Monday, October 31, 2016

Quote of the day

Matt Levine:
I am a former derivatives structurer and I find annuities terrifying.


Andrew Stevens said...

I'm pretty sure he's just talking about variable or index annuities, not fixed annuities, which are usually pretty simple.

I was once asked to analyze a couple of different investment options on an indexed life insurance product (which is sort of like a variable life product but in a fixed chassis). After a couple of hours of thinking about it, I was able to list the pros and cons of the two investment options and had a good handle on which potential market scenarios would benefit one over the other. I remarked that if it took me a couple of hours to analyze, no agent or client stood a chance. Nevertheless, the product is still on the market.

FLG said...

For some reason, I'm surprised there is still a market in these products because I would never buy a financial product that I didn't understand. But then it occurred to me, a goodly portion of the population seems to buy financial products with little to no understanding, so whether it's a rather simply understood 5-year ARM or a difficult to understand variable annuity, they're more or less buying them on blind faith anyway.

Andrew Stevens said...

I take some issue with the "Math Teachers" article in the New York Times (and even a little with Levine). I would discourage anyone from buying variable or indexed annuities, but the article really confused the issue by not clearly distinguishing them from fixed annuities. In my opinion, many people who should be buying fixed annuities in order to eliminate their risk (or all but eliminate their risk, since I suppose they are still subject to counterparty and regulatory risk) are not currently doing so. So articles like this one are not that helpful in building financial literacy.

Andrew Stevens said...

Fixed annuities are very easy to understand. I give you a big lump sum now in exchange for guaranteed cash flows for as long as I live in the future. I thereby pass all interest rate or market risk to the insurer in exchange for a (likely) somewhat lower return than I could have gotten by investing it myself (and even that might be offset by the tax deferral benefits). But if I can comfortably live on the guaranteed cash flow stream, what do I care?

Depending on the contract, there can be inflation risk, but even that can be hedged, either through the annuity or by some other method. (Also, one needs to consider mortality risk so married couples should certainly consider a joint life annuity.)

Andrew Stevens said...

Oh, forgot to say that of course it also eliminates longevity risk.

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