4. For the FIA, the return for the same 35 benefit years is 3.69 percent with an initial investment of $123,000.
5. It would take the immediate annuity policy 16.73 years to recover the capital outlay, while it would take only 9.84 years for the FIA to recover the entire capital outlay, which is a difference of 6.89 years. This is a significant difference as the payout from an annuity is only a return of investment in the early years.
6. These findings show that immediate annuities may actually cost more with lower benefits in comparison with FIAs.
IV. Discussion
1. It is commonly believed that FIAs entail higher cost in the form of surrender charges and high sales commissions as compared with DIAs and SPIAs which have low commissions and no surrender charges. In a recent article by Michael Edesess and Robert Huebscher, the authors indicate that the sales and the marketing costs of a FIA that clients have to pay for may range from 8.5 percent to 9 percent, and may be as high as 12 percent for the annuities in their study. A Close Look at Ibbotson’s Research on FIA, Advisor Perspectives, January 28, 2019.
2. The implication of high costs is that annuities that have high costs benefit the insurers and the sales force more than the consumers. Yet the data on actual policy cases in our study do not bear that out. In fact, our sample FIA consistently yields higher benefits than either the DIA or the SPIA.
3. Cost is often used as a measure of whether an investment is desirable. For annuities, surrender charges and sales commissions associated with FIAs are often used to indicate the high cost of FIAs, which are then considered less desirable for clients.
4. Based on our benefit comparisons, it is clear that neither surrender charges nor high sales commissions lead to higher costs for FIAs that would impact the benefits of FIAs. The reason is probably that the true costs for annuities are unknown. Except for charges and fees that insurers are willing to disclose or are required by law to disclose, advisors really do not have good information on the costs of annuities, which are essentially embedded in the design of a product. Since surrender charges and sales commissions are about the only cost items known to advisors, they have been used as proxy to determine the costs of annuities. As the findings of our study show, the focus on these cost items is essentially misplaced, and is also misleading.
5. Moreover, surrender charges may be irrelevant for FIA where the annuity is intended to generate lifetime income. Surrender charges operate like the back load for mutual funds. They are inconsequential if the owner/annuitant does not intend to cancel the policy.
6. If surrender charges are irrelevant for FIA, it serves to match the absence of surrender charges for DIA and SPIA as these income annuities do not allow policy cancellation once they are in force.