fixed annuities -- issuer insolvency risk

[medved]

I am considering buying a fixed annuity -- either deferred for several years, or waiting several years and then buying an immediate annuity. The reason I would do this is that I do not have a pension, and I think I would sleep better at night with some minimum annual income that is guaranteed. I would probably put only 10% or so of my total net worth into annuities.

I am not really asking whether you think this is a good idea or not. I realize there are different opinions about that. But I can figure that out for myself

My question is whether anyone has considered, in buying annuities, the risk of issuer insolvency/default. That risk is probably small -- but it is not zero.

There are state guaranty funds, but they tend to have relatively modest limits -- like a few hundred thousand dollars. (And if you move to a different state after you purchase the annuities, there is also the issue of which state's guaranty fund and applicable limit governs).

Has anyone, in an effort to address this risk, purchased a number of separate annuities from different issuers? For example, if you wanted $2mm in annuities, and the state guaranty limit was $300k, you could buy 7 separate annuities. I guess one could also ladder the annuities -- say, for example, buying one a year, and thereby diversify interest rates as well.

Any experience with, or thoughts about, this?

Thanks.

 

[MarieIG]

I have not done this, but I have thought about it. I would not buy an amount over the state guarantee. Nothing wrong with laddering, and you can income streams trigger at different ages and at different (hopefully better) interest rates.

 

[Potstickers]

When I looked into the state guarantee funds, it seemed as if the coverage was based on the state in which you live at the time that the regulator declares the insurer insolvent. So, even though your annuity might be sold by a company based in Pennsylvania, if you live in Florida, it would be Florida's limits that apply.

Buying annuities with values (and I'm not sure how they're valued) below your state's guarantee limits would seem to be a reasonable risk mitigation strategy.

But I am certainly no expert.

 

[zinger1457]

Spreading it out seems like a reasonable approach, you'll also want to factor in the ratings (https://www.immediateannuities.com/insurance-company-ratings/) of the insurance companies you're considering buying from. It's been awhile since I priced fixed annuities but from what I recall the payout did vary quite a bit from one insurance company to the next for a given $ amount so you might take a little hit in the total payout by spreading it out but it's probably worth the extra safety benefit you'll get.

 

[brewer12345]

Issuer insolvency is definitely worth guarding against. There are state guaranty funds, but they are a pretty weak backup so I would not plan on depending upon them.


I used to deal with insurer creditworthiness professionally. If I were putting a substantial amount of money into a SPIA or deferred annuity, I would adhere to the following rules:


- spread the money out to 3 or 4 insurers
- only buy from companies rated AA-/Aa3 or better
- whenever possible, buy from mutual insurers, the bigger the better

 

[Lawrence of Suburbia]

I have about 67% convinced myself to buy a SPIA (or two) when the time comes; but the % of my portfolio I would spend is a fraction of my total -- 12% or so, or just enough so that the combined S.S./SPIA income equals about half what I need in monthly living expenses. That small shift in asset allocation away from the usual stocks/bonds/rebalance model means that my WR from that larger part of my portfolio is significantly smaller (3.6%-ish instead of 4%+). And, as I'm not retired yet, I'm going to wait and see what my real-life WR is. May not need the SPIA. I may get by on my musician skills.

 

[medved]

The question of “real life withdrawal rate,” or spending rate, is one that I find challenging to predict. I honestly have no idea what I will end up spending in retirement. And I think the amount that I am spending these days is not a good proxy, or even close to a good proxy, for what I will spend in retirement. I think I’m going to have to just live my life in retirement for a few years and see how it goes.

That seems a little inconsistent with the way most people around here seem to do things, with a lot of planning and modeling, but I just don’t see it for me.

 

[Red Badger]

While there is always some risk the issuer(s) failing, my aversion to annuities is inflation risk. We have some of the conditions (low unemployment, massive debt, etc) that preceded the Great Inflation that lasted over a decade. Just a few years of even high single-digit inflation could wreak havoc on a fixed annuity. I have a very modest non-cola pension (which I am grateful for). For me, that is enough interest "exposure" for our little nest egg.

