John Oliver Does Us All A Service

john_oliver_retirementWe know from Mary Poppins that a spoonful of sugar helps the medicine go down and, similarly, a healthy dose of humor is the best way to learn about something as baleful as personal finance. John Oliver does us all a good 20-minute service in nailing key points about retirement, in this bit from a few weeks ago.

 

The video is worth watching and includes such key points as:

  1. Annuities suck (Especially variable annuities, I should add).
  2. Financial Advisor” is a meaningless title that tells you nothing about their qualifications.
  3. Fees matter a lot. A lot. A  lot.
  4. Suze Orman has a crazed look on her face (ok that’s my own editorializing right there).
  5. Actively managed funds tend to lag passive funds, by approximately the amount of extra fees.
  6. Insurance companies are particularly egregious fee-chargers when it comes to financial services.
  7. Personal investing – despite the best efforts of the financial infotainment industrial complex – can be made startlingly simple.

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Guest Post – Annuities Are Expensive

lars-Kroijer-on-TVAnnuities are an important and sometimes dominant part of the investment portfolio for millions of savers.  While in certain instances there is a requirement for pension scheme participants that they put a part of their pension savings into an annuity, others decide to have them because they find great comfort from having a secured cash flow until they die (some annuities continue payments for dependants).

I certainly don’t have a problem with annuities.  There is great intangible value to be had in knowing that you are going to be ok in your old age, regardless of how old you become.  Particularly if you have an annuity that is adjusted for inflation (some adjust for changes in the retail price index), you have a very good picture of your spending power in retirement, without worrying about the oscillations of the markets or dying with a lot of money that you may have no use for (you’ll be dead…).

But there are a couple of things I would encourage you to think about when purchasing an annuity.

 Who guarantees your payment in the future and what is their credit quality?

Keep in mind that you will be expecting payments many years into the future.  If you buy an annuity at age 50, with some luck you’ll be looking for a payment half a century into the future, and at that time your quality of life may greatly depend on actually receiving that payment.  In most cases annuity providers are insured by a government backed scheme, but you want to make absolutely sure that this is the case.  You certainly don’t want to be in a case where a Lehman style bankruptcy means that you are left with nothing in retirement when your earnings potential has greatly diminished (keep in mind that annuity providers are likely to be struggling exactly when markets are tough and you probably need them the most).

 The price of the annuity may be very high – be sure you need it!

You are essentially lending money to the insurance company for a very long time.  You can try to figure out at what rate the following way for a standard (non-inflation adjusted) annuity:

  1. Figure out your life expectancy. There are many life expectancy calculators on the internet[1] – it will be more accurate if you can incorporate where you live, etc.  This will give you a good idea of how long the insurance company expects you to pay your annuity for (make sure you tell them all the bad health stuff – as morbid as it sounds in this case you want them to think you are going to die soon).  I was surprised by how long I can expect to live, which according to a friend in insurance is a common reaction.
  2. Search around for the best annuity and be sure that the payments are in fact guaranteed by someone other than the annuity provider’s general corporate credit. Assume we are doing an annuity that you buy for £100; what will your yearly payments be?
  3. Figure out the internal rate of return (IRR) on your payment. Your IRR is the rate that the insurance company effectively borrows from you at.  So year zero: -£100, year 1: +3.75, year 2: +3.75, etc.  You can do this in excel.  Keep in mind that unlike a bond you don’t get the principal back at the end (there are annuities that do this, but the interim payments are just lower to reflect this).
  4. Figure out the average time to future payments (the duration – also use excel); depending on your circumstances it will perhaps be 15-20 years. If you start receiving the annuity payments now this will be half the years you are expected to have left to live.
  5. Compare your IRR to a government bond of a maturity similar to the duration and in the same currency (your average time to payment in 4 above).
  6. Apply some sort of discount to the annuity IRR to reflect the inflexible nature of the product and perhaps stiff penalties if you try to get out of the annuity. Depending on the policy these penalties can very stiff and you should discount the value of the annuity accordingly.

Consider any tax advantages of the annuity; these are at times significant.

