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August 31, 2011 at 08:00 PM
Be wary of annuity pricing that appears unequal. One of the parties to the deal may be benefiting at the expense of the other.
Since entering the insurance business 13 years ago, I have attended many training sessions and scores of seminars. Often, speakers at these meetings will make reference to a “three-legged stool” as an analogy for the pillars of financial services transactions. This allows the speaker to create a more vivid image in the minds of their listeners while they instruct.
Let’s use that same reliable three-legged stool example to explain fixed and indexed annuities.
In this example, each of these parties represents one leg of our stool. When each of these parties is receiving comparable benefits, the three legs on the stool all are in equal height. Our stool stands firm when we sit on it. But if one of those legs ends up longer than the others, we are likely to face injury when relying on its inequitable structure.
What would result in such a calamity? There are a few scenarios in annuity pricing that could result in an uneven distribution of benefits. Regardless, you must remember that when it comes to annuity pricing, there are only so many pennies in a dollar (meaning that rich benefits can’t be offered out of thin air; other features must be scaled back in order to compensate for inflated features).
So, if one of the legs on our stool is relatively longer, that means that one (or both) of the other legs is conversely shorter. (Remember, the insurance company’s leg on the stool will generally never be shorter. If the insurance company cannot make their required spread, the annuity product will not be offered for sale.)
? CDs vs. annuities
Let’s look at an example. Considering today’s miserably low interest rate environment, it is tougher than ever to garner interest in annuities. In fact, the average indexed annuity cap is a mere 4.04 percent (for annual point-to-point strategies only). Indexed annuities’ value proposition doesn’t seem so attractive when the offer is “worst-case scenario, zero percent; best case scenario, 4.04 percent.” This may sound pretty good to the guy earning a mere 0.94 percent on his bank CDs; but for seniors, 4.04 percent is likely equivalent to the minimum guaranteed rate on the fixed annuities they bought before the turn of the century.
