A Guarantee is Only as Good as the Guarantor

I often shake my head in dismay when I read financial “advice” columns. So many important details are glossed over. An October 11, 2009, New York Times article discussed the benefits of life annuities as a form of protection against outliving your retirement savings. So far so good. But the article compared the income stream from investing in treasury bills for 20 years with the income stream from a life annuity, without bothering to point out that from a risk perspective the writer was comparing apples and oranges.

“Guaranteed until death – no matter how long she lived,” was the phrase used. Nary a word that the “guaranteed until death” part is only as good as the financial institution issuing the annuity. Without mentioning the word “risk,” there was a casual admonition that it was important to buy from a “highly rated” company. I can safely say that no one who bought a life annuity from AIG is sleeping soundly now and AIG was as highly rated as they come. The closest the article came to acknowledging there might be risk with life annuities was the comment to “perhaps” diversify by buying several smaller annuities from different firms. Actually, that was the best advice in the entire piece.

The article also failed to touch upon how inflation can devastate a fixed-income investment such as a life annuity. Life annuities certainly have their place in retirement planning, but the financial press does a great disservice when it fails to fully cover the risks involved. Quite frankly, the article read like a warmed-over sales brochure for an insurance company.

The “guarantee is only as good as the guarantor” principle applies elsewhere as well. I frequently receive bids for work touted as being “guaranteed.” Generally my response is “How long have they been in business? Have you seen their balance sheet? Do you know how deep their financial resources are?” A guarantee can be pretty meaningless without the resources to back it up or the track record to give it credence.

A healthy skepticism, a desire for sufficient supporting evidence, an unwillingness to take things at face value are traits that will serve you well over the long haul.