As an example, when I did the above exercise as a potential annuitant, the IRR I received on my investment was slightly lower than the equivalent UK government bond.  So I essentially would be lending money to the annuity provider decades into the future at a lower rate than I would the UK government, ignoring the flexibility I would have in trading the UK government bonds if my circumstances changed.  In other words, the insurance I received from the annuity provider against running out of money in very old age was very costly.

It is not surprising that the IRR for your annuity is not great.  Annuity products are expensive to manage, and not necessarily great business for the insurance companies, as you deal with the administration of cash transfers to thousands of annuitants, in addition to marketing, overhead, re-insurance that the annuity provider will be able to pay you, and their profit and capital requirements of the annuity provider.  Just think that it costs money every time someone calls up to complain that they have not received their £300 and multiply that by a million customers – even if you are not the costly customer you share in paying for those costs by being on the same annuity platform.

My conclusion on annuities is that if you don’t have a lot of savings and worry about having enough into old age, annuities are well worth the poor return they promise on your investment.  If you don’t have a lot there is great value in knowing exactly what you have and that it will be enough.  An annuity can give you that.

If you have more assets and are highly likely to leave an estate for your descendants then perhaps reconsider annuities.  After adjusting for potential tax or other benefits the return on the assets you put into an annuity is mostly quite poor and you could make more money investing on your own.  You will of course not have the guarantee of additional payments if you live beyond your life expectancy, but considering your other assets you will be fine even without those additional monies.  Also annuity providers make large sums from the hefty penalties from changing or cancelling annuities and if there is any chance that you may be doing that do consider that in evaluating an annuity (a lot can change in decades ahead so even if you consider that unlikely now that may change in the future).  This could include if you wanted out because you no longer considered the future annuity payments secure.  Just imagine how you would feel if your old age living cost was promised by a Greek insurance company that was backed by the Greek government in case it defaulted.  You would hopefully have run for the hills a long time ago.

As evidenced by the IRR on the annuity the return profile is extremely low risk/return and that may not suit your risk profile – if you can afford greater risk in pursuit of greater returns in your portfolio an annuity may lock you in to lower return expectations for decades ahead.

[1] I used a couple including one from University of Pennsylvania:  wharton.upenn.edu/mortality/perl/CalcForm

 

Editor’s note: I like annuities even less than Lars. For example, please see my related posts on annuities:

Ask an Ex-banker: Annuities!

Using Discounted Cash Flows to Understand Annuities

 And please see related posts by or about Lars Kroijer:

Book Review: Investing Demystified by Lars Kroijer

Podcast with Lars Kroijer on Having an ‘Edge’ in Markets

Podcast with Lars Kroijer on Global Diversification

The Simplest Investment Approach Ever, by Lars Kroijer

Don’t Buy Too Much Insurance, by Lars Kroijer

Agnosticism Over Edge Can Earn You 7 Porsches, by Lars Kroijer

 

 

[1] I used a couple including one from University of Pennsylvania:  wharton.upenn.edu/mortality/perl/CalcForm

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Part V – Discounted Cash Flows, using an annuity to learn the math

PiggyPlease see my earlier posts

Part I – Why don’t they teach this in school?

Part II – Compound Interest and Wealth

Part III – Compound Interest and Consumer Debt

Part IV – Discounted cash flows – an example using a pension buyout

Preamble

In the last post I used the example of a pension buyout to show how the discounted cash flows formula worked, and I argued that discounted cash flows are the key to all investing decisions.[1]  Everything else you get inundated with – from the Financial Infotainment Industrial Complex – is just a whole lot of hype, gimmicks, tricks and tips.[2]

Which makes it all the more odd that almost nobody outside of the financial industry has ever heard of discounted cash flows, never mind actually using the formula in their investment life.

So, allow me to peel back the curtain a bit more, using the example of an annuity investment.[3]

 

“Life’s but a walking shadow, a poor player
That struts and frets his hour upon the stage
And then is heard no more”

 

Another example using discounted cash flows, to value an annuity

Is that guaranteed monthly income annuity offered by an insurance company a good deal or not?  To answer the question you’d need to know how to discount cash flows to put yourself on an equal footing with your insurance company offering you the annuity.  Which I did on my site once before.[4]

Let me break down some of the numbers, by way of example, or possibly by way of inspiration to others who want to start calculating discounted cash flows in their own life.

