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  • Purchasing Power Principle

    February 8, 2012 by Jacob Stern

    February 01, 2012

    By Jacob Stern

    InsuranceNewsNetMagazine,
    February 2012

    Most producers who offer indexed annuities understand the many
    benefits of the product: annual reset, protection of principal, ability to
    participate in a variety of markets and tax deferral. But one important aspect
    that is often overlooked is how these products can help protect our clients’
    purchasing power of their dollars.

    Many people in retirement, or nearing it, want to ensure they can
    continue their lifestyle. But many do not understand the effect that inflation
    can have on their dollars. Inflation is a silent killer of purchasing power and
    many simply ignore this factor. Using the U.S. Labor and Statistics website,
    anyone can view the official inflation numbers.

    There have only been a few times when inflation was below zero and
    is often in the 2 to 3 percent range. For example, if inflation were at 3
    percent for a year, people would have to earn 3 percent on their funds just to
    be able to purchase the same amount of goods as they did a year ago.

    To make matters worse, if the person happens to be invested in
    vehicles that can lose value, it magnifies the situation. In this article, we
    will examine how inflation can destroy a person’s purchasing power and how
    market losses are magnified by inflation. When beginning a conversation with
    clients about how much income they need in retirement, many agents forget to
    factor in inflation. Inflation, like losses and gains in investments, has a
    compounding effect that’s almost always to the downside (since deflation rarely
    happens, even during a recession). So, purchasing an indexed annuity can
    provide clients an added layer to combat inflation and protect their purchasing
    power.

    The Numbers

    I analyzed many years of S&P 500 data to fully understand how
    inflation can erode purchasing power. I started with March 2000 and baselined
    the S&P 500 to 1000 (actual value was 1498, but because we are looking at
    the percent changes, using a baseline of 1000 makes it easier to understand).
    In the analysis, I also assumed purchasing an indexed annuity with a modest cap
    of 5 percent (annual point-to-point) at the same time in March 2000.

    Fast forward five years to March 2005, and the baseline S&P
    500 was at 851. However, factoring in inflation, the “purchasing power” S&P
    500 was at 751. This means that if clients were 100 percent invested in an
    S&P 500 fund, they lost approximately 25 percent of their purchasing power.
    If the person looked at their annual statement from their broker, they would
    only observe a 15 percent loss (1000 down to 851). But because inflation has a
    compounding effect, the purchasing power was further depleted.

    In March 2005, the S&P 500 value of the baseline indexed
    annuity stood at 1100. As most agents understand, the down years in the market
    simply turn into zeros instead of losses for the client. In addition, with
    annual reset, gains in the indexed annuity can still be achieved even though
    the S&P 500 value is below the original value of 1000. So, the clients had
    gains of 10 percent over five years in their indexed annuity. Inflation brought
    the indexed annuity’s purchasing power to 971. If the client had the indexed
    annuity, they would have only lost approximately 3 percent of their purchasing
    power compared to 25 percent in an S&P fund.

    March 2009 was an especially tough purchasing power time for
    people who invested directly in the S&P 500. The baseline S&P 500 value
    was at 625. Factoring in inflation, the person’s purchasing power was down to
    499. So, the person lost more than half of their purchasing power when compared
    to what they could have purchased in 2000. The indexed annuity, however,
    performed much better. The baseline value stood at 1213 in March 2009, a little
    more than a 20 percent gain on their money nine years later. Inflation kept the
    purchasing power of the indexed annuity at 970 so people lost just 3 percent of
    the overall purchasing power instead of 50 percent.

    Fast forward once again to March 2011. The baseline S&P 500
    was at 1082, but the purchasing power value was only at 823. This means that
    over the 11-year period, clients lost approximately 18 percent of their
    purchasing power. Another way to think about this situation is that the clients
    can now only purchase 82 percent of what they could have purchased in March
    2000. For people in retirement and on fixed income, this situation would
    directly affect how the person lived. Take a look at the indexed annuity,
    however, which provided a much better situation for the client. The baseline
    value of the indexed annuity was 1337 and the purchasing power was 1016. The
    indexed annuity kept up with inflation over the 11-year period. Obviously there
    were no real gains with the indexed annuity, but the clients could still
    purchase the same amount of goods in 2011 as they could in 2000, unlike
    purchasing an S&P 500 fund.

    Never Forget Inflation

    Inflation can be a damaging enemy for a client’s retirement funds.
    It is very important that agents discuss inflation with their clients,
    explaining how detrimental it can be to their standard of living during
    retirement, using examples similar to those provided above.

    By changing the conversation from gains or losses to purchasing
    power, clients can gain a better appreciation of the power and protection of
    the indexed annuity. It is one of the few instruments that can help clients
    hedge against inflation and reduce their volatility.

    Jacob Stern is CEO of Imeriti, a national insurance marketing
    organization based in San Diego. Imeriti has been wholesaling
    investment-oriented life insurance to financial institutions, stockbrokers,
    financial planners and broker/dealers for more than 30 years. He may be
    contacted at Jacob.Stern@innfeedback.com.

    © Entire contents copyright 2012 by InsuranceNewsNet.com, Inc.
    All rights reserved. No part of this article may be reprinted without the
    expressed written consent from InsuranceNewsNet.com
    .

    Originally Posted at AnnuityNews on February 1, 2012 by Jacob Stern.

    Categories: Industry Articles
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