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

itwasntme001

michaels said:

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?

If you want to hedge longevity risk 100%, then index linked annuities are the best value.  If you want to try to manage this risk yourself, you will find it will be more costly or worse, thinking you have hedged it whereas in fact you haven't at all.

BritishInvestor

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. 

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?

1. What data are you using for your SWR numbers?
2. What timeframe?
3. What costs?
4. What's the typical asset allocation an annuity provider holds? It's certainly not 100% equities.

Thrugelmir

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.

Annuity provider will as far as possible match guaranteed returns to forecast liabilities.  The annuity provider has an array of costs to cover that you don't as an individual. 

You do realise how low the yields are on Government Gilts with 30 years plus maturity dates? 

[Deleted User]

michaels said:

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?

If you have zero DB pension (including State) then annuity is a very good solution for at least a portion of your portfolio.  All other equity based solutions always carry some risk of failure. They are never 100% safe.  If you have some DB pension and can afford a major drop in your stock and bond portfolio then you don’t need to buy annuity the moment you retire. Later on annuity might still be a good option. 

zagfles

michaels said:

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?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

MK62

SWR is a potential black swan fallacy......and today, while annuities might seem poor value measured against historic data, nobody really knows if that perception will turn out to be the reality - improbable perhaps, but it's not impossible that they might turn out to be shrewd investments.

Personally I'm taking my chances with drawdown, and given that I can adjust/suspend my withdrawals to match the conditions at the time, something an annuity provider cannot do, I think the "odds" are good - however, it's a judgement call, and in the end it's a matter of opinion on how big a gamble it is......your personal attitude to risk will dictate that I think.......very risk averse people might prefer the certainty an annuity provides.

I'm not that risk averse, and have gotten used to the ups and downs of the stock market - though while I've seen crashes come and go in the accumulation phase, I've yet to really see one since retiring......I thought this year was it, but that turned out to be a  blip really in the grand scheme.....my "plan" can cater for it, but when it comes I'm sure actually living it won't be quite the same as looking at it on a spreadsheet....

BritishInvestor

zagfles said:

michaels said:

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?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

"There's only speculation, usually based on the assumption that the future will be similar to the past."
Surely you mean the assumption is that the future is not worse than the worst historical outcomes of the past?

[Deleted User]

zagfles said:

michaels said:

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?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

Cancer is something we can’t control so its different.  Having a pension “less than hoped” isn’t a problem. The main risk is outliving your money.  Not a pleasant scenario. Even a 5% probability seems unacceptable to me. 

zagfles

BritishInvestor said:

zagfles said:

michaels said:

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?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

"There's only speculation, usually based on the assumption that the future will be similar to the past."
Surely you mean the assumption is that the future is not worse than the worst historical outcomes of the past?

OK put it another way, that the past is some sort of guide to the future. That what didn't happen in past can't happen in the future.

The other thing of course is, if you're looking at the "worst case scenario" from past data, is what the "worst case scenario" is in terms of how long you'll be drawing the pension! The mistake often made with so-called "SWR" calculations is "well the worst case in terms of investment performance over 30 or 40 years is..." without considering the "worst case" (or rather "best case") in terms of your own longevity! From past data would be living to 120!

"Safe", as always, is a relative measure. My car is "safe", doesn't guarantee I won't get killed or seriously injured in it.

michaels

Deleted_User said:

zagfles said:

michaels said:

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?

Yes, if you want a guaranteed income for life, then index linked annuities are what you should go for. As above, there's no such thing as a "SWR" from a drawdown pension. There's only speculation, usually based on the assumption that the future will be similar to the past.

Personally I'm willing to tolerate some financial risk, after all we tolerate risk in virtually every other walk of life, if I can live with a 1 in 2 chance of getting cancer I can certainly live with a chance my pension might be less than I'd hoped for. Like all things you weigh up the risk and cost/benefit of your options.

Cancer is something we can’t control so its different.  Having a pension “less than hoped” isn’t a problem. The main risk is outliving your money.  Not a pleasant scenario. Even a 5% probability seems unacceptable to me. 

Isn't the problem that we have no idea if it is a 5% or 1% or 0% probability - what we do know is that probabilities based on historic performance seem to be a long way away from the probabilities implied by current market pricing.

Which do you trust?