I just went on my preferred insurance provider’s website[5] and asked for a quote on a 15-year fixed time-period annuity.  In exchange for a $100,000 lump sum from me, the insurance company offered me $641.15 per month, guaranteed, for the next 180 months.  The question I ask is whether that is an attractive investment for my $100,000?

To answer the question I’m going to use the discounted cash flows formula Present Value = Future Value/ (1+Yield/p)N.

I offer a bit more explanation of these variables in a footnote[6]

I can discount exactly 180 different future payments of $641.15, by dividing each of them by (1+ Yield/12)N.

For the first cash flow, N is 1.  For the second, N is 2.  For the 180th monthly payment, N is 180.

This looks like this table in my spreadsheet, which contains 180 rows of numbers and discounted cash flows formulas:

N Period Monthly Payment Formula: PV = FV/(1+Y/p)N
1 $641.15 =$641.15/(1+Y/12)1
2 $641.15 =$641.15/(1+Y/12)2
3 $641.15 =$641.15/(1+Y/12)3
$641.15 =$641.15/(1+Y/12)
180 $641.15 =$641.15/(1+Y/12)180

 

Once I have programmed a spreadsheet to calculate 180 individual discounted values for $641.15, I next program the spreadsheet to add up all 180 payments.[7]

Next I can input a value for Y, or Yield, to try to figure what kind of deal I’m offered by my annuity company.

I compare the sum of all 180 values to my original $100,000 investment.  To come up with a comparable yield on the annuity, I input different values for yields into my spreadsheet.  For my purposes I can find the ‘yield’ through ‘iteration,’ basically trying different values until I match up the sum of discounted annuity payments to a final value of $100,000.

If I assume Y is 2%, as I’ve shown in the table below, it turns out the sum of all cash flows is too small and does not quite add up to $100,000.

N Period Monthly Payment Formula: PV = FV/(1+Y/p)N Calculation
1 $641.15 =$641.15/(1+0.02/12)1 $640.08
2 $641.15 =$641.15/(1+0.02/12)2 $639.02
3 $641.15 =$641.15/(1+0.02/12)3 $637.95
180 $641.15 =$641.15/(1+0.02/12)180 $475.09
TOTAL $115,407.00 $99,633.46 $99,633.46

 

If I instead assume Y is 1.5%, it turns out the sum of all cash flows is too large and adds up to more than $100,000.

N Period Monthly Payment Formula: PV = FV/(1+Y/p)N Calculation
1 $641.15 =$641.15/(1+0.015/12)1 $640.35
2 $641.15 =$641.15/(1+0.015/12)2 $639.55
3 $641.15 =$641.15/(1+0.015/12)3 $638.75
180 $641.15 =$641.15/(1+0.015/12)180 $512.04
TOTAL $115,407.00 $103,287.51 $103,287.51

 

 

So I keep trying to find, using my spreadsheet, the value that makes all 180 discounted payments of $641.15 equal to $100,000.  Once I find that, I know what kind of yield, or return, my insurance company offers me on my annuity investment

It turns out, through iteration, that 1.92% is the yield I get by investing $100,000 today and receiving $641.15 per month guaranteed for the next 15 years.

The fact that 1.92% is an absolutely pathetic return is not surprising, nor notable.  As I’ve written before, insurance companies are in the business of buying money cheaply and selling money expensively, and retail annuities are the ultimate source of cheap money for them.

What is notable is that we, as consumers, have no way of evaluating the return on an annuity if we can’t do discounted cash flows.

Which is why I say, ask not what you can do with your insurance company.  Ask what your insurance company is doing to you.

Just like credit card companies do not want you to know that the average American household, carrying the average credit card balance, at an average interest rate, will pay $2.6 million over 40 years because of compound interest[8], similarly, insurance companies can build massive skyscrapers in major cities because they know how to use the discounted cash flow formula to get money cheaply.

And you don’t.