 

[medved]

The inflation risk is real, and recency bias is dangerous. But I think I can deal with that risk by devoting only about ten percent of my investible assets to annuities and having some of the rest in equities and TIPS, both of which can be expected to offer a measure of inflation protection.

 

[Lawrence of Suburbia]

I see SPIAs as of more value to someone whose retirement savings are in the "barely enough" category -- not for someone so wealthy that they could just live off the dividends. It is, after all, insurance against utterly running out of money. So, putting 10-15% into one while leaving the rest in stocks and bonds -- there's your inflation hedge.

 

[MikeTN]

I have annuities from TIAA. TiAA has the highest possible rating from each of the three major rating services. I have been receiving annuity income from them for 8 years now, and I have no complaints.

 

[Senator]

According to my Annuity sales guy, that is nothing to worry about.

 

[MikeTN]

Wade Pfau has made the case that a portfolio of Single Premium Annuities (SPIA) and stocks is superior to a portfolio of bonds and stocks in many cases. See, his article, "A Broader Framework for Determining an Efficient Frontier for Retirement Income" in the Journal of Financial Planning. https://www.onefpa.org/journal/Page...Efficient Frontier for Retirement Income.aspx

 

[REWahoo]

Wade Pfau has made the case that a portfolio of Single Premium Annuities (SPIA) and stocks is superior to a portfolio of bonds and stocks in many cases. See, his article, "A Broader Framework for Determining an Efficient Frontier for Retirement Income" in the Journal of Financial Planning. https://www.onefpa.org/journal/Page...Efficient Frontier for Retirement Income.aspx

In the spirit of full disclosure, please note that Wade Pfau is "Professor of Retirement Income" at The American College of Financial Services, which describes itself as: (my bold)

Serving as a valued business partner to banks, brokerage firms, insurance companies and others since 1927, The American College of Financial Services has assembled a faculty of the foremost thought leaders in financial services to help advisors and their clients succeed.

https://www.theamericancollege.edu/about-the-college

 

[Sunset]

I am considering buying a fixed annuity ..... I would probably put only 10% or so of my total net worth into annuities.

........ in an effort to address this risk, purchased a number of separate annuities from different issuers? For example, if you wanted $2mm in annuities, and the state guaranty limit was $300k, you could buy 7 separate annuities. I guess one could also ladder the annuities -- say, for example, buying one a year, and thereby diversify interest rates as well.

Any.... thoughts about, this?

Thanks.

Well if 10% is $2mm , then the total nut is $20mm.. very nice..

As for the spreading of risk by buying annuities from various companies, spread over a time line, I think it's an excellent idea if you are going to buy annuities.

Although personally I'd wait on annuities until past age 70 or in 8 years, whichever comes first.

 

[Lawrence of Suburbia]

Someone with $20m should be able to live more than decently on dividends alone! > $500k from VWIAX, fer gawdssake.

 

[hesperus]

Is the annuity idea on the advice from your FA? I remember your earlier thread seeking allocation advice from a couple of years ago:
http://www.early-retirement.org/forums/f28/asset-allocation-81607.html#post1721036

 

[medved]

It is an idea I have discussed with the FA. I would not really say the FA is advocating a SPIA or deferred Income annuity, but more just trying to make sure I consider it and helping me think through the pluses and minuses. Some part of this is really more psychology than finance - I feel like I will sleep better knowing that I will have $X a year for the rest of my life and my wife’s life come hell or high water.

 

[Sunset]

It is an idea I have discussed with the FA. I would not really say the FA is advocating a SPIA or deferred Income annuity, but more just trying to make sure I consider it and helping me think through the pluses and minuses. Some part of this is really more psychology than finance - I feel like I will sleep better knowing that I will have $X a year for the rest of my life and my wife’s life come hell or high water.

Well, you do realize that is an impossible standard, there are a number of possibilities that would cause all your annuities to stop paying. They are rare, or unlikely, but not impossible.
The obvious one is you and your wife are vacationing in Australia, and the country you bought all your annuities in becomes embroiled in a nuclear exchange wiping out all major cities.

