Are Annuities At Risk?

In the ongoing search for higher income, many investors have turned to annuities as a way to get better rates than bank CDs and other fixed-income products offer. Yet with the financial troubles that annuity giant AIG (NYSE: AIG  ) currently faces, investors are concerned about what could happen to their annuities if the insurance companies backing them don't survive the credit crunch.

Falling rates, more annuities
The big drop in short-term interest rates over the past year has hurt retirees who rely on the income from their investments to cover living expenses. Yet while rates on bank CDs have fallen from last year's levels, fixed annuities often offer substantially higher rates. In particular, with banks now a major seller of fixed annuities, comparing their rates against CD rates was easy -- and made fixed annuities look extremely attractive.

Unfortunately, it's not as easy for some investors to understand exactly what protections were included in each product. The FDIC, which protects bank accounts up to $100,000, requires banks that offer outside investment products like fixed annuities to be explicit about the fact that only bank deposits are entitled to FDIC insurance protection.

Health matters
For the typical saver, FDIC protection makes buying bank CDs a lot simpler. Even if you bank with institutions like Washington Mutual (NYSE: WM  ) , Wachovia (NYSE: WB  ) , or National City (NYSE: NCC  ) , all of which have their shareholders sweating over whether their entire investment will go up in smoke, you can buy a CD and not have to worry about losing a penny. The worst things you'll have to deal with are the hassle of getting your money back early and the search for a new account elsewhere.

Annuity owners, however, don't have the same assurances. As the insurance companies themselves will remind you, annuities are backed by the ability of the company to pay claims.

That lack of protection forces you to look at how healthy the insurance company is. Because annuity owners often agree to keep their money with an insurance company for years, you need to be absolutely confident that your company will still be around before buying an annuity. Yet although AIG's drop has been the most significant, competitors like Allianz (NYSE: AZ  ) , AXA (NYSE: AXA  ) , and ING (NYSE: ING  ) are also trading near 52-week lows.

A backstop for investors
Concerns about the health of insurance companies may be enough to persuade you not to buy a new annuity. But what if you already own one?

Fortunately, there's some good news for annuity investors who are concerned about their money. Guaranty associations provide some protection for investors when insurance companies become insolvent.

Because insurance is regulated at the state level, different states have different levels of protection. According to the National Organization of Life and Health Insurance Guaranty Associations, every state provides at least $100,000 of coverage for annuity owners if an insurance company becomes insolvent. Some states provide more, with New York and Washington covering up to $500,000 in annuities.

However, this additional guaranty protection shouldn't lull you into a complete sense of security. Although guaranty funds have handled fairly large isolated insurance company failures in the past, such as the failure of Reliance Insurance in 2001, there is concern that a string of problems could overwhelm the system.

Be safe
During turbulent times, it's important to know the full extent of every risk you take with your investments. If you own an annuity, keep in mind that even if shares of your insurance company fall to zero, you're still likely to get at least some money back, either from the liquidation of the company or from your state guaranty association.

Nevertheless, before buying an annuity, you still should check out the financial condition of the company that's selling it to you. If you're not convinced it will weather the current credit crisis, you'll probably sleep better at night if you buy that insured bank CD instead.

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Fool contributor Dan Caplinger doesn't own any annuities, and he doesn't own shares of the stocks mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is never at risk.


Read/Post Comments (5) | Recommend This Article (16)

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  • Report this Comment On September 15, 2008, at 8:28 PM, jamesboss wrote:

    What about this concept about "legal reserve"? Each company is supposed to have more on deposit than in policies. Additionally, the financial trouble of a parent company cannot lead to the looting of this annuity company's balance sheet. Any comments?

  • Report this Comment On September 16, 2008, at 10:14 AM, Sierrasunrise wrote:

    It makes me crazy everytime one of you stock pushers want to slam insurance products. What's the matter, can't sleep at night because you cost that senior their entire portfolio? If you had $100,000 in the dow 10 years ago you would have $121,557 today...now if you had placed those funds in an annuity you would have $248,129 today...I'll take the annuity. Numbers don't lie! Granted a Fixed annuity is not for everyone, and I would NEVER recommend a variable annuity to one of my clients...but if you have a 401K or IRA...it may very well be the safe and sane move you need to make.

