Sunday, June 22, 2008


"Every few years, it seems like the marketplace produces a 'study' of variable annuities that makes the product look too good to be true--a creative fusion of research and PR. I'm referring to a white paper titled 'Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit (VA+GMWM).' ... This objective evaluation was (as the cover page discloses) sponsored by Nationwide Financial, whose Best of America annuities are among the hottest-selling products in the industry. ... It's helpful to note a few things that aren't made clear in the white paper. First, this account isn't annuitized. Although the distribution is being held constant, the insurance company that sold the rider isn't reaching into its pocket to pay the difference. All the distribution money is still coming from the annuity holder's (diminishing) investment account--ultimately from the pockets of the people who will inherit it. ... Second, there is no inflation adjustment during these periods (in this case seven years plus) when the income is frozen .... And third, for most of these annuities, the yearly cost of the rider is higher than you might think. ... Then comes the part that had me scratching my head. The study assumes a 0.4% mortality and expense (M&E) fee for each year and a GMWB rider fee of 0.6%. Come again. ... What about sales loads? ... Most important, the paper makes no mention of taxes. ... With my eyes still glazed from the spreadsheet, I called Peng Chen, the lead author of the Ibbotson study. He was clearly alarmed at the tone of my questions. 'The M&E is typically a lot higher than what you see in the table.' ... What about taxes? 'We didn't take taxes into consideration.' ... 'I'm not a tax expert,' Chen said, 'but I know the average mutual fund has a 100% turnover ratio. If you're talking about a low-cost index fund, then it's a different story. ... But alas, the sheer number of assumptions that lean favorably to the VA/GMWB rider makes it hard to conclude that it's all just a coincidence", Bob Veres (BV) at Financial Planning, May 2008.

I am surprised Ibbotson Associates, a company I've long been aware of and respected, like BV, put out this paper. Chen should be ashamed of himself. Chen's not a "tax expert". Fine, he should have called one. For a fee, I'm available. BV is correct, M&E for variable annuities averages about 1.5% a year, not 0.40%. These annuities have loads, the money coming out of them is taxed at ordinary, not a combination of ordinary and capital gains rates as mutual funds. Chen, are you learning from Yoshizawa at Moody's, a "structure expert' whatever that is, who knows nothing of the paper she's structuring? The paper is available at Ibbotson's response to BV's criticism is also at the website. In my experience, variable annuities (VA) are an oversold product. Some insurance people I know who sell annuities, refuse to sell VAs and direct their clients who buy other annuities to, drumroll please, buy mutual funds!

1 comment:

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