Fixed Annuity Sales Continue to Soar While Massive Inflation Risks are Ignored

Bloomberg reports that there is continued strength in fixed and immediate annuity sales.  Overall fixed annuity sales increased 50% in 2008, with immediate annuity sales increasing 15% in 2008.  As indicated earlier, variable annuity sales decreased 15% in 2008.

Much of the fixed annuity sales momentum is attributed to consumer reactions to market risk or volatility experienced over the past couple of years.  Fixed annuity sales also increased after the market implosion earlier this decade. 

In general, there tends to be a correlation between stock market movements and annuity sales.  Variable annuity sales tend to be strong in rising markets, while fixed annuity sales pick-up in the wake of market downturns.

While the fear-based reactions are understandable, there is a reasonably strong possibility that fixed annuities are not the safe-havens they are perceived to be.  In fact, recent purchasers of fixed annuities may actually be assuming massive inflation risk by locking-in their annuity payments when interest rates are at historic lows.

Fixed annuity payments are contingent on prevailing interest rates.  Interest rates are at historic lows in light of the financial crisis.  It is quite possible that the Federal government’s massive monetary and fiscal stimulus efforts will result in much higher inflation in the near to medium term. 

Consumers who have locked-in their purchasing power through a recent fixed annuity purchase may be setting themselves up for many years of continued financial misery.  It is likely comforting for many to convert a lump sum into a fixed payment rather than see that savings subject to the extreme market volatility that seems to occur almost daily.  However, a seemingly safe and “fixed” $500 monthly payment will be reduced 50% to a $250 monthly payment over the course of 14 years if inflation averages just 5%.

Inflation protection is available with many fixed annuity purchases.  Consumers would be wise to consider this option—which naturally comes at a cost—if they are considering fixed annuities.  At the same time, the current interest rate environment and inflation outlook may be enough to entirely reconsider fixed annuities in the near-term.