What IS an annuity? Part 2

So what IS an annuity? Short answer: its where you pay a fee to give all your money to an insurance company and then you pay them fees to withdraw it.

There are actually three basic annuity contracts-variable, guaranteed and income:

• variable: you pay fees to buy a mutual fund and then pay fees to withdraw it;
• guaranteed: you pay fees to buy an uninsured CD and then pay fees to withdraw it;
• income: you pay fees to buy any of the above and pay fees to make regular withdrawals.

Either choice is a bad choice. They are all costly, illiquid and opaque.

• Costly because you can buy the above much cheaper with minimal fees;
• Illiquid because of fees, delays and restrictions in getting out.
• Opaque because of hidden/complex terms and lack of public pricing information.

Plain old life insurance is not included in the bad choice category. Life insurance, even whole life for some, is a wonderful and necessary product. Just as car, house and flood insurance can be. Beware policies that combine life insurance with investments and annuities. Buy your life insurance separately do not let it get bundled/confused with other products

To illustrate my point (illustrate is a favorite but vague term of annuity salesmen), lets look at one particular annuity example:

The simplest offer I could easily find today online is a "single premium-deferred annuity" from one of the rare companies that publicly posts their rates. Their 10 and 20 year rates are 4.30 and 4.35%.

Its identical to a 10 or 20 year CD but its NOT a CD. Its an insurance contract and insurance companies are typically NOT FDIC insured. Firstly, 10 or 20 year certificates of deposit barely exist. Secondly, today's U.S. Treasury 10 or 20 year bonds are yielding less than 3%! 

So they are selling you a 10 or 20 year CD with a "guaranteed" yield of 4.30% or 4.35%. This "guarantee" is backed by the full faith and credit of the INSURANCE COMPANY. But what does the company do with your money other than deduct fees?

Sadly, this company, headquartered in South Carolina, is a subsidiary of a subsidiary of a subsidiary etc. etc. at least according to Bloomberg. The ultimate parent of this particular insurer is a bank in Greece with low-B credit ratings. The company's stated insurance industry AM Best rating is B++.

But that does not tell us what the insurance company does with formerly your money and now its money. Here's a quote from the company's public financial summary (click on the About tab in the link):

"As of December 2018, the portfolio is primarily invested in bonds and has an overall credit quality of 1 or 2 (investment grade), using the National Association of Insurance Commissioners (“NAIC”) financial rating designations, with an average net yield of 5.20%."

Ah yes, they invest in a high yield corporate bond portfolio yielding (as of this date) 5.2%. How nice of them to offer policy holders a return of 4.3 or 4.35%. Frankly, if you really wanted this kind of portfolio, you could buy a great high yield long term bond fund-a Pimco High Yield bond fund today yielding 5.38%* comes to mind.

Let's not pick on this one company (they DO show their rates publicly) it may be one of the better ones out there.

*Individual bonds and bond portfolios,"guarantee their rates", bond fund rates change with prices. Buying individual bonds may be better than buying bond funds.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.