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.)
In Scenario Two, adding the immediate annuity income means the man has a guaranteed minimum lifetime income, after 10 years, of $2,283 a month (i.e., $1,000/month from the lifetime immediate annuity and at least $1,283/month from the annuity with GLWB).
In Scenario One, the man with the corporate bond that came due would have to get an interest rate of 11.4% to match that income. Not impossible, but unlikely.
One more thing about Scenario Two: if the annuity with GLWB returns 8% a year, the original investment of $110,000 would grow to $237,482 in 10 years. So, the corporate bond holder in Scenario One would have the original $240,000, while the annuity owner in Scenario Two would have almost as much plus the $1,000 a month for life from the immediate annuity.
Agreed, 8% may be hard to get, so let’s address asset levels in a different way. A man, healthy at age 70, has a life expectancy of 15 years, 3 months. If he invests $110,000 at age 70 and this grows at about 5.25% a year, he’ll have $240,000 upon reaching his life expectancy (though 50% of people outlive their expectancy).
There is myth that immediate annuities reduce assets. For those who are healthy, the reverse is more likely: those who buy an immediate annuity and invest the difference in annuities with guarantees (or other instruments) will very likely end up with more income and more assets than those who use other vehicles.
Clearly, pairing immediate annuities with other investments provides less liquidity and “assets” for a while. But that occurs in the years prior to financial stress. Usually, financial stress occurs later in retirement, when the corrosive impact of inflation has more of an impact and when higher pharmaceutical and other health related costs often kick in.
By comparison, how much liquidity does the bond holder in Scenario One really have? If he requires $1,000 a month, and most do, what can he really do with the $240,000 bond? Selling means losing income and that is usually impossible.
Many retirees sacrifice a great deal of income for a liquidity that seems apparent, but is not real. The annuity business must teach retirees that there is choice: a) liquidity early in retirement, which means the retiree is likely to sacrifice income and liquidity later in retirement or, b) less liquidity for a while (and admittedly the risk of dying early and never regaining the asset) with no sacrifice of income and in all likelihood more income, assets and liquidity later. The wise choice is clear.
Our economic turmoil is unfortunate and distressing. It puts, among many other things, enormous pressure on retirees to get more income out of the fixed portion of their portfolios. For the annuity business, this situation provides a substantial opportunity to deploy its underutilized immediate annuity product in conjunction with its well utilized annuity with GLWB to provide the higher level of guaranteed lifetime income that the retired population now desperately needs.