Metlife Inc (MET), Manulife Financial Corporation (USA) (MFC): The Biggest Threat to Annuity Investors

Why age matters
The CBO study doesn’t argue that annuities are never warranted for anyone. For those who are rich enough for annuity payments to cover even unexpectedly large health costs, annuities still make sense. On the other hand, the more risk-averse you are, the less you should generally annuitize.

Moreover, age plays an important role in the annuity decision. The older you are, the more advantage an annuity has over regular fixed-income investments due to the mortality credit. Yet the risks of health problems also rise with age. The study found that the sweet spot for annuities falls roughly in your 50s, when annuities start to pay a higher mortality credit but the risk of bad health news is still relatively low. By your 60s and 70s, on the other hand, the incidence of negative health surprises overwhelms any benefit of the mortality credit, and only once you reach your late 80s or 90s does the mortality-credit factor take precedence. In other words, for many of those who have just retired, the timing is bad for annuitizing your wealth.

Interestingly, the CBO research comes to the conclusion that younger households would actually do best if they could sell annuities short. By doing so, they’d essentially be betting against their own health, and the paper suggests that if they later suffered an illness or injury that reduced their life expectancy, they could then buy an immediate annuity much more cheaply. In the real world, there’s no mechanism for short-selling an annuity, and an annuity tailored specifically for someone whose life expectancy is below average isn’t the easiest to obtain, either.

Being smart
Even with more realistic assumptions, the CBO study still doesn’t reflect reality for many families. In particular, the study’s conclusions apply to those who don’t wish to leave money to future generations, instead expecting to spend down their entire wealth during their lifetime.

For annuity sellers, the interesting takeaway of the study is that annuities could look more attractive if a broader range of products were available. Given the tendency of the insurance industry to provide ever-evolving new products, the net result of the CBO study could be annuities that are better tailored to retirees’ overall needs.

The article The Biggest Threat to Annuity Investors originally appeared on Fool.com and is written by Dan Caplinger.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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