I was thinking of the illogic of indexed annuity’s and annuities and the way they are often pitched to investors with the promise that you can get market-like returns while not losing money during market downturns.
Let’s step back and look at the role of the insurance company in this transaction. The investor gives their money to be invested to the insurance company and the insurance company, of course, will invest that money in the investment vehicles of their choice. Part of the returns earned and principal invested will be kept by the insurance company and shared with the selling agent. Right away, that puts the insurance company at a disadvantage, because they have to overcome that drag on returns.
This leaves the investor in the position of assuming that the insurance company investment department is very skilled and can deliver the returns of the market while things are going well and sidestep the downturns when market conditions aren’t so hospitable.
One simple way to test this theory would be to look at the returns of mutual funds and sub accounts managed by insurance companies prominent in the offering of these guaranteed products. If they perform comparably to the market during upturns and adeptly miss the downturns, then these claims may be warranted.
One of the bigger companies that markets and sells indexed annuities is Allianz. They have a target retirement fund (AllianzGI Retirement 2015 A) for people planning on retiring in 2015. According to Morningstar, its three-year performance versus its category is -3.27% and its five-year performance is -1.73% versus its category – so much for superior skill. (Data Source: Morningstar Office – 11/22/2014)
Their “Managed Volatility” fund, which by its name you would think is designed to manage volatility pretty well, went down nearly 42% in 2008. That doesn’t bode well for a claim to be able to miss market downturns.
If there is no ability to deliver superior returns than the market or miss market downturns, then what is the likely outcome of investing in such products? The answer would be bond-like returns. Not long ago I took an illustration from an insurance company for their indexed annuity product and compared the returns they said they got with a 5-year government bond index. They were back-testing the product over an extended period of time to show how it would have performed in the past.
The amusing aspect of this brochure had to do with the fact that the company in question was proud of how their product would have performed. However, as I pointed out on the radio show, the performance of a portfolio of extremely conservative government bonds was actually greater. Keep in mind that these government bonds give investors little protection against inflation. Since we usually invest to safeguard money for future spending, a portfolio that won’t protect purchasing power can lead to great economic stress as the dollar continues to decrease in value.
