Annuities Part 3

We now move on from Ben of our previous post as Jack Otter segue ways from Ben to another Jack (Hough) for more discussion. Who is Jack Hough? Jack has been an associate editor at Barron’s since 2012 and writes “stories with a focus on investing” according to his Barron’s bio. Before that, Jack spent 9 years at SmartMoney and spent 8 years on Wall Street as an investment advisor. 

Now Mr. Otter says: “One important thing here, Jack, is that there is nothing magical about annuities. they take your money and they invest it in the same stuff that we talk about here every week, stocks and bonds.” 

Once again, Mr. Otter is referring to SPIAs but does not say so. And who said there is anything magical about SPIAs? They are a unique financial product and creature of the Internal Revenue Code, and they do things that no other product does. But magical? No. As to what the Insurance companies invest in after they “take your money” is, in fact, the general account of the company which is comprised of substantially more than just stocks and bonds. 

Having been set up for a predictable response, Jack Hough delivers. Mr. Hough says, “Right. Which raises the question why couldn’t you just do that for yourself? Why would you give the money to the Insurance company to do it for you? Well, you could do it yourself. I mean this is for someone who doesn’t want to or isn’t into figuring out an investment portfolio. They want to take a chunk of money and they want to turn it into an income that’s going to last for the rest of their lives. That’s the key with an annuity. It’s an insurance company. They can tie it to your life span instead of leaving it up in the air about whether the money will last.” 

There is a profound misunderstanding of what a SPIA is being exposed here. No, Mr. Hough, one cannot do this themselves. SPIAs are guaranteed cash flows promised in exchange for a lump sum of money. The income flow amount depends on prevailing interest rates at the time of the purchase and, most critically, the anticipated life span of the annuitant based on age and gender and in some cases health of the annuitant. There is a mortality cost built into the income flow calculation. No one can do that themselves. 

And now for the second most ignorant thing said during this video. See if you can spot it. Mr. Hough continues: “There is something a little comforting about, you know, if you’re buying life insurance, I have life insurance, I’m basically betting on myself dying, which is, you know, I mean you have to do it right? You buy an annuity, you’re betting on yourself living. There’s something a little comforting about that. You should be eating healthier, by the way, if you own an annuity.” 

Mr. Hough, betting, or gambling occurs when one creates a risk that did not exist before the bet was made. It is the very creation of risk. By contrast, when a life insurance policy is purchased, a pre-existing risk (usually pre-mature or untimely death) is transferred from the insured to the insurance company. You have it precisely wrong, Mr. Hough. 

Is one betting on living when they buy a SPIA? Once again, there is really no bet being placed. The pre-existing risk of outliving one’s income is transferred to the insurance company. This fundamental misunderstanding of risk and risk transference is common among people who should know better. 

To be continued… 

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