Given that I have never dealt with annuities and given that I have never liked them (because investment texts degrade them because of their high cost and complexity), it has been really interesting for me to discover that academics love annuities. There seems like almost universal support for annuities as the solution to retirement income spending needs (at least deferred income annuities).
The initial investment for a lifetime deferred fixed annuity paying $1000/mo in 20 years is $26,894.
The PV of a deferred fixed annuity based on 20 years of monthly $1000 fixed payments is $57,108 (assuming 5% discount rate).
Looks like the annuity is a much better deal than trying to construct it yourself.
Showing posts with label deferred annuities. Show all posts
Showing posts with label deferred annuities. Show all posts
Saturday, May 2, 2015
Tuesday, March 31, 2015
An Idea Whose Time Has Come
Laurence Siegel et al of his ilk have really thrown a gauntlet to the financial services industry.
But first: I don't like Laurence's close ties and basic advocacy of insurance products and insurance companies - because I don't trust them (they are run by actuaries with ROI hurdle rates on products). Because insurance companies can't control market returns they control their shareholder returns by embedding high costs into their products to cover their business and market risk.
Having said that, Laurence has outlined a simple, robust way for the industry to meet and support the post retirement needs of retirees. To this end he advocates the creation of new low cost annuity companies insulated from corporate default risk structured as follows:
These ideas are something the industry should, and can easily do, but won't because it can't make money from it. Someone will no doubt have a go at it but are likely to struggle. It will be a number of years before the industry mutates toward this model.
But first: I don't like Laurence's close ties and basic advocacy of insurance products and insurance companies - because I don't trust them (they are run by actuaries with ROI hurdle rates on products). Because insurance companies can't control market returns they control their shareholder returns by embedding high costs into their products to cover their business and market risk.
Having said that, Laurence has outlined a simple, robust way for the industry to meet and support the post retirement needs of retirees. To this end he advocates the creation of new low cost annuity companies insulated from corporate default risk structured as follows:
- Separate corporate structure insulated from financial exposure to affiliated companies.
- All reserves held in default-free Treasury bonds and TIPS and properly hedged to the liability as closely as possible at all times.
- “Participating” policies, so that any longevity surprises are
used to reduce annuity benefits proportionally instead of forcing the
insurer to default entirely on some of the benefits (after going
bankrupt)
Advocate for setting up a 20 year TIPS ladder based on expected withdrawal rate complemented by a deferred income life annuity to protect against longevity risk.
- Very broad participation so there is little adverse selection.
Withdrawal rate or spending rate based upon an annually recalculated variable annuity (ARVA).
These ideas are something the industry should, and can easily do, but won't because it can't make money from it. Someone will no doubt have a go at it but are likely to struggle. It will be a number of years before the industry mutates toward this model.
Saturday, February 14, 2015
The Retirement Conundrum
Notes from Jason Scott's FAJ article "The Longevity Annuity: An Annuity For Everyone?"
The retirement conundrum is how to "turn a pool of assets into a stream of retirement income."
Academics says annuities are the way to go. People don't like annuities and the advisory industry doesn't like annuities. Annuities are too complicated, too expensive, and force you to give up your assets.
The research indicates that a deferred annuity (as distinct from an immediate annuity) is optimal for retirees unwilling to fully annuitize. For a typical retiree, allocating 10-15% of wealth to a deferred annuity set to start late in retirement creates spending benefits comparable to an allocation to an immediate annuity of 60% or more.
It was four decades ago that economic theory concluded that individuals who wish to maximize guaranteed spending in retirement should convert all their available assets to an immediate annuity.
Deferred annuities are preferable to immediate annuities because of the well documented behavioral biases in decision making and maximize the insurance benefit per premium dollar.
The benefit of insurance depends upon the cost of insurance to the cost of replacement of the asset insured. You are looking to maximize the benefit per premium dollar (self insurance cost - insurance cost)/insurance cost). To evaluate the potential insurance benefit, one simply considers the likelihood of a payout. If an insurance payout is unlikely, insurance is generally cheap relative to self insurance and insurance can provide substantial benefits. If an insurance payout is highly likely, insurance cannot be provided at must of a discount to self insurance.
Securing spending in the future with bonds (liability matching using zeros) is analogous to setting aside the full replacement cost of the car (or income desired). A zero coupon annuity offers spending in 20 years at nearly a 50% discount to self insurance in the bond market.
Implication: Get retirees or those close to retirement to take some portion of their accumulated assets and purchase a 10, 15, 20, 25 year deferred annuity. They can use the difference to live on (along with social security) until the deferred annuity kicks-in (while using the residual assets as well).
Immediate and deferred annuities just represent a bundle of zero coupon annuities. The difference is that immediate annuities add near term, low value annuity payments to the bundle, ie. they are much more expensive because they are much more likely to be claimed.
The optimal bundle of zero coupon annuities to purchase depends upon the amount of assets the retiree is willing to annuitize.
Uber wealthy don't really need to deal with this issue. Also the poor (those with few liquid assets) and the unhealthy are not good candidates for deferred annuities.
The retirement conundrum is how to "turn a pool of assets into a stream of retirement income."
Academics says annuities are the way to go. People don't like annuities and the advisory industry doesn't like annuities. Annuities are too complicated, too expensive, and force you to give up your assets.
The research indicates that a deferred annuity (as distinct from an immediate annuity) is optimal for retirees unwilling to fully annuitize. For a typical retiree, allocating 10-15% of wealth to a deferred annuity set to start late in retirement creates spending benefits comparable to an allocation to an immediate annuity of 60% or more.
It was four decades ago that economic theory concluded that individuals who wish to maximize guaranteed spending in retirement should convert all their available assets to an immediate annuity.
Deferred annuities are preferable to immediate annuities because of the well documented behavioral biases in decision making and maximize the insurance benefit per premium dollar.
The benefit of insurance depends upon the cost of insurance to the cost of replacement of the asset insured. You are looking to maximize the benefit per premium dollar (self insurance cost - insurance cost)/insurance cost). To evaluate the potential insurance benefit, one simply considers the likelihood of a payout. If an insurance payout is unlikely, insurance is generally cheap relative to self insurance and insurance can provide substantial benefits. If an insurance payout is highly likely, insurance cannot be provided at must of a discount to self insurance.
Securing spending in the future with bonds (liability matching using zeros) is analogous to setting aside the full replacement cost of the car (or income desired). A zero coupon annuity offers spending in 20 years at nearly a 50% discount to self insurance in the bond market.
Implication: Get retirees or those close to retirement to take some portion of their accumulated assets and purchase a 10, 15, 20, 25 year deferred annuity. They can use the difference to live on (along with social security) until the deferred annuity kicks-in (while using the residual assets as well).
Immediate and deferred annuities just represent a bundle of zero coupon annuities. The difference is that immediate annuities add near term, low value annuity payments to the bundle, ie. they are much more expensive because they are much more likely to be claimed.
The optimal bundle of zero coupon annuities to purchase depends upon the amount of assets the retiree is willing to annuitize.
Uber wealthy don't really need to deal with this issue. Also the poor (those with few liquid assets) and the unhealthy are not good candidates for deferred annuities.
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