I was thinking about the claims that I often hear from people marketing investment products that promise “reasonable returns” (whatever that means) with no risk of loss. It made me consider the wide variance in standards of risk disclosure in the investment industry.
Since an annuity is a product of the insurance industry, people naturally think “safety” and “guarantees”. If my house or car is insured, they are replaced with no issues (or I’m indemnified) if there is a problem. I won’t have less than I started with or go into financial ruin when calamity strikes.
This concept carries over to investing with “insured” investments. The question is, can I lose money in a “guaranteed” indexed annuity? The answer is YES. If you withdraw your investment before the surrender penalty period has expired, you will be suffer a loss that varies based on the policy contract. Furthermore, the principal is only protected if you hold the annuity through this surrender period. This could be as long as ten years and, in some cases, longer. Most contracts allow for the ability to withdraw a certain percentage (usually 10%) every year with no penalty, but the main investment is locked up until the surrender period has been completed.
Another form of loss that people pay far less attention to than they should is inflation risk. Fixed return or “safe” investments are greatly affected by inflation and often barely keep up with its affects. In the 15 year period from 1968 to 1982, the cost of living (as measured by the Consumer Price Index) tripled. Those on a fixed pension or stuck in fixed “risk free” investments would have suffered the most. Inflation doesn’t draw as much attention as stock market risk, because the losses are far more gradual than a 1000 point drop in the Dow. The risk, however, is serious and shouldn’t be downplayed.
Are there other circumstances that can lead to loss? The answer, again, is YES. In the fine print of every insurance contract is language that goes something like this: “All guarantees are based on the financial strength and claims paying ability of the issuing insurance company, who is solely responsible for all obligations under its policies.” The insurance company may be in great shape when you buy the annuity, but that is not when their financial wellness is important. It is claim time that matters. What if a downgrade in stability is due to a sudden systemic issue? What insurance company could possibly be immune to wide-spread problem in the American economy? Such a problem reared its head in 2008 and many insurers got a good taste of their vulnerability. Many significantly reduced their guarantees and some sought to buy people out of contracts that they concluded were unsustainable.
My issue is that insurers can get a free pass saying that there is low risk to investors in their contracts when that is clearly not the case. I believe that it misleads investors who seek safety at all costs.
In the investment industry, compliance standards dictate that mutual fund companies and securities firms must disclose that losses are entirely possible and “past performance is no guarantee of future results”. Risks are always present when we invest our assets and they should be disclosed. Language declaring any investment as “safe”, “risk-free” or “guaranteed” should be viewed with a healthy dose of skepticism and marketing using this language should be revamped due its misleading nature.