'Annuities are poor value' - what do they know that we don't?

michaels

Historically conservative 100% no failure SWRs are considerably higher than annuity rates even with durations well above the average life expectancy.
Why should this be. 

1) Annuities should be cheaper because the pooling of longevity risk means that rather than having to set a rate that covers the maximum likely life expectancy they only need to cover average life expectancy.  So for a 65yo a sensible SWR would be based on at least 30 years of drawdown whereas for an annuity provider the average pay-out term is likely to be closer to 20 years.

2) There is also the issue that in general annuities pay less for a surviving spouse whereas a drawdown pot remains available.

So why are annuities so expensive?

[Deleted User]

1. “No failure SWR” does not exist. Its a misnomer.  There is a conceptual problem with defining a constant withdrawal rate from an inherently volatile asset like stocks. SWR is based on a portfolio of mostly stocks.  

2. SWR is typically calculated based on past 100 years’ worth of data for the next 30 years. Annuity has no expiry. The main risk for the vendor is that you will live way too long. 

3. You pay for buying an insurance policy. Thats what annuity is.  A company is pooling risks and providing you with an insurance product. They take a cut. 

4. You should really compare annuity rates to coupons on long term government bonds.  Thats a truly safe product, up to the point of expiry.  Makes annuities look pretty good, huh? In fact, one of the strategies in this environment involves a 60 year old buying an annuity with a portion of your portfolio and spending the proceeds to buy bonds. You gain vs just holding bonds right away if you live to 75 or so. 

tacpot12

I think the answer is that annuity providers have to make a profit, and so they charge what they feel the market will stand. I agree there are many reasons why annuities should be better value than they are, but it's up to the providers to set the price. Perhaps your drawdown portfolio should have some investment in annuity providers as it is clearly a very profitable market!

itwasntme001

I find it hard to believe a 100% SWR is a lot higher than annuity rates.

I agree a 100% SWR MAY be a bit higher than the equivalent (in terms of age) annuity - because insurance firms need to take into account costs, although that would be offset by the pooling of risk.

I think annuity rates make sense where they are because return expectations have fallen - just look at government bond yields.

Thrugelmir

tacpot12 said:

I think the answer is that annuity providers have to make a profit, and so they charge what they feel the market will stand. 

Markets are driven by competition. Where there's an opening someone will exploit it. 

Profit is subjective. As the insurer doesn't know how long people will live and be paid the annuity. This a business model where the final outcome isn't known for years. Somebody born today will live on average 10 years longer than someone born 50 years ago. 

Thrugelmir

itwasntme001 said:

I find it hard to believe a 100% SWR is a lot higher than annuity rates.

People wish to have their cake and eat it. Having a comfortable well funded retirement while living an inheritance as well. 

SWR's are subjective.  A 100% is always achievable. 

Thrugelmir

michaels said:

Historically conservative 100% no failure SWRs are considerably higher than annuity rates even with durations well above the average life expectancy.
Why should this be. 

People are creating investment scenarios from historical data that weren't actually available at the time?  

dunstonh

So why are annuities so expensive?

The provider is required to guaranteed payment for life (and possibly beyond if there is a 20-30 year guarantee period or value protect).  They invest in gilts which are at all-time lows.   The lower the rate, the lower the margin.     And with virtually all annuities being health-focused nowadays, the cross-subsidy effect is much reduced.  And with far fewer people buying them, the cross-subsidy pool is much reduced.

michaels

Deleted_User said:

1. “No failure SWR” does not exist. Its a misnomer.  There is a conceptual problem with defining a constant withdrawal rate from an inherently volatile asset like stocks. SWR is based on a portfolio of mostly stocks.  

2. SWR is typically calculated based on past 100 years’ worth of data for the next 30 years. Annuity has no expiry. The main risk for the vendor is that you will live way too long. 

3. You pay for buying an insurance policy. Thats what annuity is.  A company is pooling risks and providing you with an insurance product. They take a cut. 

