John P Huggard’s Response to My Questions on Living Benefit Variable Annuities

I have written three posts on Living Benefit Variable Annuities over the last month. I believe they should be given serious consideration as part of any Baby Boomer’s retirement pension plan.  (For those Aussie Readers this post is more relevant in the US.)

After my post, “Guaranteed Income for Life for Baby Boomers” a friend send me an email about some of his concerns with Living Benefit Variable Annuities. So I decided I’d write to John P Huggard an authority on variable annuities and the author of “Investing with Variable Annuities” and ask him to respond.

He expressed two concerns with Living Benefit Variable Annuities and these are;

  • With the “Guarantees” the insurance companies do not fully disclose how much money they are holding back as reserves for these guarantees. He has no proof this is the case but believes it might be the case.
  • He doesn’t agree with your description that Annuities are a cheap or inexpensive insurance.

John P Huggard called me in Sydney Australia yesterday morning Sydney time, and asked if he could respond to my questions. I was both surprised and pleased he took the time to do this.

We spent about 20-30 minutes on the phone with him doing most of the talking. Here are his responses.

John said, other than government mandated resources, no insurance company sets money aside to honour guarantees. They use about ten different methods of protecting your money against loss. These include;

  • Hedging where they will use Put Options to protect their investments over 10 years.
  • Re-insurance – They calculate a break-even point if a catastrophe was to occur and then any exposure above that point they will insure against.

He also responded to someone who might be worried about the guarantees for ten years resulting in no money being left after that period. He said no one has lost a dime to a variable annuity company.

On the second issue he said annuities are NOT insurance policies. They are an investment with a feature being a death benefit. For example if you purchased an annuity for $100K which decreased to $90K and you had died, then your next-of-kin would still get the $100K back. The insurance company would make good the difference as part of it’s death benefit.

If however your annuity increased in value above $100K at the time of your death, no death benefit would be paid.

John said Annuities are not cheap. But he stated that they are not more expensive than mutual funds. He said Mutual Funds tend to cost twice as much as Variable Annuities and this can be proven if specific funds are chosen.

Index Funds though like Vanguard’s S&P500 Index are cheaper but in 2000-2003 this index dropped 48%.

A variable annuity would be more expensive in this case, but after 10 years you would get your money back guaranteed 100% from the variable annuity. Compare that to the S&P500 index over 10 years from 2000. At some point you would have been down 48% and you still would not have your capital back today. You would have had an emotional roller-coaster of a ride too.

John said Living Benefit Variable Annuities are not for everyone. If a 25 year old walked into his office to take out an annuity he would advise him to invest in equities for the long term because he has plenty of time before retirement to make high returns.

But if someone who was 61 years old walked in with $1M to invest, John would most likely recommend a living benefit variable annuity because of the need to protect the capital when in retirement.

A financial adviser might advise putting that same money into mutual funds. Taking a 4% safe withdrawal rate would provide $40K but if 1% was taken in fees that would leave $30K. Take some tax and the pension would be down to only $24K.

If the stock market crashed 25% and your $1M dropped to $750K, your pension would drop to $18K in order to maintain the safe withdrawal rule.

Compare that with a living benefit annuity on $1M that John says will guarantee $60K after expenses (fees and charges), leaving $48K after tax for the retiree to live on – for life. That’s twice as much as investing in mutual funds.

What is even better is that if the insurance company makes good profits on your $1M they will raise your guaranteed withdrawal rate. If it increases to say $51K after expenses and taxes, it is locked in. That means if the next year the returns are poor for the insurance company you keep drawing $51K for life unless it is increased again. It will not go down.

Again I want to emphasise you need to do your own research. Get John’s book and get some information about living benefit annuities from other sources to cross-check everything John has said.

If it all checks out and with the financial markets the way they are, it seems to be a ‘no-brainer”.

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