Annuities I’d Like to See

Yesterday’s post discussed the three main functions of that pot of assets you’ve accumulated toward your retirement. Since the mainest of the main functions is to provide you with a stream of retirement income for the rest of your indeterminate life, the purchase of an annuity with some of those assets theoretically serves that function quite well. Emphasis on the word “theoretically.” If only the absolute right insurance product existed! If anyone out there knows of a product that meets all of the following criteria, please post a comment or send me an email. And pass this post on to your insurance agent to get some additional professional perspective.

Longevity Insurance. According to some academics, the most efficient use of your hard-earned assets would be to use a small portion of them (I’ve seen estimates of 10% to 15%) to purchase an annuity that doesn’t start to pay you unless and until you reach an advanced age. Say 85. So the annuity is really a form of insurance. Longevity insurance. Some insurance companies, but not too many, offer annuities of this sort.

Buying a pure annuity requires a trade-off. You lose emergency access to the funds, and you eliminate your children’s inheritance. But you get something valuable in exchange: Every dollar goes toward providing you a lifetime allowance. So using only 10%-15% of your assets for this purpose sounds like a pretty good trade-off .

Inflation Adjustment. The ideal annuity/longevity insurance would have inflation protection by increasing annual payments by changes in the Consumer Price Index. Such a product exists (one is offered by AIG) in the world of immediate annuities, but not in the world of longevity insurance where payout is deferred 20 years or so. That would be nice to have.

Low Creditor Risk. Speaking of AIG, you want to buy an annuity only from a company that is superbly solvency. You’ll be relying on that solvency for a long long time. All states offer a guaranty fund in case an insurer goes belly up, but only up to stated limits which differ from state to state, and which may not cover your entire annuity.

Rate Risk. The annuity you’re able to buy will vary, largely with current interest rates, depending on when you buy it. For example, an article by Chen and Malevsky point out that $100,000 would have purchased a $1,150/month annuity in the 1980’s, but only about $700/month in 2003. That’s a 36% drop, just depending on what year you bought the thing. An ideal annuity product would allow you to buy a little slice of your longevity insurance each year during your working years—and beyond—in order to hedge against this fluctuating market.

Transparency. It’s hard to know whether you’re getting a good deal from your insurer. It would be nice if there was some uniform basis on which to compare similar, but not identical, products from different insurers.

If there were products meeting these criteria, maybe that would solve the "annuity puzzle," as it's been called: The mystery of why more people don't buy these things.

Any annuity you purchase ought to then have an impact on how you invest and spend the balance of your assets. Indeed, the same statement applies to your Social Security benefit and any pension you’ve earned. The existence of these largely-guaranteed streams of income can free you up for greater spending and a higher percentage of riskier higher-yielding investments.

All credit for some of the good ideas expressed in this post goes to discussions with my friends Peter (of Stembrook Asset Management) and Jennifer. All of the bad ideas, of course, are mine.