Questions and Answers: Annuities and Insurance Companies in these Turbulent Times.

How do annuities work?

Annuities are tax-deferred insurance contracts that offer owners either a lump sum or a series of payouts after an accumulation period.

What’s the difference between ‘fixed’ and ‘variable’ annuities?

Fixed annuities earn a guaranteed interest rate during a certain period. They are backed by assets in the insurance company’s general account, usually bonds. Fixed annuities depend entirely on the financial soundness of insurers, which are regulated primarily by state insurance departments.

Variable annuities can also come with guaranteed benefits, such as death benefit and a minimum return, riders for which the owners generally pay extra. However, they are quite different in other ways: A portion of deposits go to the insurance company to cover administrative costs and guaranteed benefits; the rest is invested in a portfolio of mutual fund-like investments selected by the annuity owner. These investment accounts are separate from the rest of the insurance contract. Variable annuities are exposed to market risks. If annuity owners’ investments perform well, there is the potential upside of a bigger payout; but, if they perform poorly, value and income potential fall.

How have variable annuities been affected by recent market conditions?

Many variable annuities have gone through the same volatility as mutual funds in general.

Should I be worried if the share price of my insurer declines?

Not necessarily; in some cases, publicly traded insurance companies’ stock prices have declined partly because of their efforts to raise capital. And while raising capital can dilute existing shares, it also improves an insurer’s ability to pay claims. A decline in the stock value of a company does not always indicate immediate trouble for annuities or life insurance policies.

Should I worry if the financial strength rating of my insurer declines?

Financial strength ratings, supplied by rating agencies, such as A.M. Best, S&P, Moody’s, or Fitch, are an evaluation of the ability of a company to make good on its guarantees. A decline from an ‘excellent’ financial strength rating that is still in the ‘good’ range is not cause for alarm.

Recently A.M. Best has downgraded some of the insurance companies they follow, though most remained in the “secure” [excellent to good] range, meaning they are still regarded as financially sound.

What happens when an insurance company has problems?

State regulators usually monitor struggling companies and work with them to try to get additional capital, or to sell the company to a stronger insurer that can make good on all of its claims. State receivers, who include the state insurance commissioner of the company’s home state, help to find other insurers to take over the annuities and life policies from the troubled company. The terms of the annuity or life policy usually remain the same.

What happens if no insurer wants to take over the contracts of a failed insurer?

If an insurer is declared insolvent by a court and is liquidated, state laws require companies to pay annuity and life insurance policy owners first and in full before paying claims of other creditors. State Guarantee Associations then make good on the annuities and life policies. For example – and each state has their own guidelines – death benefits are often protected up to $300,000; cash values are often protected to a maximum of $100,000.

For annuities, the State Guarantee Associations protect the death benefits, guaranteed minimums, and other contract guarantees. However, investment account losses because of market declines are not covered.

What are my options if my insurer is at risk of insolvency?

Regulators and consumer groups warn that annuity owners often stand to lose more when rashly surrendering a policy than they would risk from the insurance company failure. If your annuity policy is still in the surrender period, and the contract is below state guaranty limits, you may decide to wait and see what happens. If your surrender period is over or nearly finished, you could consider a Section 1035 tax-free exchange into another annuity contract from another insurer. Please remember:

1. Starting a new contract will involve a new surrender period, and may have new charges and fees; and

2. Under Section 1035, annuities may be transferred to other annuities, life insurance policy cash surrender values may be transferred to other life or annuity policies, but annuities may not be transferred to life policies.

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