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Insurance-based annuity income guarantees are not investments
Many investors rationally seek retirement income guarantees through annuities and related insurance products. When they purchase such insurance with their labor income and/or investment assets, they change the complexion of their portfolios. When they shift investment risk bearing to an entity providing a guarantee, they cease to be investors for that portion of their assets. Furthermore, they often must pay a high price to shift asset risk to the guaranteeing organization.
Insurers intend to make a risk-adjusted profit on the asset beyond the guarantees provided. Therefore, on average an individual can expect to receive less total value than he would likely have received had he kept the asset and retained the corresponding risk. However, there is one risk that individuals retain and cannot shift. This risk concerns whether the assets of the guaranteeing entity will be adequate to fulfill its future obligations. The sad, yet still ongoing saga of the 1991 collapse of Executive Life Insurance Company is a reminder of this nontransferable risk.
Shifting risk and return to an insurance company can be rational, since the length of one’s life span is uncertain and tolerances for risk vary from one individual to another. Risk pooling based upon longevity can benefit participants, if the price paid for the guarantee is not excessive. The total price of shifting asset risk in such arrangements is the key issue to individuals – in addition to the future risk of the insurance contract non-fulfillment. |
