Press Room
Press Responses

January 13, 2003

Letters to the Editor
Consumer Reports
P.O. Box 2015
Yonkers, N.Y. 10703-9015

To the Editor:

We are writing in response to the article entitled "Should you buy an annuity now?" that appeared in the February issue of Consumer Reports. The article demonstrates a fundamental misunderstanding of annuities and does a serious disservice to your readers by misinforming them about a valuable financial product that is helping many Americans negotiate the difficult path toward permanent financial security and a worry-free retirement.

In the interest of fairness, we would like to note at the outset that we do not disagree with all of the statements set forth in the article. For example, the article advises investors to consider the "financial strength" of the insurance company issuing the annuity. We agree. The financial strength of the insurance company is a relevant consideration - as is the financial strength of a bank, mutual fund or brokerage house with which an investor is considering doing business. We also agree with the article's favorable recommendation of "fixed-rate annuities that provide a predictable return."

However, we strongly disagree with the article's characterization of variable annuities. The article compares variable annuities to mutual funds, noting that investors put their money into "mutual fund like" sub-accounts. The article then goes on to describe variable annuities as "horrible deals" because "any long term capital gains you earn in a variable annuity are taxed at ordinary income rates." However, this is more than outweighed by the fact that earnings on investments in a variable annuity are tax-deferred.

In October, 2000, PricewaterhouseCoopers conducted a study comparing the after-tax returns of variable annuities and mutual funds and concluded that variable annuities "are frequently a more attractive investment relative to mutual funds for long-term savers." Using historical income and expense data, the study found that for the average investor and the average variable annuity and mutual fund, the after-tax payouts funded by variable annuity investments are substantially larger than for mutual fund investments for holding periods as short as 10 years.

Moreover, not all gains on mutual funds are taxed at capital gains rates. Mutual funds generally must distribute all dividends, short-term gains and long-term capital gains realized by the fund through its investment activities. Mutual funds investors are taxed annually on their share of distributed income. A mutual fund investor includes all dividends and short-term capital gains distributions in ordinary income. Across all mutual funds, the PricewaterhouseCoopers study found that over 40% of the total return was taxable at ordinary income rates.

But the article doesn't stop there. Even "worse", are the two "extra layers" of expenses charged by variable annuities - "management and marketing fees for each sub-account" and "insurance charges." In view of the fact that mutual funds charge fees for management and marketing, we find the characterization of these variable annuity fees as "extra layers" somewhat puzzling.

The insurance charges pay for the insurance benefits that are imbedded in the product, including the death benefit - which is ignored by the article. The standard death benefit provided by variable annuities guarantees that if the policyholder dies while saving for retirement, his or her beneficiaries will receive the greater of the amount of money that was invested or the policy's value at the time of death. Many variable annuities go even further and offer enhanced death benefits that lock in investment gains every few years or even every year.

Many investors consider the death benefit to be vitally important. It gives people the confidence to stay invested in the stock market, which historically has been an excellent source for long-term growth, since they know their family will be protected against financial loss if they die when the value of their investment has declined. Particularly given the prolonged decline in the stock market, we find the failure to even mention this valuable insurance benefit to be inexplicable.

In addition to the death benefit, the insurance charges also pay for payout options that protect individuals from outliving their assets by guaranteeing them payments that will continue for the rest of their life, no matter how long that is. The article takes a rather dim view of lifetime annuitization, concluding that:

For people who are fearful of managing their own retirement funds and have no dependents, such vehicles are heaven-sent. But, there are other no-risk ways to get a stream of income, like laddered CDs or U.S. Treasury Bonds.

We respectfully disagree. A number of studies have been conducted comparing the amount of income generated from lifetime annuities with self managed "home made" annuities. In January, 2002, PricewaterhouseCoopers conducted one such study and concluded that "lifetime annuitization provides real value to investors who want to ensure they have income as long as they live." The July, 2002 issue of Money Magazine came to a similar conclusion:

How can an annuity pay a higher income than you could manage on your own? The answer is that while you must base your payments on a single life - yours - insurers base annuity payments on a pool of many lives. And they know that while some people will live to their life expectancy and beyond, others will die earlier. So insurers can boost their payments by, in effect, transferring money from the people who die early to those who die late. (emphasis added)

One final note. The above quoted passage from your article notes that lifetime annuities are heaven-sent for people with "no dependents." Lifetime annuities offer a full range of payment options which allow the policyholder to choose payments which will continue for as long as either spouse is alive and/or for a specified number of years, such as 10 or 20 years.

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No product or investment is perfect for everyone, and investors need to fully understand their alternatives so that they can make choices based on their individual needs and circumstances. We share a common goal of educating the public about variable annuities and trust our response will assist you in this effort.

Sincerely,

Mark J. Mackey
President and CEO
National Assn. for Variable Annuities (NAVA)
Reston, VA