A reader had some thoughtful comments and questions about my analysis of the Manulife IncomePlus annuity. Here are his comments (edited for brevity) followed by my thoughts.
1. You describe the worst case scenario in which an investor makes withdrawals beginning in the first year. The product is best suited to the investor who leaves cash in the investment for at least 15 years so that the guaranteed income grows at 5% per year (albeit simple rather than compounded) for that period.
An example will help here. Our investor Ida puts $400,000 into IncomePlus. In my earlier analysis of IncomePlus, I focused on the case where Ida draws a guaranteed income of 5% or $20,000 per year for the rest of her life. But, suppose that Ida is only 50 years old and doesn’t need any extra income until she is 65.
IncomePlus rules permit Ida to defer payments for 15 years and then collect a guaranteed $35,000 per year for the rest of her life. This figure came from increasing the $20,000 by 5% (not compounded) for each year Ida deferred payments.
On the surface, $35,000 per year sounds not too bad. But this ignores inflation. Even if inflation averages only 3%, Ida will only get $22,500 in today’s dollars in the year she turns 65. By age 90, this drops to $10,700. If inflation averages 5%, this is $16,800 at age 65 and less than $5000 at age 90. Pass the cat food.
If Ida lives to age 90, her guaranteed $35,000 per year amounts to a 3.03% per year return on her original $400,000 investment. If she dies younger than this, her return is even worse. This investment has all the inflation risk of a long-term government bond, but with lower returns than a bond.
2. You describe scenarios where the market performs poorly for 20 years.
It’s true that I’ve focused on the income guarantees. The point is that the guaranteed income is very low because of decades of inflation. However, it is possible for the guaranteed level of income to rise if our investor Ida’s mutual funds within IncomePlus perform well. Unfortunately, they have to perform very well to overcome the very high fees charged. The market could perform reasonably well and still not trigger any increases in Ida’s payments.
3. Some of the funds available to IncomePlus investors charge lower MERs than you quoted.
The funds with lower total fees are the ones containing a lower percentage of stocks. The only way to have a chance at doing significantly better than the minimum guaranteed payments is to have as much exposure to stocks as possible.
4. The product might enable some investors, who would otherwise be too skittish, to buy into today's markets or to feel comfortable maintaining some exposure to markets during volatile times.
It is true that this product’s guarantees may draw in nervous investors. However, IncomePlus behaves more like a bond than like stocks. The high fees charged prevent investors from participating in very much of the market’s upside. In the future, IncomePlus investors are likely to see positive news about stocks, but see their payments increase minimally or not at all.
5. The fact that Manulife had to inject new capital partly to boost its reserves for products of this kind suggests the product is not as one-sided as you suggest.
Let’s try an analogy here. Suppose that I offer people a $1000 bet on the flip of a coin. But, they don’t realize that I’ve rigged the coin to come up my way 90% of the time. If I happen to lose the first flip and scramble to raise the $1000 I owe, is this evidence that the bet wasn’t one-sided? Manulife lost one round of a bet stacked in their favour. I like their chances in future rounds.
6. Those who bought earlier this year may be glad they did that rather than investing directly in mutual funds or equities.
You are right that these people are probably glad, particularly those who need money right now. However, if our 50-year old investor Ida, who doesn’t need income until she is 65, just stays invested in a low-cost stock index and waits out the current downturn, she is likely to be better off than investors who bought into IncomePlus early this year.
Despite our differences, I appreciate comments from readers. I’m more interested in learning the truth than I am in trying to argue than I’m right.