A Cure for Inflation? Fixed Indexed Annuities.
April 27, 2012 by Dave Vogel
By Dave Vogel
April 24, 2012 •
Remember when a can of soda cost a nickel? And candy bars were just a dime? Those days are long gone, as inflation over time has raised the price of just about everything. In the past, what your clients earned through wage gains or from their investments generally outpaced the rate of inflation. That difference, in the long term, has helped raise the overall standard of living of many people. Today’s inflation rates create a very different reality for your clients—one that is potentially quite frightening.
The most widely used measure of inflation is the Consumer Price Index (CPI). It is used to measure the changes in prices of all goods and services purchased for consumption by households. It is also an important measure of the overall health of the economy. Over the past 12 months, the CPI increased 2.9 percent, according to the Bureau of Labor Statistics. But does that paint the whole picture? Would you say the impact to your clients’ budget has been only 2.9 percent in the last year? Not likely.
The CPI number has, in the last few years, been suppressed by the decreasing cost of some non-essential but useful items, like televisions and computers. The things we have to buy—life’s essentials—are skyrocketing. In the last 12 months, the price of beef is up 11.5 percent. Milk is up 9.2 percent. Gas? Up almost 10 percent. And the prices for college and health care have routinely outpaced that of general inflation for a decade or more.
Calculating inflation’s toll
A recent study by the American Institute for Economic Research developed the Everyday Price Index (EPI) to better reflect the day-to-day experiences of Americans. What they essentially did makes sense. They tweaked the calculation to scale back the percentage on some of the bigger categories with products that consumers can delay or avoid purchasing and focused on categories that are needed and purchased on a daily or weekly basis. A nice, new 50-inch HDTV or an iPhone is a luxury to many, while breakfast and dinner or the gas for the drive to work is not. With these revisions, the EPI for 2011 came in at a staggering 8 percent—well above the 2.9 percent increase indicated by the CPI.
In reality, those with additional mouths to feed or who have above-average commutes are likely experiencing even higher rates. CPI and EPI are just different attempts to capture a majority of the prices people are paying for an “average” basket of goods. What really matters, at the end of the day, for all individuals, is that their own income is keeping up with their own expenses.
So where does that leave your clients? In a financially scary place. Today’s inflation rates present a very serious challenge for those living on a fixed budget or in retirement. At the 8 percent EPI rate, the average American will lose half his purchasing power in just nine years. Even at the CPI rate of 2.9 percent, purchasing power would be halved in 25 years. But people in or near retirement could still have several decades of need for inflation-protected income. Making the situation worse, interest rates are still near record lows, and most bank savings accounts, money market and CDs are yielding less than 1 percent.
“Going broke safely” is a situation where investors have unknowingly kept money in low-yielding accounts or under the mattress. While it allows investors to sleep at night, inflation, over time, will erode the purchasing power of that safe money.
Fighting back, with annuities
Fixed and fixed indexed annuities provide the opportunity to combat inflation and your clients’ potentially shrinking purchasing power. Fixed indexed annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and earnings potential that is linked to participation in the increase, if any, of an index or benchmark. Acutely aware of the threat of sidelining consumer cash, insurers are innovating rapidly to give consumers and producers additional options for enhanced crediting on fixed and fixed indexed annuities. For example, several carriers have introduced interest-rate-based crediting strategies that use a point on a published “swap curve” as the benchmark rate. For its part, ING developed an index crediting strategy that bases credits on an increase, if any, in the three-month LIBOR. If this benchmark rises from one annuity anniversary to the next, so does the interest credited. Strategies such as these serve a dual purpose of combating inflation and dealing with interest-rate uncertainty.
As part of an overall strategy to combat “going broke safely,” portfolio diversification is as important as ever. How much of your clients’ portfolios are in different asset classes? Too many people learned the hard way that a portfolio holding mostly stock could be very risky. And going too far in the conservative direction can have its own dangers; they just take longer to materialize.
That leaves the door open for you to talk about alternatives. Fixed and fixed indexed annuities provide the opportunity to combat inflation and your clients’ potentially shrinking purchasing power. You can help them understand the value of fixed and fixed index annuities with an analysis of their spending patterns and expected future expenses. Do your clients have a good concept of their own personal CPI? This can be a helpful lead-in to talk to your clients about the real cost of inflation, put a plan in place that utilizes investment vehicles that are designed to combat inflation, and help them identify whether they are truly prepared for the future they envision.
Dave Vogel is an advanced sales annuity consultant for ING U.S. Insurance Sales Support. Vogel has more than 10 years of experience in the financial services industry. Prior to joining ING, he worked as a financial advisor for two national financial service companies specializing in financial planning business. Dave earned his CFP in 2005, focusing on retirement income and estate planning.
Annuities are issued by ING USA Annuity and Life Insurance Company (Des Moines, IA), member of the ING family of companies.