With June designated as “Annuity Awareness Month,” many Americans are aware of the word “annuity,” but may not understand what annuities are or how they actually work.
The History of Annuities
Annuities go way back, much further back than the 25-year milestone we’re celebrating in 2020. In fact, some archeological evidence suggests that they existed in Egypt from 1100 to 1700 BC. Annuities first gained prominence during the time of the Roman Empire. In return for their service, soldiers and their beneficiaries received annual payments for life known as annua, the basis for the word annuity.
In the 17th century, European governments started to use annuity-type strategies to pay for wars and public works-type projects. Contracts structured in the form of “tontines” were issued to feudal lords in exchange for funds. The noble investors would contribute to a large pool of cash and receive annual payments for life. Upon the lord’s death, the payments ended and the remainder was redistributed among the group. If you were lucky enough to outlive everyone else in this arrangement you received the balance of the pool.
In America, the first annuities were created as lifetime payment plans for church pastors in Pennsylvania. Seventeen years later in 1776, “The National Pension Program for Soldiers” was passed even before the Declaration of Independence was signed. These early annuities provided lifetime income payments to the soldiers of the Revolutionary War and their families.
Commercial annuities were made available to the public beginning in 1812. Decades later, in 1905, Andrew Carnegie founded what became known as the Teacher’s Insurance Annuity Association (TIAA.) Teachers can still get annuities through the same company which is now known as TIAA-CREF—and it was this organization which launched the first variable annuity in 1952. Prior to that, the only annuity structure available was the single premium immediate annuity (SPIA), sometimes called “income annuity” or “pension annuity.”
Despite their simple structure in the beginning, annuities have become increasingly sophisticated over time. There are many different types of annuities with a variety of policy features available, plus countless variations offered by the attachment of optional policy riders.
As a consumer, when you invest in something, typically you assume all the risk. Since annuities are not investments, but instead are contracts with an insurance carrier, they allow you to transfer risk to the carrier. (The only exception might be “variable annuities,” which are linked to a market index and rise—and fall—in accordance with the value of the index.) The risk you always do assume is that annuity payouts are subject to the claims-paying ability of the insurance company who has underwritten the policy.
Recent innovations like fixed indexed annuities—created 25 years ago—allow for growth in relation to an index, but the consumer is protected from loss of principal if the index falls.
Fixed Indexed Annuities (FIAs)
The first fixed indexed annuity, KeyIndex, was offered by Keyport Life in February of 1995, with the help of Genesis Financial. Richard Kado, president of Genesis at the time, is considered the original architect of the fixed indexed annuity. In an interview about the development of the first FIA, Kado said that the spark for indexed annuity designs really came from a question that was asked by a financial planner.
The planner asked, “I provide a lot of interest-earning products to my clients; they don’t have a lot of upside potential, but they’re very safe. And on the other hand, I’ve got products that participate in the market—equity-based products—with a lot of upside potential but, as we all know, with a lot of downside potential as well. Can I get something in between?”
Fixed indexed annuities are linked to equity-indexes, so they have the potential for accumulation, but they are not actually invested in the stock market. One of the problems with equities is that they are too volatile for some people. Arguably, one of the most important features of a fixed indexed annuity is that even in a market downturn, the value of an FIA doesn’t go down. Indexed annuities can work well because of the balance between the growth potential and protection from market risk.
Fixed indexed annuities were born in an economic environment that should be eerily familiar to the pre-retirees of today: falling bond yields combined with a rocky stock market. The FIA was developed to provide potential value above and beyond a minimum guarantee by linking it to the performance of an underlying index, allowing the capability for growth. The more recent addition of a guaranteed lifetime withdrawal benefit expands the guarantee of the FIA to income that the investor cannot outlive. Additional innovations include designs that remove the growth caps found in older versions of fixed indexed annuities. Uncapped FIAs allow consumers to realize much greater potential gain, although gains may be limited by other factors such as participation rates and spreads.
How do innovative insurance companies and product designers provide guarantees plus potential growth? They take advantage of efficiencies in the marketplace that consumers don’t have access to. Institutional transactions may have minimums of 10 to 100 million dollars, and insurance companies can pool money together and take advantage of “wholesale” transactions.
The increasing pace of innovation and adoption by satisfied customers has led larger and more familiar carriers to step into the marketplace. Additionally, industry-leading economic powerhouses and Ivy League experts have created exciting new indexes linked to fixed indexed annuities which have been outperforming S&P averages.
Lifetime Income for Retirees
With people living much longer and pensions quickly becoming a thing of the past, annuities can help provide income throughout retirement without the fear of running out of money. Most annuities sold today are deferred annuity products like variable annuities or fixed-indexed annuities with a focus primarily on building and growing wealth, with the eventual goal of turning on the pension-like aspect, called “annuitizing,” the policy at retirement.
If you are considering the purchase of an annuity, it’s important to speak with a financial professional who understands them, and can explain the fine print of an annuity contract. Quantum helps some of the nation’s top financial advisors explore the FIA options for their clients and helps provide additional insight into annuity policy design and underlying architecture.
Annuities have limitations. They are long-term vehicles designed for retirement purposes, and have surrender charges during the first years of ownership depending on policy terms. They are not intended to replace emergency funds, to be used as income for day-to-day expenses, or to fund short-term savings goals. Investing involves risk.
A fixed indexed annuity is not a stock market investment and does not directly participate in any stock or equity investment. It may be appropriate for individuals who want guaranteed interest rates and the potential for lifetime income. Guarantees and protections are subject to the claims-paying ability of the issuing insurance company.
Past performance is not a guarantee of future results. The Quantum Group, and its affiliates, have a financial interest in the sale of their products. Insurance products like FIAs contain fees, such as mortality and expense charges (which may increase over time), and may contain restrictions such as surrender periods. Guarantees are based on the claims-paying ability of the insurance carrier.