By David Merkel, CFA of Alephblog
Those that have read me for a long time know that I am a proponent of immediate annuities. Though they pay a fixed stream of income, they are more useful than bonds, because they provide longevity insurance; they can be tailored to prove an income that you can’t outlive, for you and your spouse.
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But I got really annoyed when I saw an ad that said the following:
- 7% Income Guaranteed
- No RISK of Principal
And if you click on it, it takes you here, where they talk about 8%+ returns. Total garbage.
Yes, if you are old enough, when you buy an immediate annuity, the annual payment may be 7% or more than the amount that you gave to the insurance company. But with the yield on long low-investment grade bonds hovering above 5%, I can tell you with certainty as a life actuary that the life companies are not providing a 7% return to retirees — it is far, far less, more like 4%, or maybe less.
So why the difference? Immediate annuities work off of the idea that a lot of people will die, and money from their annuities is reallocated to the living (minus a profit for the insurer, on average). The insurer earns 4.5% on its investments, and additional money of 3.5-5.0% from deaths of annuitants supports the payments of those living, with 1% to cover commissions, administration, and profits.
So, they advertise that they are paying you 7-8%+, when they are really paying you 4.0-4.5%, and exposing you to the risk of inflation, because that payment will never rise. Ask them for payout levels on inflation-adjusted immediate annuities, and watch your jaw drop as you see how relatively low the payments are.
This is dishonest advertising, because not only are they not giving you the true level of returns, but they tell you there is no risk of principal. Guess what, though I like immediate annuities, the only reason there is no risk of principal with them is that you surrender your principal when you buy one. Your principal is gone, and you have a payment stream that will disappear at death (or death of you and your spouse).
This advertisement was probably put together by an independent agency, but blame still goes to the insurers that allowed themselves to be involved in such a scam:
- Fidelity Investments
- Genworth Financial
- Midland National
- New York Life
- Pacific Life
- Prudential (US)
Shame on all of you. This is deceptive advertising that defrauds those who trust the representations of your agent. State Insurance Commissioners, please take note.
If something seems too good to be true, it usually is, and this is another example of that.