    Your article is designed to frighten folks away from annuities...By scaring them into thinking their money isn't safe, it's safer than the bank! And more productive. Well, lets look at a couple thing...in the bank, they have to have 3 cents, yes that's right, 3 cents on reserve for every dollar of money invested with them, ie your CD, Savings, etc. FDIC what does that stand for? Federal Deposit INSURANCE Company. HMMMM...you have an INSURANCE company, INSURING the bank deposit. And in the next sentence you are slaming INSURANCE companies. Well my friend, FDIC has 20 years to pay you back those funds. They are no longer rated, because their rating was so bad. You are only insured up to $100,000. And let's look at that great interest rate your client is getting at the bank...hm..1-2%? Well, inflation has just eaten that up and your client will be taxed on the interest received each year, so now they are in the hole! Yes, your advise is very sound financially, makes nothing but sense to put my money in a CD and pay the government to keep it there while I lose money with inflation. Yes, that's bright.

    Now let's take a look at your insurance part of your portfolio. Every INSURANCE company must have a reserve on hand that is more than equal to their client's investments. Even AIG, the problem with AIG is they got into the broker business, wallowed with the pigs on wall street and they are scrambling to pull their fat out of the fire.

    Yes, take a look at your insurance company, find out what their reserves are, ask a LICENSED INSURANCE AGENT, NOT A BROKER for a recommendation. That recommendation should be made after a careful review of your entire financial situation. If that agent recommends that you put your entire portfolio into a single insurance product, walk out. You should always be diversified, you should always have cash on hand, 6 months reserve in the bank and then a carefully designed portfolio of products to address your goals.

    I cannot tell you the number of clients that are ringing me off the hook yesterday and today, wanting to roll their investment money off wall street. I sleep at night, my client's sleep at night, those that made the move last year when I predicted that the DOW would drop into the 10K range are sleeping at night, they call me giddy with delight. How many of your Brokerage clients are calling you...I bet your phone is ringing off the hook too...with unhappy customers, people who placed their trust in you and have lost their life savings. Shameful.

    And folks, get ready, it's not over. I think we will see a freefall into the 9000 range. You have a housing market that has not hit bottom, we are only half way there if that and you have the largest population in history hitting retirement age in 2011, drawing on the social security system and medicare. This country is in for a long hard ride, hold on Alice!

  • Report this Comment On September 16, 2008, at 10:20 AM, Sierrasunrise wrote:

    oh, and your money...in a FIXED annuity...grows TAX DEFERRED! You are actually triple compounding, and if you are receiving social security and being taxed on those funds, you may actually be able to relieve a portion or all of that tax burden by shifting your portfolio to Annuities. NO WONDER the SEC is working like a dog to try to get FIA's into their perview. Their brokers have little ability to make money for their clients in this market so they have to scramble for a product that will work. Pathetic.

  • Report this Comment On September 18, 2008, at 11:48 AM, thehorse111 wrote:

    The author missed two of the most important problem with the issuers of variable/index-linked annuities: dynamic hedging and deferred aquisition cost accounting (DAC).

    Dynamic hedging (similar to portfolio insurance in 1987) works almost all the time, but not always during meltdowns. What if the guarantors can't guarantee?

    The carriers have been pushing out the DAC assuptions for years creating profits out of thin air. This works great so long sales are increasing. When sales are decreasing (as they are now)...watch out! Eventually this will hit earnings hard, which in turn raises cost of capital, which hits cash flow, which hurts the carriers ability to guarantee against market losess for the previously sold variable products.

    I am short insurance "giants" like ING for a good reason. Some will fail in the financial meltdown. Almsot all will be financially battered because of falling earnings. And DAC will have a lot to do with that, even if the financial writers don't know what "DAC" means.

  • Report this Comment On September 21, 2008, at 11:03 PM, CandidCameron wrote:

    There is every reason to worry about insurance companies and annuities now that H.R. 5840 may be folded into the Big Bailout. This bill calls for ALL insurance policies (except health insurance) to be put into Mr. Paulson's hands, rather than protected by state regulations. It is masquerading as an "information" bill, but read it. And weep. If Paulson is given the absolute power he is after, we may all be in huge trouble.

    So get busy and let your representatives know that you do not want your IRA hijacked to pay for bad banking and stock market practices! And do it fast, because Paulson is pressuring a vote (as people always do when they are afraid people will actually read and evaluate the contracts they are signing).

    CandidCameron

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