The unfolding economic turmoil has placed an enormous burden on retirees, but provides a massive opportunity for the annuity business.
The problem is that retirees cannot wait for problems to resolve; they need income now.
An important part of the solution is to help retirees extract more income out of a large and usually underperforming part of their portfolio: their fixed investments.
Most financial advisors suggest that retirees put at least half their portfolio in fixed assets, according to research by my firm. Further, they typically recommend increasing the fixed portion as retirees age; this resonates with retirees’ increasing risk aversion. Hence, the massive investments in bank certificates of deposit, Treasuries and money market funds, as well as bonds.
The problem is, while the need for safety is clear, the returns from fixed investments are not that high. Most retirees simply need their fixed portfolio to provide more income.
Annuities represent the best way to accomplish this. Therefore, annuity companies should put renewed focus on helping retirees get much better performance on the fixed side.
One example of how to do this is to combine an immediate annuity with an annuity that offers guaranteed lifetime withdrawal benefits. Here is an illustration of why this is preferable.
Scenario One. Assume a 70-year-old man wants $1,000/month and buys a 10-year corporate bond. Using a 5% return, he must invest $240,000 to get this amount. After 10 years of getting $1,000 a month, he will need to reinvest his $240,000, but it is unclear how much income he will be able to derive at that time.
Scenario Two. Here, the man gets $1,000/month (guaranteed for life) via only $130,000 placed in an immediate annuity. He takes the remaining $110,000 and puts it into a GLWB that guarantees the benefit base will at least double in 10 years if no withdrawals are made.
In 10 years, the man is guaranteed a minimum of $1,283/month for life from the annuity with GLWB–or more, if the annuity performs well. (The $1,283/month guarantee reflects the guaranteed benefit base that doubled to $220,000 in 10 years, when the man is age 80, plus the frequently available guarantee of 7% of benefit base for life for payments starting at age 80.)