Please see earlier posts

Part I – Why don’t they teach this in school?,

Part II – Compound Interest and Wealth

Part III – Compound Interest and Consumer Debt

Part IV – Discounted cash flows – Pension Buyout Example

Part VI – Conclusion, or why everyone needs to know this math for the good of society

and Video Posts

Video Post: Compound Interest Metaphor – The Rainbow Bridge

Video Post: Time Value of Money Explained

 

 

Be Rational Get Real


[1] Put it this way, if you’re an individual (I will exempt broker-dealers, HFT and many professional investors from this next statement because they are often doing something different) and you’re not employing a discounted cash flows formula, you’re gambling, not investing.  Which is to say, 99.5% (and I rounded down to be conservative) of us are gambling when we purchase an individual stock.

[2] Are the Chinese buying it?  Is your gym-budding selling? Will baby-boomer demographic trends boost this?  Is Bill Ackman short the stock?  Is it a breakthrough miracle drug?  Will nano-technology make it obsolete?  All hype.

[3] I’m using an annuity to illustrate the use of the discounted cash flow formula because it’s easier to talk about the straight math of future annuity cash flows than it is to talk about modeling future stock dividends and profits.  That involves a longer conversation about equities actually just being a series of future cash flows, which most people will not want to wrap their head around at this time.

[4] By the way, I just re-read my piece on annuities from six months ago.  You should go read it.  It’s good.

[5] I mentioned USAA before in my piece on annuities, because their customer service is awesome.  I have no relationship to them other than as a customer and I just like them.  I assume their quote is standard for an annuity provider, neither better nor worse than the competition.  As I wrote you before, USAA, you should totally make me your President Palmer, peddling life insurance for you.  Call me, maybe.

[6] This time with the formula I’ve introduced the variable p, which is the number of times per year that money gets compounded.  In the case of monthly payments, p is 12, because I have to take into account compounding 12 times per year.  N remains the number associated with each payment, from 1 to 180 in our example, unique to each monthly payment.  Yield, also known as Discount Rate, is the variable I’m going to solve for, to figure out whether the investment is a good deal or not.

[7] Those of you reading this who have spreadsheet experience will note that it’s very simple to create 180 nearly identical rows of formulas simply by a click-and-drag of a single formula.  Similarly, adding up 180 different discounted cash flows is as easy as typing “=sum()” into a spreadsheet cell and referencing the correct cells.  Out pops the answer.

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Ask an Ex-Banker: Annuities!

Q: I am thinking about buying an annuity.  I want to generate dependable income,  BUT,  how do I make sense out of whether or not an annuity is a good investment in addition to providing a degree of comfort.  The tradeoff seems a big gamble,  i.e. how long I will live.  –Captain Bill H., Friendship, Maine.

A:  Apparently annuities are a growing segment of the retirement market, so Bill, your question is timely.

I thought it would be useful to explain how a banker thinks of an annuity.  By “banker,” I also mean to explain how your insurance company thinks of the annuity they’re offering you.

From the banker’s – as well as insurance company’s – perspective, an annuity is a great deal, and it’s not a gamble.  From your perspective, the story is more mixed.

HOW A BANKER OR INSURANCE COMPANY THINKS OF AN ANNUITY

First off, your insurance company – despite what your friendly insurance broker may tell you – does not offer you the annuity to “guaranty your financial health,” “generate dependable income,” “protect your loved-ones,” or to “make sure you have sufficient income in your retirement years.”  The insurance company, instead, is an investor maximizing its profit.  When considering an annuity, let’s always keep that in mind first.

Now, like all for-profit financial companies in the known solar system, your insurance company seeks to buy money cheaply and to sell money expensively.  This falls under the well-known investment activity: “Buy low, sell high.”

I do not mean to be obtuse when I write “buy money cheaply,” since to the non-financial person “buying money” may begin to sound like Orwellian tautology, but bear with me for a moment.  Financial people -including the people who employ your friendly insurance broker – definitely think of their business as buying cheap money and selling expensive money.

Now let’s briefly peek ahead at the Answer Key in the back of this blog: your annuity represents an opportunity to buy cheap money for the insurance company.

Ok, back to the main text of my answer.

