Fixed Payment Annuities

On Fixed Payment Annuities by David Merkel, CFA of Aleph Blog

Before I start, thanks to all those who e-mailed me over my “sorted weekly tweets.”  I am likely to continue doing them.  That will start next week, because I have had a flood of new clients, and other obligations.

On Fixed Payment Annuities

How often do you run into articles in quality publications talking about annuities that will pay a fixed sum over your life, or over your life if you live past a certain age?  Not often, right?  Right.  Well, today I got two articles on the same day:

Vanguard’s move into PE may change the landscape forever

Private equity has been growing in popularity in recent years as more and more big-name funds and institutional investors dive in. Now even indexing giant Vanguard is out to take a piece of the PE pie. During a panel at the Morningstar Investment Conference this year, Fran Kinniry of Vanguard, John Rekenthaler of Morningstar and Read More


Longevity insurance is an important topic, and everyone should consider getting an income that they can’t outlive.  That said, there are two problems with this:

  • Inflation, and
  • Credit risk (will the insurer survive to make the payments?)

It is possible to buy inflation-protected annuities, but at a cost of a lower initial payment.  With credit risk, consider what the state guaranty funds will cover in insolvency, and realize that any payments over that amount could be lost due to insurer insolvency.  If you have a large payment, only buy from strong insurers.

Then there are the deferred fixed payment annuities.   You are 50 years old, and you want a payment stream that kicks in when you are 80, should you live so long.  You can buy a lot of income that far out, which will help you if you survive, subject to the same two main risks: inflation and credit risk.  I am not aware of any deferred inflation-adjusted payment annuities.

Now, you can think of your annuity as a replacement for long-dated fixed interest bonds.  A portfolio of fixed payment annuities, cash, maybe some commodities/gold, and stocks could be very stable, balancing the risks of inflation and deflation, and of high and low real rates.

There is the added benefit of the regular income which is useful to average people, who are okay with budgeting, but really don’t understand investments.  Just beware inflation and credit risk.

One more note: most insurance agents will never suggest immediate annuities to you because when you buy one, that’s the last commission the agent ever gets.  They would rather you buy a deferred annuity, where they can gain another commission when the surrender charge period is up, and roll you to a new product.

Summary

Longevity insurance is good, but be sure you avoid credit risk, and have other assets to compensate for potential inflation risk.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.