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AUGUST 06, 2013

Insurers' Overpromises Bad for Insurers, Worse for Investors

If you're worried about investment losses and outliving your savings, you may have been told annuities are the answer. But are they?

Persistent low savings rates during the housing boom, the housing bust that removed the proverbial “piggy bank” of home equity, along with increased life expectancies, have made many retirees, and those approaching retirement, face a very real fear of outliving their assets.

This ongoing ticking of the longevity clock has led many to purchase annuities, attracted by tax-deferred growth of deposited funds and the lifetime income guarantee (the “sleep-at-night” factor).

Insurers Stepping Over the Line

The primary benefits for consumers who own an annuity is the guarantee of lasting lifetime income no matter how long the annuitant may live. Over the past decade, annuities have increased in popularity on the heels of two large bear markets and increased stock market volatility. This worry about investment losses gave insurers an "in" to offer many seemingly generous guarantees to stoke the demand from annuity purchasers.

Yet, while these features give the annuity holder the peace of mind in knowing that they will never outlive their retirement income; things don't look quite so bright for the insurance companies on the other side of that promise. In fact, depending on an investor’s actual needs and goals, these contracts may not be good for either side of the transaction—practically the opposite of capitalistic exchange where both parties benefit.

In fact, the recent financial crisis of 2008/2009 shined a fairly bright light on just exactly how much these guarantees can cost insurers. Large potential future obligations in the form of guaranteed income are requiring many firms to raise capital reserves, thus lowering the profit earning ability of their capital, in order to continue backing up these promises to annuity holders.1

In addition, thanks to increased longevity and the need for supporting income, many consumers are holding on to their annuities for much longer than expected, resulting in a grave miscalculation by insurers on their policy lapse rates.2 This, too, will potentially end up costing insurance companies billions more than originally anticipated on their annuity income guarantees.

 Are Annuity Issuers Going Back on Their Word?

In an effort to regain profits and lower risk, some insurance companies have taken to enforcing a few objectionable tactics.3 For example, some are clamping down on the choices of funds in their variable annuity products, as well as forbidding additional contributions into existing annuity contracts.

Another potential "solution" by some insurers has been to offer to buy back annuity contracts from their customers—a plan that could essentially change the retirement income situation for many annuity holders who are counting on that income guarantee for their living expenses.4 Although this may represent an opportunity for owners that realize they don’t need or want the income benefits anyway.

One large issuer of annuities has even gone so far as to require the owners of certain of its variable annuity guarantees to move a minimum of 40% of their annuity money into bond funds.5 A portfolio that is 55% stocks, 40% bonds, and 5% cash is pretty safe already. Why pay for insurance on top? This is like wearing a belt with suspenders.

And what if these consumers refuse to agree to the changes or don’t respond in time? The annuity provider may remove the unprofitable guarantee from the policy anyway, here again, changing the incoming cash flow for thousands of annuity buyers who were counting on these promises, as well as paying for these "privileges" over time.6

While insurers seem to have gone back on their word regarding in-force annuities, they have also likely stopped offering many of the guarantees that were previously part of these products.

In any case, annuity shoppers need to be especially careful before they deposit a large sum of retirement savings into an annuity. We think many annuities are sold unnecessarily to investors that are better served by other strategies. And this trend is yet another reason why it makes sense to limit the amount of your nest egg invested in an insurance contract. Your contract can be changed at the whim of a single company to improve their bottom line.

1 http://online.wsj.com/article/SB10001424127887323998604578565711321338272.html

2 Ibid

3 Ibid

4 http://www.lifehealthpro.com/2013/07/11/axa-proposes-another-variable-annuity-buyout-offer

5 http://online.wsj.com/article/SB10001424127887323998604578565711321338272.html

6 ibid

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