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Annuity Ponzi Schemes?

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December 27, 2008 – Comments (7)

One of my favorite players on here brought up annuities today and then what should happen?  I read a bit about them in with Mish.

I would not buy an annunity today or ever.  These things are likely to be making payments from cash received for new annuities and be covering the fact that can't meet their financial obligations or even close to them because of new sales.

7 Comments – Post Your Own

#1) On December 27, 2008 at 2:18 AM, starbucks4ever (97.43) wrote:

I always assumed life insurers make profits by exploiting people's ignorance about inflation... 

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#2) On December 27, 2008 at 12:54 PM, BGriffinFlorida (26.92) wrote:

Jackson National has offered (for several years) and continues to offer several annuity products that track various indexes and return a minimum of 6% annually.  Basically Jackson National is selling a program where you get all the upside, minus fees, but no downside, infact, not less than 6% annually... ABOVE THE HIGHEST YEAR END BALLANCE!

 So if you put in $100,000.00 in 2003, and at the end of 2006 you had $140,000.000, even if the index fell to half of that, you would still be earning 6% on the $140,000.00, aand the ballance would not have fallen below that amount.

There is no way this is sustainable.  I suspect this program was developed considering the stock market performance only over the last 20 or 40 year. Recent (and further) declines will make these contracts very difficult to honor.  In all likelihood this will lead to yet another bail out.

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#3) On December 27, 2008 at 3:38 PM, garyc27 (< 20) wrote:

To paint a 2000 year old insurance product as a "PONZI SCHEME" is at best naive.

Which type of annuity is being discussed, individual or group annuities?

Which type of contract fixed annuity, variable annuity, immediate annuity, deferred annuity?

Which type of premium payment, lump sum, fixed rate, periodic or variable?

There are very valid reasons to purchase an annuity: receipt of an inheritance and the ability to receive that money in the future such as in the case of a disabled child, sibling, parent or spouse.  In addition, there may be tax benefits for some that may be unattainable in other investment vehicles.

With a fixed annuity, the insurance company invests the premiums in fixed-rate investments such as bonds. You earn a guaranteed fixed rate of return for a specified initial period. When the initial period ends, your assets are rolled into a new time period at a new rate. The new rate may be better or worse depending on the state of the economy. In many fixed annuities, there will be a guaranteed minimum rate which is often related to the rate of treasury bills. With a fixed annuity, your insurance company is taking on the investment risk.

Variable annuities are quite different. With a variable annuity, your premiums are invested in the likes of stocks, bonds, mutual funds, money markets, and even real estate. Many mutual funds are part of a family of funds and the investor can transfer funds among members of the fund family without incurring additional fees. Similarly, the owner of the annuity may have the option to transfer the assets within the annuity between various investments. Thus with a deferred variable annuity, the amount of dollars developed during the accumulation period can vary substantially depending on the performance of the investments.

The payout of the variable annuity is based on the number of units held by the annuitant. A unit is analogous to a share in a mutual fund. You own a certain number of shares in a mutual fund but the value of the share fluctuates. Similarly, the annuitant is credited with a number of units, but the value of those units will fluctuate resulting in a variable payout.

With the variable annuity, the risk is taken by the holder of the annuity rather than the insurance company.

The funds for a fixed annuity are held by the insurance company in a general account. The funds for a variable annuity are held in a separate account for the holder of the annuity. Many variable annuity contracts allow a mixture of mixed and variable with some finds held in the general account, and some in the separate account.

If you own an annuity it would be wise to read the contract!

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#4) On December 27, 2008 at 3:51 PM, starbucks4ever (97.43) wrote:

If prices and money supply remain more or less stable, then life insurance companies are running a Ponzi scheme. It may be that most of them will be able to honor their contracts by recapitalizing, trimming expences, etc. It may also be that most of them will eventually go Madoff, and this second possibility is more likely than the first. It could also happen that Bernanle's printing presses will eventuallydevalue the contractual obligations of insurance companies. The third possiblity is the most likely because the second is more likely than the first.

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#5) On December 28, 2008 at 12:54 PM, garyc27 (< 20) wrote:

Ponzi

A Ponzi scheme is a type of investment Fraud that promises investors exorbitant interest if they loan their money. As more investors participate, the money contributed by later investors is paid to the initial investors, purportedly as the promised interest on their loans. A Ponzi scheme works in its initial stages but inevitably collapses as more investors participate.

Insurance

Insurance works on the basic principle of risk-sharing. A great advantage of insurance is that it spreads the risk of a few people over a large group of people exposed to risk of similar type. The concept behind insurance is that a group of people exposed to similar risk come together and make contributions towards formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums. However, some risks are just uninsurable, as an example acquiring Long Term Care insurance for an Alzheimer’s patient.

Insurance companies use risk management to underwrite insurance policies and establish premiums. Risk management means that the insurer creates a risk pool of similar or common risks. The insurer uses actuarial science to quantify the risks that they are willing to assume and the premium they charge to assume them. Actuarial science uses statistics and probability to establish a model for the perils covered and the insurer’s exposure.

One aspect of actuarial science is the law of large numbers. The law of large numbers states that as the number of exposures increases so does the probability of the expected results. In the case of life insurance, mortality tables are used to determine the risk of a person of a certain age dying before they would be expected to die. Therefore it is extremely unlikely that all 30 year old males will die on the same day or even in the same year.

The formula for insurance an insurance company to profit is fairly simple:

Earned Premium + Investments – (Losses + Underwriting Expense) = Profit

Some insurance carriers will return a portion of premiums as a "dividend" when the loss ratio is less than expected.

If you believe that insurance is a "Ponzi Scheme", since the most common insurance policies use the same methodologies outlined above, I would suggest that you immediately cancel your home owner’s policy, automobile policy, any healthcare policies, worker’s compensation, individual and group life policies, if you own a business cancel those policies as well.

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#6) On December 28, 2008 at 1:21 PM, dwot (42.57) wrote:

Exactly BGriffin...

morgan628, I have already found extreme challenges collecting on valid insurance claims and cancelling my insurance policies is already in the works.  The "ponzi" isn't apparent right now but as the population ages and the birth rate declines it will be highly obvious.

 

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#7) On December 29, 2008 at 10:45 AM, SnoopyDancing (< 20) wrote:

Remember the options markets play a HUGE role. Large insurers trade throughout the day to match the liabilities to policyholders & annuityholders with projected future cashflows. Huge, well-funded and highly technical departments exist to hedge these multi-billion dollar bets. Yes, the reduction in sales of new annuities is hurting bottom lines since operations still drain cash, but hedging can cushion many market losses.

Really low sales levels may cause costly unwinding of the options, though. Unwinding credit default swaps that many companies entered into in the past year or two will also take a bite out of this year's profitability. Top that off with dicey private investment partnerships that are always popular with wheelers & dealers, commercial mortgages that have dropped in value, credit markets that have made even bondholders think twice, accounting regulations that require US companies to take gigantic writedown losses before disposals of assets in a largely down market and you have a perfect storm for some insurers.

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