Avoid Evaluating Risk Products With Investment Tools
“There is a lot of controversy in the press about variable products and their use,” said Terry Altman, a financial professional with MONY Life Insurance Company, Troy, Mich., in an educational session at this years Society of Financial Service Professionals annual meeting here.
A lot of that controversy is generated by members of the press and public who do not have a good understanding of variable products, specifically life insurance and annuities, said Altman.
“Most of the confusion around annuities is a result of someone asking the wrong question,” he said, explaining that addressing poor questions asked about annuities and life insurance can create confusion for both advisors and clients. To illustrate his point, Altman drew a parallel to someone asking the question of which type of car you would prefer: a Ferrari or a tractor?
Altman noted that this question is poorly statedit doesnt ask which is more expensive, or which has more appeal, or which goes the fastest. Obviously, the answer to this question purely depends on the vehicles intended use.
“The most important question here is what do you need it for? You cant pull stumps with a Ferrari,” he said.
This logic carries over into a discussion on annuities. Many people considering immediate annuities feel they can earn a better return by investing their money in the market, but Altman said this is not the right comparison for people to make. They do, however, and as a result many planners try to evaluate the internal rate of return (IRR) of an annuity vs. an investment.
Altman believes this approach is flawed in that these people are now using investment tools and terminology to evaluate risk management tools. “Its like trying to decide between the Ferrari and the tractor without knowing what you want to use it for.”
Furthermore, determining the IRR for either an annuity or a life policy is impossible because the time period is an unknowna critical component of the IRR calculation.
But this is the view many pundits in the financial press have when evaluating these products, he said.
Similarly, when it comes to life insurance, “the press will always favor term over permanent because you can buy more death benefit with the same premium,” Altman explained. Of course, this is only true if you die while the insurance is in force, he added.
Even many financial advisors discuss cash value life insurance with clients as having “a savings element, an investment element or cash accumulation.” Some planners even refer to cash value life insurance as a “forced savings plan,” he said. But all of these approaches completely miss the point of life insurance, he said. “All these terms are investment terms, this is a risk decision.”