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.