Good financial products are bought, not sold. We are continuing our series of articles analyzing some of the most aggressively sold financial products – those that are advertised on television. This is the second installment in our series. The previous installments were on Lear Capital and Ty J. Young.
In the prior installment on this series, I exposed the deceptive marketing used to sell fixed-index annuities (FIAs). Today I will look at a firm that purchases annuities from investors – the Annuity Action Network (AAN). It is a way for clients to borrow money at a high interest rate, but it may be an appropriate solution under certain circumstances.
You can see AAN’s televised advertisement here.
The AAN inaccurately bills itself as a not-for-profit organization, “dedicated to providing reliable information regarding annuity payments and the liquidity option.” But the AAN is a web site operated by DBL Capital, which is very much a for-profit corporation. This was the only instance of deceptive marketing I encountered.
DBL Capital is a Florida-based corporation in the structured-settlement business. They will purchase the cash flows from an annuity or a legal settlement. In effect, you are borrowing money from them. You receive a lump-sum cash payment, and in return you forgo certain future cash payments.
The person with whom I interacted at DBL was courteous and promptly provided the information I requested. There was no “hard sell” to engage in a transaction. But that doesn’t mean you should choose this option.
Let’s look at the economics of selling an annuity.
Selling an annuity
I obtained the rates for a single-premium immediate annuity (SPIA) from a web site and used that hypothetical data to obtain rates from DBL. I used a basic SPIA with a $1 million investment for myself, a 62-year old male residing in Massachusetts. The monthly payments would be $5,057 from a large, highly rated insurance company.
DBL offered two options. I could sell them the payments from the SPIA for the next 10 years for $206,899 or for the next 20 years for $280,025. That is roughly 21% and 28% of the price I paid for the SPIA. Payments to me from the SPIA would resume at the end of the 10- or 20-year period.
I reviewed DBL’s contract and there was no indication that it could recover any funds in the event you died prior to the end of the 10- or 20-year period. This is obviously a critical issue and anyone considering this option should have the contract reviewed by an attorney.
I applied the Social Security mortality tables to the projected payments and calculated the internal rate-of-return (IRR) of those transactions. It is approximately 24.6% for 10 years and 19.0% for 20 years. (As a point of reference, the IRR of the SPIA is -0.35%.) This is approximate because I used annual payments for the SPIA when applying the mortality data, but in reality the payments are monthly. Also the person at DBL said that the price they would pay could go up by as much as $25,000 “if everything comes back looking good,” which leads me to believe that you can negotiate with them. But I used the quoted price.
Those IRRs correspond to high rates of interest – roughly what you would be charged on credit card debt. But they are not usurious.
Are there situations when borrowing at this rate of interest makes sense?
When you should sell your annuity
One of the cardinal rules of personal finance is to always pay off your credit card bills in full to avoid paying high interest rates. Likewise, it almost never makes sense to sell an annuity and effectively borrow at 19% to 24.6%. If you need to purchase something – a car or a house – take out a home or car loan. A home-equity loan is far cheaper than this and is a better way to increase liquidity. It may also be possible to obtain capital through an on-line lender, such as Lending Club, at rates far cheaper than DBL is quoting.
But there are a number of situations where one might consider this option. One is if you need a down payment – say for a home – and you have no other source of liquidity.
A second situation is if you believe your mortality risk is greater than what is indicated by the standard actuarial tables. In order to qualify for this sale, you must fill out a form about your health. You don’t need to take a physical exam. Assuming you answered those questions honestly and completely, there may still be a reason you believe your health is compromised. In this case, the effective IRR is lower than what I calculated.
In the unlikely event that you believe the insurance company owning your annuity is in trouble and faces a risk of not being able to fulfill its obligations, then you should consider selling it. But the purchaser may have the same information as you, and may build this into the price you are quoted.
Lastly, if instead of owning a SPIA, you owned an annuity that was contingent on market performance, such as a variable or fixed-index annuity, your capital market assumptions could lead you to conclude that selling the annuity was a preferable option.
Those are very unlikely scenarios. The best option is to avoid high-interest debt and not sell an annuity under these terms.
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