All insurance companies need a massive pile of money to operate,[1] so they constantly evaluate the best ways of buying money.  When acquiring money, insurance companies have a choice of where to get their money.  I’ll run through the three main ways:

  1. Sometimes insurance companies acquire equity capital through the sale of shares to private or public stock investors.  In other words, the companies sell part of themselves to other owners, in exchange for money.  All publically owned insurance companies have done this.  Equity capital is typically considered extremely expensive money, so insurance companies do this only as a last resort.[2]
  2. Often insurance companies acquire debtor capital money, otherwise known as borrowing, possibly from a bank but more commonly in the form of a bond from institutional investors.  An investment grade insurance company[3] may be able to borrow $1 Billion for 10 years right now at, say, 4% in the bond market. This means the insurance company gets use of $1 Billion, it pays $40 million per year in interest for that privilege, and then it returns the $1 Billion in principal at the end of 10 years.  Since rates are historically low right now, and the institutional bond market is extremely efficient at providing capital to insurance companies, this is a great way for insurance companies to acquire money on the cheap.
  3. And finally, there’s rock-bottom cheap money: your annuity.[4]  Given all the costs of acquiring you as a customer[5] and servicing your annuity for your life, plus the retail nature (ie. small size) of the money you’re providing to the insurance company, you would expect this money to be VERY cheap indeed, to make it all worthwhile for the insurance company.  Again, remember, they don’t actually care about all the comforting things President Palmer talks about during the Allstate ads.  To provide you, the customer, with an annuity, it’s got to be really cheap money.  If it wasn’t super cheap, they would just borrow money from the bond markets.

How cheap is cheap?  I just went on my own personal preferred insurance company/bank’s website[6] and applied for a $100,000 annuity.  I’m 40 years old and applied for a lifetime monthly annuity, with a (fairly typical) 20 years of guaranteed payments.[7]  In exchange for my upfront $100,000, the company offered $358.39/month for the rest of my life.  The company guarantees that, even if I die suddenly, the first 20 years, or 240 monthly payments, will be paid to my heirs, for a guaranteed payment amount of $86,013.60.

Now, if you’ve been following closely up until now, you’ll already know that I set up my answer to Bill’s question as a less than ringing endorsement for annuities, but the actual quote allows us to see exactly how good or bad the annuity opportunity is in pure financial terms, for both the insurance company and the annuity buyer.[8]

The insurance company will never tell you the cost of borrowing money from their perspective, but I will share with you what their cost would be for my specific annuity.

If I live my expected[9] additional 37.8 years to the ripe old age of 77.8 then the insurance company’s cost of money is 2.79%.[10]  Another way of thinking about the calculation is that I would earn 2.79% annually on my $100,000 for the next 38 years if I am lucky enough to live that long.  If I’m unlucky, and live fewer years, then my insurance company effectively borrows money at substantially less than 2.79%, possibly below a 0% cost of funds.  In that early death scenario, they get money that’s cheaper than free!  Equivalently stated, the % return that I receive on my annuity could be negative if I die before my expected time.[11]

If, instead, I live as long as I expect to live, that is to say, until age 100,[12] then my return can be as high as 3.84%, and the insurance company’s cost of funds is equivalently 3.84%.  Notice this is still below the 4% they can expect to pay to borrow money in the bond market, making an individual annuity worthwhile to them even if I far exceed my life expectancy.

Let’s take another example.  Let’s say Bill, the original questioner above, is a 70 year old man, who can expect an additional 13.7 more years, according to the Social Security actuarial tables, living to the wise old age of 83.7.  I applied online to my same insurance company as a 70-year-old man,[13] willing to take just 10 years of guaranteed payments (a reasonable scenario rather than the 20 years of guaranteed payments that a 40 year old might want.)  For his $100,000 annuity premium, Bill could expect to receive $597.19/month for the rest of his life with 120 guaranteed payments.

What is the insurance company’s cost of funds in this case, and conversely, Bill’s expected return?  If Bill lives to his expected life-span, he would receive a total of $98,536.35, or less than he paid upfront for the annuity, for a negative return on his money.  In other words, under a reasonable baseline scenario, the insurance company acquires money at a negative rate of interest.  That’s better than free!  That’s awesome.  If you’re a death-eating, snake-tattoo-on-your-arm annuity provider, of course.

