your friend a disservice in focusing on the market performance in the last 5 years. That performance is not normal and likely will not continue in the future. At the most, you could point out the average market performance, but to say she "lost" thousands of dollars really has little to do with the future and is setting her up for possible pain in a future down market. I would concentrate on the monthly full losses and limited monthly gains.

 

[jazz4cash]

OP
Looking forward to your update after meeting with the annuity salesperson. I believe you know a lot more about this product than the seller and they will be unable to answer any of your questions without consulting home office.

 

[Scuba]

OP
Looking forward to your update after meeting with the annuity salesperson. I believe you know a lot more about this product than the seller and they will be unable to answer any of your questions without consulting home office.

Could be true. I met with the annuity owner Friday and showed her the double digit differences in her return vs the underlying investments return. The S&P 500 and NASDAQ have made money each of the last five years, while her account has lost money three of the last five due to the capping of returns. She hadn’t understood the capping that her annuity has.

We agreed on a list of questions to cover during her appointment. One of the most important questions is to better understand the downside protection. If her account loses value even while the market/underlying investments perform well, I wonder what happens when the market crashes?

Our appointment is this week. Should be interesting.

 

[pb4uski]

Just out of curiosity, who is the issuing insurer?

 

[youbet]

I think the bombshell question is to ask why the agent put your friend in the product that has unlimited losses but caps out with 2% gains......then shut up

I would prep your friend that you are looking for a good answer when you ask this and she should stay quiet as well

There may be an uncomfortable pause

I really doubt that the annuity gives no consideration in exchange for the 2% gains cap. The consideration may not be a good value, but I doubt that the answer will be something simple like "by assigning you all the losses and limiting your gains to 2% we make more money." Scuba needs to research a little deeper to determine what the consideration is that her friend will receive in return for the 2% gains cap so it can be discussed at the meeting and is not a total surprise.

Of course, if in fact Scuba's friend was told there was some of downside protection and there is none of any sort, then we have a serious legal issue which will likely require professional help to resolve.