4. You should really compare annuity rates to coupons on long term government bonds.  Thats a truly safe product, up to the point of expiry.  Makes annuities look pretty good, huh? In fact, one of the strategies in this environment involves a 60 year old buying an annuity with a portion of your portfolio and spending the proceeds to buy bonds. You gain vs just holding bonds right away if you live to 75 or so. 

Part of what the markets do is pool and share risk, thus we would expect an annuity provider to be able to provide a higher return that simply buying govt bonds to cover the likely distribution of policy holder longevities.

Seems like the big discrepancy is telling us that SWRs based on historical returns are actually higher than current market consensus for probable future returns and if you believe in efficient markets you are basically betting on the market being wrong if you plump for a 'historically conservative' 3.25% SWR for a retirement that might last more than 30 years.

[Deleted User]

michaels said:

Deleted_User said:

1. “No failure SWR” does not exist. Its a misnomer.  There is a conceptual problem with defining a constant withdrawal rate from an inherently volatile asset like stocks. SWR is based on a portfolio of mostly stocks.  

2. SWR is typically calculated based on past 100 years’ worth of data for the next 30 years. Annuity has no expiry. The main risk for the vendor is that you will live way too long. 

3. You pay for buying an insurance policy. Thats what annuity is.  A company is pooling risks and providing you with an insurance product. They take a cut. 

4. You should really compare annuity rates to coupons on long term government bonds.  Thats a truly safe product, up to the point of expiry.  Makes annuities look pretty good, huh? In fact, one of the strategies in this environment involves a 60 year old buying an annuity with a portion of your portfolio and spending the proceeds to buy bonds. You gain vs just holding bonds right away if you live to 75 or so. 

Part of what the markets do is pool and share risk, thus we would expect an annuity provider to be able to provide a higher return that simply buying govt bonds to cover the likely distribution of policy holder longevities.

Seems like the big discrepancy is telling us that SWRs based on historical returns are actually higher than current market consensus for probable future returns and if you believe in efficient markets you are basically betting on the market being wrong if you plump for a 'historically conservative' 3.25% SWR for a retirement that might last more than 30 years.

You are discovering that SWR does not exist. Otherwise insurance companies selling annuities would have used it.  Instead they use long term government bonds because SWR isn’t for real. 

michaels

Deleted_User said:

michaels said:

Deleted_User said:

1. “No failure SWR” does not exist. Its a misnomer.  There is a conceptual problem with defining a constant withdrawal rate from an inherently volatile asset like stocks. SWR is based on a portfolio of mostly stocks.  

2. SWR is typically calculated based on past 100 years’ worth of data for the next 30 years. Annuity has no expiry. The main risk for the vendor is that you will live way too long. 

3. You pay for buying an insurance policy. Thats what annuity is.  A company is pooling risks and providing you with an insurance product. They take a cut. 

4. You should really compare annuity rates to coupons on long term government bonds.  Thats a truly safe product, up to the point of expiry.  Makes annuities look pretty good, huh? In fact, one of the strategies in this environment involves a 60 year old buying an annuity with a portion of your portfolio and spending the proceeds to buy bonds. You gain vs just holding bonds right away if you live to 75 or so. 

Part of what the markets do is pool and share risk, thus we would expect an annuity provider to be able to provide a higher return that simply buying govt bonds to cover the likely distribution of policy holder longevities.

Seems like the big discrepancy is telling us that SWRs based on historical returns are actually higher than current market consensus for probable future returns and if you believe in efficient markets you are basically betting on the market being wrong if you plump for a 'historically conservative' 3.25% SWR for a retirement that might last more than 30 years.

You are discovering that SWR does not exist. Otherwise insurance companies selling annuities would have used it.  Instead they use long term government bonds because SWR isn’t for real. 

So given an annuity pools longevity risk, despite the provider profit margin it is actually probably better value for an individual than drawdown - is that the conclusion I should be drawing?