Why not more annuities?

From a reader in the know:

Annuities are often unappealing because they’re expensive, and they’re expensive because of the capital rules and market dynamics. Capital rules make it challenging for insurers to back annuities with anything but investment grade debt. Using a 50/50 A/BBB portfolio would require capital of about 5% of annuity premium. Additionally these products never sell without the intervention of a sales rep, who will require a commission of 3-10% depending on annuity type.

So now the insurer’s shareholders have committed 10% of premium and need to earn a return on that equity. If I target an ROE of 12% (common in the industry), I need to earn a net 120 bps of spread (and more to amortize the commission!). So in effect, the customer is paying to get a treasury yield or worse. It’s understandable why they may prefer to take their chances with more traditional investments.


Annuities are also famously opaque where each one is a unique snowflake which makes comparisons impossible.

Why though haven’t the discount brokers entered annuities? Is it the verification problem? I.e. you have to spend quite a bit of money to confirm the age and other circumstances of a buyer? I still think the answer is that with social security and private pensions there just isn’t the demand.

They are quite complex to explain to people uncomfortable with concepts like compounding interest, discounted cash flows, etc. You'd be surprised how many people struggle with mathematical concepts like this. That requires a person.

It's also a heavily emotional decision - you're signing away the vast majority of your hard-earned life savings. That requires trust, and the human animal is a highly pro-social creature that often requires face-to-face contact to form trust.

The irony is that if you are buying an annuity, the trustworthiness of the person selling you the annuity has, rationally, very little relevance to the purchasing decision.

Even at higher cost though, annuities start to make sense as you get into your mid 70s and face a situation where the probability spectrum on life outcomes has significant weight from 0 all the way to 25 years. There's just no reasonable draw down model that doesn't leave a lot on the table without creating risk at the long end. The only way around this is if you see significant utility in dollars you leave for your kids or grandkids but are also comfortable pushing all this risk/variability into their inheritance amount.

Much like a UIT or whole life insurance policy, people don't wake up one morning deciding they want to buy a product like that. It must be sold to them. There are "no-load" annuities but they aren't very large compared to the commission variety.

I thought traditional annuities were offered by insurance companies because they used the same risk pool. If so, "discount brokers" would be just that, and not adding value.

The discussion from a reader in the know doesn't seem to cover the actuarial aspect.

@TimothyTTaylor on twitter:

Countries where annuities are required or become a default option have thicker markets for annuities. A common steps is that the annuities market gets a few "standard" contracts, similar to the 30-year fixed rate mortgage, which then structure the market.

Essentially, the guarantee is expensive. The Treasury should offer them.

The commissions are high because they have to be jammed to be sold and usually they put bells and whistles on to cover up the fact that the returns are low. More or less.

Social Security + Annuities = Too Much Complacency

I'm one of the luckiest retirees alive after 40 years on the faculties of four universities. I retired in 2006 shortly before interest rates collapsed. My wife and I got TIAA lifetime annuities at interest rates that are unheard of these days.

If I retired today lifetime annuities would not be a good deal. In 2006 they were a great deal for security, although I missed the subsequent runup in common stock prices.

I'm still happy with lifetime annuities and probably will live longer not having to worry about stock market crashes.

Same here. When i annuitized my entire TIAA stash, I looked at the costs of annuities being offered by other companies. This was just from curiosity, and I don't have specific figures, but my impression was that TIAA annuities back then were a much better deal than anything else I'd seen. We sure did get lucky with the interest rates

Because interest rates suck. Because the stock market is roaring. Because crypto is moving again.

Where are you getting your 5% number? After-tax C1 is much lower than 5% for A and for BBB--neither is above 2%. Are you including C3? If duration-matched, C3P1 requirements are minimal.

Also, the capital requirement is not simply set aside and held as cash. Those dollars are invested and earn a return.

Your point on commission (or acquisition costs more broadly) is a valid one, but the capital requirements to me are a red herring.

It does seem a little high but I guess it depends on what level of redundancy you're assuming. I've seen anywhere from 300% to 500%, so seems in the general ballpark.

why not an annuity?
for us its definitely the high commissions&costs

I wonder if American financial institutions are not conning us out of our money with those strange and unsatisfactory financial instruments.

Is it possible that our country's economy is a house of cards ripe to be sashed by the winds of change?! Is all we read on newspapers a dog and pony show designed to separate hard-working Americans from their money?!

Would Washington and Jefferson have supported the increasingly out-of-control finantialization of our country's GDP. In a certain way, I don't think so.

Some other countries seem to be dealing in a more wise way with the economic changes the world is going through. I visited Brazil, in South America, a few months ago, and I all I could think, seeing the beautiful streets, mountains and beaches of Rio de Janeiro, was, And did those feet in ancient time,/Walk upon Brazil's mountains green?/And was the holy lamb of god/On Brazil's pleasant pastures seen?

We probably will never know the answer for sure, but I think it is clear that, as Brazil speedily overcomes undervelopment (it is now offically one America's major non-NATO ally), it becomes clear that, as a Nobel Prize laureate pointed out, "the times, they are a-changing".

Is this our fault? I used to actually read Thiago's comments out loud occasionally, they were that amusing! This daily morphing feels like that time my walking companion observed a flatworm on the sidewalk, and he was like, hey, I think that's one of those worms I read about that comes in on tropical plants and then becomes a pest and devastates the local flora - I better kill it. So he smashes it with a rock - and five little worms crawl off in all directions.

