while I agree with the tone of your piece (and deeply sympathize with your child) I disagree with some specifics. What "risk is assumed? Annuities are prepaid against mortality tables. There is no excess risk (uncertainty risk in mortality tables is almost always on the down side, which is a problem for insurance but a benefit for annuities
I'm not sure what you mean by "down side" risk in mortality, or why you think it is a benefit for annuities.
We know that mortality rates have been falling for a century. We don't know how much they are going to fall over the next 30 years. The insurance company makes a guess. If they are wrong, and mortality drops faster than expected, then their costs go up and they lose money. Mortality can be lower than expected either because population mortality turns out to be lower, or because the particular group that bought their product happens to be healthier than the company thought they were going to be (more mortality anti-selection than anticipated). That's the mortality risk assumed.
and "provide a market return on capital" They don't provide the capital. do you emean investment costs?
We must mean something different by "capital". An insurance company holds assets on a new block of SPIAs that exceed the assets that can be purchased with the premiums. The extra assets are provided by somebody else, that's "capital" to me. Those extra assets will disappear if the company experiences mortality losses as described above. They will also disappear if the company suffers investment losses (primarily defaults and reinvestment losses with SPIAs) in excess of whatever was assumed in pricing.
The people who provided the money to buy those extra assets expect a higher return than they would get by simply investing in treasuries (they need a higher alpha to compensate for the higher beta). That extra return shows up in the market price of the SPIA.
Note that any prudent management needs to have some capital to cover the actual economic risks. Since insurers capital levels are regulated, sometimes companies hold more capital than management feels would be adequate. That extra capital also needs to get the market return.
That leaves only "expenses in writing and managing the business"
(includes investment costs) Which I agree are real costs, but are easily regulated. Operational costs of annuities are very small , less than one percent of the value. Most of the rest is cost of sales and commissions.
Why would anyone regulate the operating expenses of an insurance company? We don't regulate supermarkets' operating expenses. How are insurers different?
I am not hostile to annuities. I bought one for my step mother in law after investigation and I'm pricing one to equalize mine and my wife's pensions.
my pension had the right to purchase 2 extra years of service at full cost, which was effectively the right to buy an annuity at an actuarially fair rate which by law had to include full costs. I did not take it because we were already more than 50 % of assets in annuities and equivalents. But it was 7% cheaper than commercial annuities and I do suffer from failed buyers remorse.
Relating to the capital issues above, is that additional annuity regulated by your state insurance laws on the same basis as private annuities? If the actuarial assumption turn out to be wrong, who loses money as a result, and is that party being compensated at market rates for taking that risk? Who's picking up the operational expenses of managing the annuity? Does the actuarial assumption include as much mortality anti-selection as we'd expect in the individual market, or is it lower because of the different "purchase" psychology? I can believe that there's no marketing expense with that offer because you're basically a captive audience, so that difference is real. I wonder if the other differences aren't all being absorbed by your employer.
I believe that annuities have always been sold like whole life life insurance rather than marketed like term insurance
I think if SPIAs have had "excess" marketing expenses in the past, those days are pretty well gone. It can be an extraordinarily simple product "You give me $X today, I'll give you $y per month as long as you live." It's actually easier to quote on the internet than term because there usually isn't underwriting. The only issue is the market is so small there are no scale economies. I'd guess there are companies that are willing to lose money on administration today just because they believe that someday the 401k rollover market is going to be huge and they want to be positioned for it, so that's a plus for buyers.