Your checks stop, and the insurance companies and possibly the government is gone.

 

[bmcgonig]

Well, you do realize that is an impossible standard, there are a number of possibilities that would cause all your annuities to stop paying. They are rare, or unlikely, but not impossible.
The obvious one is you and your wife are vacationing in Australia, and the country you bought all your annuities in becomes embroiled in a nuclear exchange wiping out all major cities.

Your checks stop, and the insurance companies and possibly the government is gone.

Good point. That's the first thing I think about when considering an SPIA

And how do you think an alternative portfolio would have performed in that situation now that the US Government is gone...?

 

[samclem]

. . . I feel like I will sleep better knowing that I will have $X a year for the rest of my life and my wife’s life come hell or high water.

You may have a guaranteed $X per year coming in, which can today buy a pizza per day (or pay the baseline bills--utilities, property taxes, etc), but the number of pizzas you can buy with that check is almost certain to go down every year if the $X remains the same. So, if "baseline buying power for the rest of our lives"" is the goal, you'll need to buy something other than a fixed annuity.

 

[pb4uski]

The credit risk of a highly rated insurer is negligible due to regulatory oversight, capital requirements, rating agency requirements, etc... much safer than a bond and state guaranty funds backstop the policy. In most cases, if an insurer get into trouble, the insurer or blocks of policies can be sold to other insurers.


If you do buy an annuity, focus on highly rated insurers like NML, NYL, MassMutual, etc. and try as best you can to stay within the state guaranty fund limits.

 

[medved]

Good point. That's the first thing I think about when considering an SPIA����

And how do you think an alternative portfolio would have performed in that situation now that the US Government is gone...?

I have also considered the risk that Pac Man could eat the insurance company or that the United States could be purchased by a country that outlaws all financial products beginning with the letter "a." But those risks seem relatively modest.

Inflation is a big risk (the "fewer pizzas" issue samclem refers to), but I think this risk can be substantially mitigated by having other investments, outside the annuity that should help keep up with inflation, such as TIPS and stocks. And I think the risk of issuer insolvency/default can be mitigated by buying from highly rated issuers, spreading among several of them, and trying to keep below or close to the state guaranty limit.

 

[Lawrence of Suburbia]

The stocks you own (or mutual funds) apart from your income annuity will keep you in pizza*. Your $X from annuities should be accompanied by $3-4X from a standard balanced portfolio.


*Presuming you're buying, I'll have a sausage & mushroom slice and a Stella Artois.

 

[sheehs1]

medved...I have considered an immediate income annuity and have not ruled it (them) out. I too would do it with about 10% to 15% of liquid investable assets. But I would either ladder them or do it for 5 or 10 year increments.

The problems I have with pulling the trigger are:
1) I've been waiting for interest rates to rise (still waiting!)
2) They are just paying me back with my own money so the thought is "I can do this myself", pulling $$ out of an account on a monthly basis. (common sense!)

I'm not too terribly concerned about the insurance company going belly up as I would only do A rated companies and stay under the state guarantee levels per company.

I am also not too terribly concerned with inflation risks as my other liquid assets (90%) are invested to "take care of that" (hopefully!).

While I still have income coming in, my thought is that as soon as that ends (If it ever does), I will route a portion to a fixed income annuity-basically building my own pension.

It would be a part of a 4 or 5 legged stool for cash flow and income AND one way to diversify funds since there is that much and more sitting in banks. I know it may not make much sense, since invested conservatively, that money can throw off income but....perhaps the real question is "Why not?", if one can protect themselves somewhat from inflation risks, get a decent interest rate return as part of the payout and has other investments.

There is some comfort in knowing that money is coming in regardless of the stock market....and other risks.

For the record I am NOT a fan of deferred annuities except at end of life stages and only when used as a wealth transfer vehicle and when we don't have 10 investing years left to weather the ups and downs of the stock market. (as if we know when that will be!)