O Thiago, the pity of it, Thiago!

we have something for that
its free
its a osprey cam


Maybe your friend should have called the proper authorities instead of trying to play God and open the Pandora's box unleashing a pest on a unsuspecting world.

My point is, Brazil is changing, and President Trump has recognized it. Only mindless bigotry makes people think all and every deserved praise Brazil gets is a poisoned fruit of propaganda. Maybe you ahould check your priors and your privilege.


Old Thiago would never have acknowledged the existence of youtube.

I really don't know what you are talking about. I am not Mr. Ribeiro. Also, I am sure Mr. Ribeiro linked to Brazilian anthems and musical/poetic numbers a few times. Your comment is baseless.

A target ROE of 12% on a safe business and commissions of 3%-10% just show low competition. Or maybe these are the same stupid customers who take adjustable interest mortgages because they don't understand risk.

Especially when the customer provides all the equity upfront.

Hey, deposit your savings with me and I'll dribble it back to you while I gamble with your savings trying to pocket 12% annual returns on your money.

The complexity and commission arguments don't make sense. Annuities are an extremely simple security--- $X/year for life. Knowing what is a good price is difficult, but competition between sellers eliminates that problem. Why don't sellers compete? Of course, some people won't go to a TIAA CREF or Vanguard and salesmen will charge them a lot, but other people will, just as they do with mutual funds. So the answer must be something like what the post suggests: regulation that requires investment in safe assets.

But what arguments hold here, about why there insn't much of an annuities market, but would be consistent with there being a large car, home, or life insurance market?

Yes, purchasing insurance costs above the NPV of payouts -- but solving the optimal consumption path is also pretty difficult with uncertain longevity. Quantifying the value of reducing income uncertainty isn't easy, but most estimates of risk preference would say it is quite large.

Hi Alan,

Lifetime annuities (for my wife and me) are more than savings payouts. If one or both of us lives long enough we will have received more in payouts than our invested capital plus interest. This makes them a bit of life insurance as well.

After the first ten years TIAA annuities are a bit like social security in that all invested capital is all lost. But who cares if the long-term payouts exceed that capital plus interest? The trick in managing to live on and on and on (which of course is an uncertain blessing).

My main point here is that lifetime annuities are not as good on average for heirs as they are for the retirees themselves. But they protect the heirs from having to support long-lived moms and dads.

"My main point here is that lifetime annuities are not as good on average for heirs as they are for the retirees themselves. But they protect the heirs from having to support long-lived moms and dads."

+1, But of course, the current returns on annuities are so awful that it's unlikely to do either.

Annuities are very expensive now, really expensive for those who don't know how the pricing works (sales can take 12% because it is an insurance product, not a security) and they can fail. Remember when Executive Life, and Mutual Benefit Life, both failed, in 1991? The PBGC had ought big chunks of annuities from each, presumably well-priced as PBGC had the power and knowledge to make a good deal. The big question for annuities is "What insurer can you trust?" It would be interesting if we could follow through on Dick Thaler's idea to allow people to annuitize moderate chunks of money, say up to $150,000, through Social Security at Social Security's cost, no sales commissions no markups. Would people trust Social Security?

It would be a decent grad paper to see if most people are intuitively skeptical of companies offering "lifetime" annuities.

This is against the theoretical belief that annuities are a frictionless product with no fine print attached, as some sort of free chicken with no counter-party risk such as default of the insurer, as if those skeptical of annuities are just financially illiterate.

There are products without commissions. Turns out, if you pay your advisor 1% a year for the same time you'd have an annuity 10+ years, it's about the same cost.

Thank you for your post and discussion.
A new supplementary retirement plan will soon be launched in France. It will allow savers to receive a capital or annuity at the end of the term. The market is perplexed about the success of annuities, especially since no tax benefit has been granted on exit from annuities. The actuarial cost of the annuity is indeed high, due to the low (or even negative) rates and the increase in life expectancy. However, it is a suitable solution for retirement, if the fees are not a deterrent. We also hope that pension increases will be clear and fair between generations of pensioners in the future.

New life annuity schemes could also provide with specific guarantees in the event of dependency. Let us hope that the market of the annuity innovates (with a part of management in unit of accounts for example allowing a financial management more adapted to the long term), hopefully along with reinsurers and insurtech.

Annuities are a great product for retirees like me without a defined benefit pension. They provide the certainty, barring an insolvent provider collapse with complete failure of regulatory monitoring, of never running out of money. You can do calculations of how much your investments would need to earn (Milevsky's Implied Longevity Yield) to beat the annuity at any given moment. Annuities usually look pretty good even at young ages, but they get better and better as one gets older due to the rising mortality credits (your share of the money of other people who die before you). Curiously, and perhaps not accidentally, people receiving annuities also live longer!

When I worked briefly for an insurance company in Canada, I learned another issue is that most people buying an annuity feel like it's not fair if they die shortly after buying it. (Or the beneficiaries of their estate feel it's not fair.) So annuity products often end up having clauses that you get your investment back if you die within the first 5 years or whatever.

That leads to products with lower returns because the people who die early ought to be balancing out the people who live longer than expected. If you give them back their money instead then, well, money from the pool has to be diverted to what is essentially a kind of term insurance for all participants in addition to an annuity.

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