Annuities range from being simple to incredibly complex and as an investor it is your responsibility to learn what you may be buying. The simplest form of an annuity is when you give an insurance company a lump sum and then they provide you with an income stream for a period certain (or life), this is known as a Single Premium Immediate Annuity. The more complex products are deferred annuities and usually are variable or indexed based.
After reading the twelfth article about how there is yet another generation woefully unprepared for retirement and how the 401(k) is a terrible product I started to think about what an investment firm or more likely in this case an insurance company can do to engage in my generation and the answer is so simple. Create and market a defined benefit pension.
Private Pensions Are All But Gone
It is no secret that private pension participants are decreasing. One Social Security Study found that,
The percentage of workers covered by a traditional defined benefit (DB) pension plan that pays a lifetime annuity, often based on years of service and final salary, has been steadily declining over the past 25 years. From 1980 through 2008, the proportion of private wage and salary workers participating in DB pension plans fell from 38 percent to 20 percent (Bureau of Labor Statistics 2008; Department of Labor 2002). In contrast, the percentage of workers covered by a defined contribution (DC) pension plan—that is, an investment account established and often subsidized by employers, but owned and controlled by employees—has been increasing over time. From 1980 through 2008, the proportion of private wage and salary workers participating in only DC pension plans increased from 8 percent to 31 percent (Bureau of Labor Statistics 2008; Department of Labor 2002). More recently, many employers have frozen theirDB plans (Government Accountability Office 2008; Munnell and others 2006). Some experts expect that most private-sector plans will be frozen in the next few years and eventually terminated (Aglira 2006; Gebhardtsbauer 2006; McKinsey & Company 2007). Under the typical DB plan freeze, current participants will receive retirement benefits based on their accruals up to the date of the freeze, but will not accumulate any additional benefits; new employees will not be covered. Instead, employers will either establish new DC plans or increase contributions to existing DC plans.
While the Department of Labor provides us with these two graphs regarding pension plans from 1975 to 2012:
The purpose of this post is not to argue whether the move from a defined benefit to a defined contribution is better or worse for our society. In fact, while I dislike my 401(k) I don’t believe it is the vehicle’s fault, rather, it is participant’s fault who can’t seem to steadily invest in their own retirement. If I had to make one complaint about the system it would be to open it up. Why are there 14 different types of retirement accounts (SEP IRA, SIMPLE, IRA, 401(k), 457, 403(b), etc.). I understand that they each have their place and nuisances, it feels like 1500 pages of the IRC could be wiped out and replaced.
A Financial Product Almost Every Generation Y and Millennial Would Buy
I am 33 so I think I am in At this point most major insurance companies (investment companies haven’t caught up yet it seems) sell some type of Deferred Income Annuity or a Longevity Annuity. Unlike deferred variable annuities these products are pretty transparent. You give $X to an insurance company and they’ll give you back $Y over Z Years. For example, if a 50 year old gave a pretty major insurance company that I can run illustrations for $100,000 he would be able to receive $963/mo for the rest of his life starting at age 65…and if you die before getting your $100K back, the company will refund the remaining amount to your family.
Most people upon hearing those numbers fall into one of two camps. The first thinks, that is a terrible return on investment I want to fight it out with the market. The second thinks, they can shift some of their risk to AAA rated insurance company to guarantee that they are going to eat for the rest of their life. In the end after the gut reactions subside people can move more towards the middle. As back office support for financial planners I have seen these products fit amazingly well into plans for 50 to 60 year old individuals and couples we are not retiring for 5 to 10 years. The retiree now doesn’t have to turn to his portfolio in the amount of $963 every month for the rest of his life. It is amazing how much something like that can relieve your portfolio during a bear market.
As you can probably tell I like the product, however, I have yet to see one that is priced and marketed towards Millennials.
The first problem is the marketing. I see ads from almost every major insurance company on a daily basis. Despite being financially sound some of these companies don’t even bother advertising to the general public (The Guardian, Jackson National, etc.), however, I have yet to see one that literally tells me I can buy a pension. Maybe some State Insurance Departments would have a problem it being referred to as that way, but someone, somewhere can come up with something catchy. How about a slogan that reads, “for the generation who is barely 35 and have seen two very real market corrections lets take some of your retirement risk off the table.”
The much bigger problem is the pricing. If it is a good enough deal it will get sold. Those companies I have had the opportunity to illustrate price horribly for someone around my age. For example, if a 35 year old put in that same $100K and took it out at 65 he would only be receiving $1,470 dollars in 2039 dollars. Inflation over 15 years is one thing but inflation over 30 is completely different. Who the hell knows what $1,470/mo will pay for? Yes, there are cost of living adjustment riders for most products but they are so prohibitively exepnsive they are almost never illustrated. Then add int he problem that most 35 year olds are not going to be cutting a check for $100K, instead it is likely they will do annual contributions which would cause that already low payout number to decrease. If I had to guess the internal rate of return would be somewhere in the low 3% range net of all fees. That is an unacceptable number considering I am signing up for 30 years in the future and the fact that the insurance company isn’t going to have to pay out every claim.
Doubt any insurance executive read this blog, but if you do, most Millenials can write me a thank you note.