Why Fixed Annuities Could Prove Toxic in an Era of Financial Repression

In a recent and highly recommended Bloomberg op-ed, Carmen Reinhart discusses the options available to governments and central banks when attempting to deal with the burden of enormous amounts of public and private debt.

Reinhart suggests that the preferred policy option for many governments--including the United States--is a form of stealth taxation that amounts to financial repression.

Financial repression consists of a prolonged period of negative real interest rates (rates that are lower than the rate of inflation) accompanied by an inflation that can be difficult to recognize.

Financial repression is an attractive policy option from government’s perspective because low interest rates combined with “stealth” inflation reduce interest expenses and contribute to deficit reduction.  

However, as discussed by Reinhart, financial repression is a tax on savers and bondholders.  Negative real interest rates and inflation are great for those who have debt payment to make, but terrible for those who are on the receiving end of those payments (savers).

Financial repression is also an attractive political option because it is hard to recognize and is not subject to the normal process of check and balances.

Retirees and soon-to-be retirees must think about the implication of living in an era of financial repression.  The reason is that the vast majority of retirees are savers who are dependent on yield as a source of retirement income.

This puts retirees on the losing-end of the financial repression equation since their income is based on negative real interest rates.

Also worth noting is that the purchase of a fixed annuity in an era of financial repression could be a terrible decision.

Interest rates are a primary ingredient for the insurance companies that manufacture fixed annuities.

As a result, current fixed annuity offerings are possibly being manufactured with negative real interest rates.

Financial repression means that interest rates are not just low, but intentionally and artificially lower than the rate of inflation.  

This means that the starting point is artificially low for the fixed payments produced by the annuity.

Compounding the destructive effects of this artificially low starting point is the long-term nature of most fixed annuities and the corrosive impact of stealth inflation.

It’s one thing to be on the losing end of financial repression for a few months or years, but quite another to lock oneself into this arrangement for decades.

Source: Bloomberg

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