Why So Critical on Annuities?

Last Updated Sep 17, 2009 5:06 PM EDT

Anyone who has been a reader of mine will not be at all surprised when I say that I'm not a big fan of annuities as a place to park our nest eggs. These insurance products come in every variation under the sun, with two types being variable annuities and equity indexed annuities. They all claim to have so called "guarantees" against adverse situations.

Needless to say, my stance on annuities earns me countless emails from financial planners (aka insurance producers) with many bringing the marital status of my parents into question. Here is a much more respectful one that I'd like to address.


You may be an exceptional money manger but you cannot control markets or investor behavior, both of these are addressed better in side of annuities. Please do not be short sighted and risk damaging someone's life by making statements like you do, people have a tendency to believe what they read.

This planner is absolutely correct that I cannot control markets or investor behavior. What he neglected to mention, however, is that the insurance companies he puts his client's nest egg in also can't control markets or investors. For anyone requiring more proof of that statement, I have three letters â€" "AIG."

Dynamics of insurance investing

Take an equity indexed annuity, which typically pays you a part of the market return (a very small part) with no downside risk. You turn over your nest egg to the insurance company and it goes to pay the following:


Insurance agent sales commission

Overhead of the insurance company

Taxes the insurance company pays

Insurance company profits

What's left of your nest egg is then invested by the insurance company. They typically invest in bonds and stocks. Recently, though, thinking that they were smarter than the market, insurance companies snapped up all sorts of derivatives that blew up in their faces.

When all is said and done, the investor gets back the return he could have received by investing directly in bonds and stocks, less all of the expenses listed above. It is for this reason that I say (and say and say) that it is better for investors to bypass the insurance company and invest direct.

What about those guarantees?

Can an insurance company really give you guarantees against a global market downturn such as we experienced in the last two years? No way. If you want guarantees, let me suggest U.S. Treasuries and certificates of deposits backed by the FDIC or NCUA. The U.S. government owns the only franchise to legally print U.S. dollars.

What about market returns without downside risk?

Many insurance producers ask me what I tell a client who wants market returns without downside risk. Much as I would have told my young son if he had asked for a unicorn, I simply tell them, "You can't have it!" Such a mythical creature does not exist. Capitalism (which was declared dead by many last March) dictates that taking a smart risk on capital should give you a higher return in the long-run. There is no free lunch that the insurance companies have access to.

My challenge to insurance producers

I do not have an axe to grind with the insurance industry. I would love to put my own nest egg in a vehicle that gives market returns with limited downside risk. For many years, I've been challenging producers to show me a product that can do just that. If successful, I promise to buy the product, send my clients to them to buy the product, and write profusely about why others should buy this product. And for these many years, nobody has taken me up on the challenge.

My advice

To date, I have never convinced an insurance producer on this simple logic. That's because their income is dependent upon them not understanding this logic. For others reading this column that do not have a paycheck riding on a lack of understanding, remember the simple logic that it is economically better to invest directly in the financial markets than to do it through intermediaries such as insurance producers and insurance companies.

There is only one way I know to make money with annuities -- sell them!


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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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