Variable annuities draw fierce debate from both advocates and skeptics alike. But whether you like the guaranteed benefits that they offer or think that they cost too much for the protection they provide, one thing is clear: Those who bought variable annuities with guarantee provisions five years ago got a screaming deal.
Plunging markets showed off the best attributes of variable annuities with guarantee provisions. Now, Hartford Financial (NYSE:HIG) is making an interesting offer to some of its variable annuity holders: It's trying to buy them out.
The pros and cons of variable annuities
The reason financial experts on both sides of the variable annuity debate have such strong reactions to the products is that they offer an unusual set of reward characteristics. On one hand, variable annuities often give policyholders upside potential similar to that of mutual funds, ETFs, or other pooled investments. Yet the insurance aspect of annuities adds the ability to provide additional guarantees, which regular mutual funds and ETFs can't do.
The view that opponents take, on the other hand, is that these guarantees are often unnecessary and are usually costly. With annual expense ratios for variable annuities typically well above what a similar mutual fund or ETF would charge, the guarantees they offer definitely come with a cost -- and under ordinary market conditions, the cost often exceeds the benefit.
How the market meltdown hurt insurers
Over the past several years, though, market conditions have been anything but normal. A more than 50% plunge in the stock market from late 2007 to the market's bottom in early 2009 brought many insurers to their knees. Even three years after the market lows, MetLife (NYSE:MET) has had to cut future benefits on variable annuities, leading to a drop of nearly half in third-quarter sales of the products. Manulife Financial's (NYSE:MFC) John Hancock division dramatically restructured its annuity business to limit sales to key partners. And earlier this year, Aegon (NYSE:AEG) and its Transamerica unit offered to pay clients in order to reduce the risks of that some of the annuity guarantees raised for the company.
But Hartford is taking even more extreme action, offering to buy out annuity holders outright. That's consistent with its decision to give up selling new annuities entirely, as the company essentially gives up its financial management business to become a pure property and casualty insurance company. As a company SEC filing said earlier this month, Hartford is "making this offer because high market volatility, declines in the equity markets and the low interest rate environment make continuing to provide [certain guarantees] costly to us. ... [W]e would gain a financial benefit because we would no longer incur the cost of maintaining expensive reserves for the guarantees."
Leaving the business
Hartford isn't the only company that has taken draconian steps to get out of the annuity business. Genworth Financial (NYSE:GNW) got out of variable annuities awhile back, and with low interest rates likely to continue for some time into the future, we could easily see more insurance companies deciding to bite the bullet and give up on the market.
But before you let Hartford off the hook, make sure you fully understand the deal that the insurer is giving you. Hartford has every incentive to get these annuities off its books in order to free up capital for other, more lucrative opportunities. The company is offering what it calls an "enhanced surrender value" in exchange for your annuity -- one that may look like a windfall to you but which could still represent or even understate the true value of what you're giving up by taking the offer.
It will be interesting to see what specific offers to Hartford customers look like. Before you just sign a document and get a wad of cash, take a more thoughtful approach and find out exactly what you're in line to get -- and what you stand to lose. Ironically, many financial advisors may urge you to hang on to an investment that they wouldn't have recommended in the first place.