Submitted by Steve Selengut
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The Real Scoop on Annuities - Part One
Insurance companies are big time financial institutions, and they once claimed possession of the largest and safest investment portfolios on the planet. Then, their role vis-à-vis Wall Street was clearly that of a giant customer for the securities the investment banks brought to market and which the securities firms distributed. Their real estate holdings were religious in size and quality. They were direct lenders to corporations, their owner-policyholders, and to other institutions. They were the Trustees who managed the private employee pension plans of the world.
Insurance companies sold life insurance policies and annuity contracts that contained guaranteed benefits that depended on their ability to invest safely and soundly. They sold investment management services that built upon their legendary reputation as an industry built upon guarantees, trust, and the financial integrity of their investment portfolios. They were not known for the production of unusually high rates of return, but they were one of only three entities allowed to utter the sacred g-word, and the only one that marketed products that protected people from the financial vagaries of life and death. It was a simpler world then, one less prone to the conflicts of interest, scandals, and financial disruptions that exist on the modern Wall Street. Today, it's difficult to distinguish one financial institution from another as they compete for the ever-growing pool of investment dollars. Insurance companies, now publicly owned, have become an integral part of an industry that seems uninterested in protecting anything other than their obscenely paid leaders.
The time-honored distinction of the annuity contract was the guaranteed retirement benefit it provided. The "you will never outlive your income" boast could not be uttered by any other financial entity! The annuity contract itself was never intended to be an investment product, although the disciplined savings of the deferred variety was certainly given well-deserved emphasis. This was the original old age and disability retirement program--- a contributory, but trustee directed, investment account that anyone could have for a few bucks a week. Like bank savings accounts and federal government securities, risk of loss was not a factor, and the guarantee was a benefit well worth the lower than market yield. Over a hundred years, the concept became generic: Annuity = Guarantee--- safe, solid, and virtually risk free. Equities were nowhere to be seen; derivatives had yet to come of age; neither seemed necessary. The guarantee was enough--- it still is, but annuities are best suited to the healthy poor.
Annuities were developed for the protection of the indigent--- people without the assets needed to generate enough income to sustain them in retirement. An annuity is a series of identical payments made over a specific period of time. Any departure from a plain vanilla, one-life, annuity reduces the payout because of additional time, cash back, or life contingencies. In its purist form, a fixed amount is paid to the annuitant until his or her death. Any leftover funds belong to the company, and the company continues to pay those who live longer than predicted by the actuarial tables--- a simple concept, actuarially pure, easy to deal with, and with no surprises (until the government decreed that men are required to live as long as women).
Annuitants would never outlive their income, but absolutely nothing would be passed on to their heirs; a dismal prospect for the kids, but a valuable benefit for the retiree. The annuity was a last resort scenario for those who didn't have the financial resources to support themselves. I don't know about you, but this sure sounds like a great way to fund a Social Security program! The companies make enough money on the plain vanilla variety to pay their salespeople between 8% and 12%. Typically, they lock-up the money for eight to twelve years with large penalties and pocket most of the additional income that their actual investment and expense experience produces--- but for those who can't fund their own retirements, this is entirely acceptable. A mandatory, fixed annuity based Social Security really needs to be considered to replace the counter-productive system in effect today--- there would be no need for the commissions.
Enter the modern day Variable Annuity oxymoron, sold by an industry that has lost touch with its noble roots, if not the realities of the stock market.
Annuities Part Two: http://retirementreadyincomeprograms.com/Inv/index.cfm/5665