Thursday, September 6, 2012

Example of a More Complicated Annuity


I received a PR announcement today with a link to this video about the new Allstate IncomeProtector(SM) Annuity:



Though the video explains things in a so-so manner, it still leaves a number of questions in mind and it gets to an important point which Moshe Milevsky brilliantly emphasized in a column he wrote for Research Magazine several years ago. Anyone thinking to buy such a product would be very well advised to read Prof. Milevsky's column very carefully.

Some basic questions I have after watching the video include: what are the fees that impact the contract value (as that determines how much will be available as death benefits or if the contract is ended) and why doesn't the video mention inflation risk (as all of these amounts are in nominal terms).

But the really important issue is exactly what Prof. Milevsky describes in his article. There are a few extra features (such as the initial bonus and the 1 time income raise 5 years after benefits start) to keep actuaries busy, but the basic example this provides is of a single male at age 60 who earns 7% a year for 10 years and then receives a fixed payout of 5.25% for the rest of his life after that. Note that the video doesn't mention 5.25%, it only says you get $19,477 from $371,000.

Prof. Milevsky's point is that treating the 7% and the 5.25% numbers separately is very misleading.

A 70 year old male could currently get a SPIA with a payout rate of about 7.8%, which is much higher than the 5.25% payout rate from this product. That effectively makes the 7% growth factor for the guaranteed income base irrelevant, as be sure to understand that the guaranteed benefit base ($371,000) is not an amount you own... it is just a hypothetical amount used to calculate your payment. The amount you own depends on the contract fees which are only mentioned in passing.

In other words, you get an attractive 7% return on your money which is later nullified by the rather low and unattractive annuity payout rate. Though you get the contract value if you end the contract, the video doesn't say at all about what the fees are, and I think clear and transparent explanations of fees should be part of any marketing presentation.

12 comments:

  1. Wade - you are right, it is confusing. The distinction between the contract value and the income base is not very clear at all, and there are a number of moving pieces to this product that are very difficult for a lay person to understand. However, at the same time, I do appreciate what the product is attempting to accomplish - to overcome the marketing challenge of SPIAs by offering an alternative that provides some liquidity while, at the same time, providing longevity protection. This liquidity comes with a cost, though, so you are not going to get the same level of income that you would get if you were willing to forgo liquidity.

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    1. John,

      Thank you. That is a good point I didn't mention. The fact that the SPIA provides no liquidity does justify a lower payout rate for this product, which does have a contract value that can be returned.

      I didn't go to the Allstate webpage to try and figure out what the fees for this are, but now I'm rather curious about it.

      Wade

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    2. Aha, information about fees may not even be available on the Internet. You may have to talk with an insurance agent to learn about them.

      That's not particularly transparent.

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  2. My knee-jerk response to these complex products is that they are _designed_ to be confusing and misleading to the average Joe. Its just like the complex negative amortization mortgages that were marketed to sub-prime borrowers.

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  3. Another question: what is the death benefit before any income gaurantee payment date, and after? I assume before it is the contract value and after $ (life only)

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  4. Wade,

    Thanks for posting this. Please follow up and tell us what the hidden expenses are for this guy.

    Ari

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  5. Thank you for the additional comments.

    Ari, I emailed the guy who sent me this video link to ask for more info. I'm not sure if he will reply, as he might be an outsourced marketing firm.

    The email says to contact your local Allstate agent for more info about this. As I am writing from Japan, that is a bit tricky for me right now. If someone else wants to seek this info, I'd appreciate it.

    We can see what the 7% guaranteed return turns into after the fees are taken out for someone who may want to cash out and get their contract value before getting the income payments.

    Again, the guaranteed benefit base and the contract value may be very different because of the compounding effects of fees. The guaranteed benefit base is hypothetical, and the contract value is what you own.

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  6. Hello Wade, your article is nice one and has good information also your Prof. Milevsky point is very interesting to know, I hope you will share more on this.

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  7. Wade nice to meet you and you are absolutely right about some thing can not change after this PR but introversion may be can change some thing for you, me always feel better when some one share there ideas with their blog and forum, because where you can did some thing as you want to know.
    Thanks Wade

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  8. 'Complicated annuity' is the most complex topic I've ever read. Every time, I confused my self in numbers. I guess this post can lessen my worries.

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  9. The 7% and the 5.5% aren't misleading in the least. They're copying other, more successful insurance companies in doing this, but it's real easy to understand. Seems you're trying very hard (unsuccessfully) to make this much more complicated than it is. I don't know much about Allstate per se, except for their auto and home insurance. But guys are seriously making a mountain out of a molehill here. And you say that SPIA will give you more? Now, in 2013? Are you outta your mind? Where's the growth in a SPIA? You should not TOUCH a SPIA until rates get real big, which ain't gonna happen any time soon. Caveat...maybe a SPIA as part of a split annuity.

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    1. Thanks for sharing, but I still think it is misleading, or at least hard to understand. You are told that you get a 7% return, but that is just for a hypothetical calculation that you only get to enjoy if you take their subsequent annuitization rate, which is quite a bit lower than the going SPIA rate for someone at the same age. It's sort of like a company doubling the price and then making a big deal out of a 50% off sales promotion. And if you don't decide to annuitize, the 7% hypothetical return is meaningless, and all you get is your contract value after all the fees and surrender charges which are completely opaque and hidden from the general public. As well, presumably their annuitization rate is tied to interest rates, so why is it a good idea to use this and lock in a future annuity rate based on today's interest rates while simultaneously saying it is a terrible time to buy a SPIA? That doesn't make any sense.

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