Now, if Bill also lives, as I’m sure he expects to, until the ripe age of 100, he can expect a much improved 5.92% return on his investment, while the insurance company conversely incurs an expensive cost of borrowing from Bill, at 5.92%.  However, the insurance company has wisely balanced the probability of free money under an ordinary scenario (Bill lives to his expected life span) versus the very remote probability of maxing out at 5.92%, if Bill hangs on to this mortal coil for a whole century.

Now, I have few rules in life, but one of them is that when you can acquire money somewhere between free and 5.9%, with the probabilities skewing much closer to free, well then you should acquire as much money that way as possible.  And figure out what to do with it later.  Like, for example, build massive skyscrapers with your money.  In a related piece of news, has anyone else noticed that insurance company skyscrapers dominate most major US city skylines? Your death, plus your neglect, help make this happen.  I’m just sayin’.

 

 OTHER FACTORS BESIDES RETURN/COST OF FUNDS – SAUSAGE MAKING

In addition to the cost of money for an insurance company, it’s worth understanding another reason insurance companies seek to provide annuities.  Most annuity providers are also life insurance companies.  This makes sense in the same way that a sophisticated slaughterhouse might provide both premium sausage meat and processed hog food, as one customer’s premature death is balanced by, or better said, hedged by, another customer’s unfortunate longevity.

What do I mean by this?  A life insurance policy allows the insurance company the opportunity to collect regular, moderate – typically monthly – premiums.  For that opportunity, the insurance company has the obligation to pay out a substantial lump sum upon the death of the insured person.  An annuity is the mirror image of a life policy.  The insurance company has the opportunity to collect a substantial lump sum up front, and then takes on the responsibility, or liability, to pay out regular, moderate – typically monthly – premiums.  When the life insured customer dies, the insurance company “loses.” When the annuity customer dies, the insurance company “wins.”  When a company can offer both life insurance and annuities simultaneously, it creates an efficient kind of perpetual sausage-making machine in which money can be continually bought cheaply and sold expensively.

A rash of deaths causing a string of sudden life-insurance payouts can be compensated by a release of the obligation to pay ongoing annuity income to the newly dead.  It all works out nicely.  If you’re an insurance company.

 

SHOULD BILL GET AN ANNUITY?

Now that we know the range of investment returns we can expect on an annuity, does it make sense to purchase an annuity, Bill’s original question?

The answer to Bill’s original question is obviously more complex than can be understood in terms of cheap money and expensive money, even if that’s the primary lens of a banker or an insurance company.

The appropriateness of an annuity for any individual owes quite a bit to the individual’s appetite for risk.  To return to geometry class, picture the XY axis where X shows an arrow of increasing risk and Y shows an arrow of increasing return.  The annuity represents one of the lowest risk and return assets you can possibly acquire, pretty much right next to the 0,0 point on the graph, just above and to the right of straight cash.

If you don’t mind providing free money to insurance companies, and you quite like the idea of cash-like returns, then annuities could be just the thing for you.  When you think of if that way, annuities are a perfectly reasonable cash substitute.  Despite S&Ps recent warning, State and Federal regulators manage to make the insurance industry a safe place to park funds for life, as long as you understand a) that the return will be terrible and b) the insurance/annuity provider will never, ever, tell you the return you are getting.  That information, if disclosed, would embarrass them.  And it’s hard to build skyscrapers when you’re feeling embarrassed.

 

For more on annuities and using the mathematics of discounted cashflows to evaluate them, please see this post:

Discounted Cashflows – Using the math to evaluate an annuity.



[1] Like a bank, the main requirement for operating an insurance company is to have a pile of money.  None of the other functions and requirements for operating an insurance company matter much if you don’t start with a pile or money and then maintain it at all times.  Once that pile of money shrinks, it doesn’t matter how good you are at the rest of the things that go into being an insurance company, you’re out of business.

[2] Like for example how Credit-crunch-poster-child-insurance-company AIG sold $17.4 Billion worth of shares in 2012, because, well, how else are they going to get money?  No one wanted to give them money anymore since they were a root cause and casualty of the 2008 Credit Crunch.

