Purchasing Power Principle
February 8, 2012 by Jacob Stern
February 01, 2012
By Jacob Stern
InsuranceNewsNetMagazine,
February 2012
Most producers who offer indexed annuities understand the many
benefits of the product: annual reset, protection of principal, ability to
participate in a variety of markets and tax deferral. But one important aspect
that is often overlooked is how these products can help protect our clients’
purchasing power of their dollars.
Many people in retirement, or nearing it, want to ensure they can
continue their lifestyle. But many do not understand the effect that inflation
can have on their dollars. Inflation is a silent killer of purchasing power and
many simply ignore this factor. Using the U.S. Labor and Statistics website,
anyone can view the official inflation numbers.
There have only been a few times when inflation was below zero and
is often in the 2 to 3 percent range. For example, if inflation were at 3
percent for a year, people would have to earn 3 percent on their funds just to
be able to purchase the same amount of goods as they did a year ago.
To make matters worse, if the person happens to be invested in
vehicles that can lose value, it magnifies the situation. In this article, we
will examine how inflation can destroy a person’s purchasing power and how
market losses are magnified by inflation. When beginning a conversation with
clients about how much income they need in retirement, many agents forget to
factor in inflation. Inflation, like losses and gains in investments, has a
compounding effect that’s almost always to the downside (since deflation rarely
happens, even during a recession). So, purchasing an indexed annuity can
provide clients an added layer to combat inflation and protect their purchasing
power.
The Numbers
I analyzed many years of S&P 500 data to fully understand how
inflation can erode purchasing power. I started with March 2000 and baselined
the S&P 500 to 1000 (actual value was 1498, but because we are looking at
the percent changes, using a baseline of 1000 makes it easier to understand).
In the analysis, I also assumed purchasing an indexed annuity with a modest cap
of 5 percent (annual point-to-point) at the same time in March 2000.
Fast forward five years to March 2005, and the baseline S&P
500 was at 851. However, factoring in inflation, the “purchasing power” S&P
500 was at 751. This means that if clients were 100 percent invested in an
S&P 500 fund, they lost approximately 25 percent of their purchasing power.
If the person looked at their annual statement from their broker, they would
only observe a 15 percent loss (1000 down to 851). But because inflation has a
compounding effect, the purchasing power was further depleted.
In March 2005, the S&P 500 value of the baseline indexed
annuity stood at 1100. As most agents understand, the down years in the market
simply turn into zeros instead of losses for the client. In addition, with
annual reset, gains in the indexed annuity can still be achieved even though
the S&P 500 value is below the original value of 1000. So, the clients had
gains of 10 percent over five years in their indexed annuity. Inflation brought
the indexed annuity’s purchasing power to 971. If the client had the indexed
annuity, they would have only lost approximately 3 percent of their purchasing
power compared to 25 percent in an S&P fund.
March 2009 was an especially tough purchasing power time for
people who invested directly in the S&P 500. The baseline S&P 500 value
was at 625. Factoring in inflation, the person’s purchasing power was down to
499. So, the person lost more than half of their purchasing power when compared
to what they could have purchased in 2000. The indexed annuity, however,
performed much better. The baseline value stood at 1213 in March 2009, a little
more than a 20 percent gain on their money nine years later. Inflation kept the
purchasing power of the indexed annuity at 970 so people lost just 3 percent of
the overall purchasing power instead of 50 percent.
Fast forward once again to March 2011. The baseline S&P 500
was at 1082, but the purchasing power value was only at 823. This means that
over the 11-year period, clients lost approximately 18 percent of their
purchasing power. Another way to think about this situation is that the clients
can now only purchase 82 percent of what they could have purchased in March
2000. For people in retirement and on fixed income, this situation would
directly affect how the person lived. Take a look at the indexed annuity,
however, which provided a much better situation for the client. The baseline
value of the indexed annuity was 1337 and the purchasing power was 1016. The
indexed annuity kept up with inflation over the 11-year period. Obviously there
were no real gains with the indexed annuity, but the clients could still
purchase the same amount of goods in 2011 as they could in 2000, unlike
purchasing an S&P 500 fund.
Never Forget Inflation
Inflation can be a damaging enemy for a client’s retirement funds.
It is very important that agents discuss inflation with their clients,
explaining how detrimental it can be to their standard of living during
retirement, using examples similar to those provided above.
By changing the conversation from gains or losses to purchasing
power, clients can gain a better appreciation of the power and protection of
the indexed annuity. It is one of the few instruments that can help clients
hedge against inflation and reduce their volatility.
Jacob Stern is CEO of Imeriti, a national insurance marketing
organization based in San Diego. Imeriti has been wholesaling
investment-oriented life insurance to financial institutions, stockbrokers,
financial planners and broker/dealers for more than 30 years. He may be
contacted at Jacob.Stern@innfeedback.com.
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