The insurance industry is another form of safe haven for risk-averse investors, especially retirees who are looking to take some risk out of their portfolios. The insurance industry is not easy to understand for most people, even for those with 20+ years of investment experience.
If you are in the market for a fixed guaranteed annuity, this post will help clarify some common misperceptions. The simplest type of annuity is a single premium immediate annuity, or SPIA. Most major carriers have this core product. It’s the most straightforward contract that exists in the annuity world. For people looking to trade money now for a guaranteed cash flow for 20 to 30 years — and to have a guarantee for those earnings — this is the type of annuity to start with. These annuities yield anywhere from 1.5% to 2.5% during these times. For most insurance companies (including insurance agencies whose principal source of business is selling annuities), this is also the lowest compensation contract. That can be a good thing for consumers.
One of the difficulties most people face when evaluating which annuity would be right for them is the alphabet soup of products. FIA, EIA, DIA, SPDA are all types of fixed annuities that are not securities products like a variable annuity. Because a 2% yield is a tough sell in these times, consumers looking for some principal protection and an upside to their investment are led to think that these annuity contracts are enhanced or superior. I candidly think that what you pay an insurance company for is the guarantee they provide. Once you start adding investment opportunities on top of any product, you tend to get inefficiencies that are difficult to understand. Products like premium bonus, death benefit, cash value, contract value, lifetime income rider etc. all offer to boost or increase the amount of income you get during the period. Just like with life insurance, you buy it for the death benefit, not because it’s an investment. The same is true for the annuity marketplace.
For example, say you have $1,000,000 in a 401k, and you need about $5,000 a month to live comfortably. The SPIA I mentioned above would only get you to about $3,500 a month. Alternatively, if you invested in a portfolio of corporate AAA investment grade bonds, with a yield of 4%, you would achieve about the same investment result but with no guarantee and with a measure of additional risk. Those risks are rate risk, call risk, and default risk. The biggest advantage to bonds over annuities is the liquidity and perhaps the costs of entry. Annuities generally carry a 4% commission on average. This fee is paid to the representative upfront for providing the advice about the product. Bonds and ETFs of bonds typically trade for five to 15 basis points. On a million-dollar hypothetical purchase, thats $40,000 for the annuity and maybe $10,000 to $12,000 per year for an ETF expense ratio by comparison. Costs factor into the yield you will receive.
For investors beginning to look into the insurance or annuity market, keep these best practices in mind:
- Working with a broker, not an agent of a particular insurance company, will give you broad exposure to all of the competitive companies.
- You may ask your advisor to sign an agreement to represent you in the purchase and establish a best interest or fiduciary obligation to you as the customer. This automatically exists if you are working with a Registered Investment Advisor (RIA), such as our affiliate firm Monolith Advisors, LLC.
- Understand the ratings of the products. You are going to want to stick with A+ and A++ ratings from A.M. Best. Only the largest and most secure companies are able to maintain these stellar ratings. New York Life, Brighthouse Financial, MetLife, Prudential, MassMutual, and John Hancock are all very large conglomerate LIFE insurance companies that have very long histories of financial stability.
- Consider the guaranteed income you really need first. If you are comfortable with $5,000 a month, perhaps you only need to generate $2,500 of that with a guaranteed annuity.
- Work with a broker or advisor experienced with annuities and traditional investments.
- Resist trying to buy more than you need or adding provisions to the policy that may appear beneficial. They will typically increase the commission and reduce your overall investment participation.
- Consider your beneficiaries, if you have a will, and whether having a death benefit (recommended) is important to you. Any annuity is a valuable asset and can be gifted or liquidated on death, or the guaranteed cashflows can be provided to a loved one. Don’t buy an additional death benefit unless you need it.
- Consider a discounted annuity from crowfly.com, as the yields of 4% to 5% are attractive and are from some of the most highly rated insurers. Buying a secondary market annuity also helps out another person who is in need or has fallen on tough times. There is a strong social impact of buying an annuity from someone else. Both sides of the equation win. Also, the yield to a buyer of a structured settlement annuity is a net yield; there are no ongoing monthly or annual expenses.
Structured settlement annuities, or structured settlements, can be a great source of income. They are typically annuities and should be included in your analysis for ratings, risk and yield. Visit crowfly.com/buyers to learn more about becoming a buyer.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).