Ebook Equity-Indexed Annuities: Fundamental Concepts And Issues
This year, 2006, represents a major milestone for the 78 million baby boomers in the U.S. as the first wave of “boomers” turns age 60. Two years from now—in 2008—these individuals will qualify for Social Security’s early retirement benefits and three years after that—in 2011—this initial wave will attain age 65 and become eligible for Medicare. This initial cohort will be followed, annually, by 18 additional waves of baby boomers reaching similar milestones, with the last of the individuals born in the 1946-1964 period reaching age 60 in 2024.
Baby boomers and succeeding generations face a somewhat daunting task in planning for their financial future especially as it relates to retirement. Many of these individuals will face retirement with no guaranteed monthly income, or with a substantially reduced amount, coming from their employers due to multiple job changes or as the result of an employer’s decision to terminate or “freeze” an existing defined benefit pension plan. Further, while benefiting from an increased life expectancy, many of these same individuals also will likely be confronted with high medical costs and long-term care costs at a time when many employers are implementing major cutbacks in their retiree medical expense plans and Medicare is experiencing significant financial pressures of its own. Given these trends, together with the projected future deficits under Social Security, it is clear that baby boomers and successive generations need to exercise greater individual responsibility in seeing that their retirement income objectives are achieved.
Asset accumulation and asset diversification will likely remain important to future generations of retirees as they approach retirement. However, whether these retirees will enjoy the “best of times” associated with a long and healthy retirement, or endure the “worst of times” that potentially could occur when a lengthy retirement period is coupled with inadequate income, may depend on how these individuals structure their retirement assets. It is in terms of asset structuring where annuitization can play an important role in retirement planning.
Annuitization is the process whereby assets are converted into a guaranteed income stream payable for a fixed period of time, or over the lifetime(s) of one or more individuals. Annuitization provides individuals with a guarantee that they will not “outlive their income”—a major concern for many retirees. It also allows persons to maximize the amount of their periodic retirement income, although it may defeat any bequest motives on the part of these individuals. Arguably, a strong case can be made for the annuitization of at least a portion of an individual’s retirement asset portfolio, especially in those instances where only a modest portion of the total retirement income objective is met through monthly income received from Social Security and/or an employer-sponsored defined benefit pension plan. In the U. S. to date, annuitization through private annuities has been an underutilized source in meeting retirement income needs. Several explanations have been offered for this phenomenon including the presence of adverse selection in the private annuity market, individual bequest motives (e.g., parents wanting to leave assets to children), and the existence of Social Security and private defined benefit pensions that provide annuitized streams of income. Although asset accumulation and diversification will remain important to baby boomers and subsequent generations as they approach retirement, it is anticipated that distribution of these assets—especially through annuitization—will assume a much greater role in retirement planning.
This monograph focuses on Equity-Indexed Annuities (EIAs), also known simply as Indexed Annuities—a category of relatively new and increasingly popular products offered by some insurers. Annuities in general, and EIAs in particular, provide a way for individuals to accumulate additional assets to help meet their retirement income needs. EIAs and other fixed annuities provide purchasers with certain guarantees including the opportunity to annuitize these assets at contractually guaranteed rates. In addition, EIAs credit interest returns to accumulation values based on the performance of an equity index that, hopefully, will provide inflation protection for these assets.
EIAs recently have received a significant amount of criticism from both within and outside the insurance industry, and these products currently are facing increasing regulatory scrutiny. A primary purpose of this paper is to address important issues surrounding EIAs. Comparisons with other financial products will be made where appropriate. Key product features, the current EIA marketplace, and issues and criticisms surrounding EIAs also are addressed in the paper. Specific recommendations are then presented, followed by a summary and conclusions section.
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