Annuities are a scary subject in our industry. Producers are scared about compliance and suitability rules. Carriers are scared about the impacts to their capital. Consumers are scared about getting burned because financial celebrities say annuities are evil. Yikes!
Are annuities really that scary? Not in the textbook sense. When I think back to the 10th grade (yes, I am grateful I can think back that far), I remember learning about annuities in math class. They were defined the same way Wikipedia defines them:
- "In finance theory, an annuity is a terminating 'stream' of fixed payments, i.e., a collection of payments to be periodically received over a specified period of time"
Annuities were a subject under the category of "time value of money." They helped us understand how to turn a lump sum into a stream of payments and vice versa. You could just plug in interest rate assumptions, the number of payments and either the principal or the payment amount into a formula and solve for the rest. When I was in high school, there were calculators made by HP that did the math for you. By the time I was in college, we were actually allowed to use them.
That was 1984, also the year I entered the life insurance industry as an illustrations clerk. I had to use those same principles for the calculation of settlement payments on death benefits, prepayments of life insurance premiums, monthly retirement income amounts and so forth. I also used them to validate the math in the finance deals when I bought my first car and my first house. To me, the annuity was pretty straightforward and nothing to be scared about. In a geeky way, it is sort of cool.
Why all the fear?
In my opinion, it's the misalignment of intention that's scary, not the annuity.
Let's face it. The Annuity with the capital "A" is not the same as the annuity with the lowercase "a." Generically, the annuity is just a math equation. It can be designed to last any length of time or a lifetime. Today, however, the industry has designed it to try and outwit its assumptions, with the return as the main attraction.
Variable Annuities, GMIB Annuities, Indexed Annuities…These "innovations" are the ones with the capital "A." They are used to defer taxes and possibly even make up for a boomer's shortfall in retirement savings. In order for them to work, they have to sustain some pretty fancy assumptions. That means someone in the equation is taking a big risk.