[3] I acknowledge “investment grade insurance company” is a bit of a redundancy in the US context, since non-investment grade insurance companies are generally not allowed to operate, but rather are put into a special receivership status by federal or state regulators, and their portfolios allowed to run off over time.  Sometimes this takes decades.  I have invested in annuities like this via my investment business, but I digress.

[4] It may not have been apparent to you as an annuity customer until now, but essentially you’re lending money, just like a bond, to the insurance company.  Instead of a $1 Billion loan in the form of a bond, you might turn over $100,000 up front in the form of an annuity.  But then – just like a bond – the insurance company has an obligation to provide regular payments back to you in exchange for use of your money.  One great aspect of this loan-in-the-shape-of-an-annuity, is that the loan isn’t limited to, for example, 10 years, like a bond.  In fact, the loan is forever.  You see, the really cool thing about your loan/annuity, (from the insurance company’s perspective) is that they never have to pay you back the principal!  You just die, and they keep the $100,000 of your money!  Seriously, how great is that? The answer is: very great, as long as you’re an insurance company.

[5] Advertising, monthly statements, fund transfers, investment disclosures, customer service for your lifetime, plus all those drinks your insurance broker provided you at the Golf Club…none of this comes cheap people!

[6] I do all my banking and insurance with USAA because their customer service absolutely rocks.  It’s leaps and bounds better than any other major customer service business I’ve ever dealt with.  Regardless of their customer service awesomeness, I believe their annuity quote to be typical.  Let this footnote serve as my unsolicited highest endorsement of USAA, although there’s no absolutely no tie between me or Bankers Anonymous and USAA.  But I kind of wish there was.  USAA, hit me up, I could be your President Palmer.   Call me, maybe.

[7] Just to walk you thought the thought process if you’ve never applied for an annuity, its common to request an annuity quote for lifetime payments with some period of payments guaranteed to avoid the “I bought the annuity today for a big premium but got hit by a bus next month” problem that most annuity buyers would never be able to overcome.  So, typically you buy lifetime payments and the annuity/insurance company agrees to pay your designated heirs at least some year’s worth of payments if you die suddenly.  For a relatively young person a 20year guarantee is not atypical.  A much older person might choose a shorter guaranteed payment period, like 5 or 10 years guaranteed.

[8] Incidentally, I’m 99% sure that insurance companies never provide a % return estimate for annuities of the type I’m providing in the main text paragraphs to follow.  So the fact that I’m providing this clear-headed financial return analysis may be largely attributed to two factors: a). I’m your best friend, and b). Insurance Companies are not your friend.

[9] Have you ever wondered what your expected lifespan is, as well as your probability of death in any given year?  The Social Security administration has the answers.   Not only am I your best friend, but I can predict your date of death as well.  Weird.  It’s like I have special powers.  Anyway, you’re welcome.

[10] How did I get this % interest rate?  I’m kind of glad you asked.  Join me a little way down the financial rabbit hole.  I got there by applying a single Discount Rate to a formula for figuring out the present value of all the expected future cash-flows.  What is a Discount Rate?  That’s the single % rate I can apply to all the future cash-flows of an annuity which add up to $100,000 (my original annuity cost).  The formula for each single cash flow is “Nth Annuity Payment” in the numerator divided by a denominator of (1+Discount Rate/12) raised to the power  of the Nth payment.  I know this makes absolutely no sense if you haven’t already worked with the formula before, but my wife made me put it in here.  I’ll tell you what, how about some curious and astute reader sends me a note asking me to explain discounted cash flows and I’ll do a whole post about it sometime soon.  Is that a deal?  In the meantime, trust me that this is how every bank and insurance company evaluates the amount they’ll pay you for your annuity.

[11] If you have a paranoid frame of mind, you can see how the annuity provider begins to resemble a financial vulture, hoping for your premature demise so they can get free money.  Does the flapping of their wings smell like death to you as well?

[12] In the year 2072, I’m comforted in my old age by my bedside Rihanna clone – scientifically engineered to remain 24 years old.  I die quietly in my sleep on our hovercraft, while she lullabies “SOS” until a pass to the next world.

[13] Let’s just agree to call me Harrison, shall we?

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