How Safe are Annuities?
Board: Macro Economics
One of the hottest selling financial products in the last few years is annuities. They come in several shapes, forms and sizes. Variable index annuities are the style most often pushed on seniors. The typical pitch is a “guaranteed return” of about 7% per year. The indexing is typically tied to the return of the stock market with enough formulas to make a mathematics PHD sigh a few times.
One common characteristic of all annuities is that they are backed by insurance companies. In the unlikely event that the insurance company goes belly up, the salesman will quickly tell you that the annuity payouts are guaranteed to some dollar amount by state insurance funds. This is all true.
Many annuity pushers will tell you that “no annuity has ever NOT paid out per the contract.” This is where it starts to get a little fuzzy.
For purposes of this post, we will define old timers as anyone over 40 years old. If you are an old timer, you might remember a high flying insurance company called Executive Life. They were the largest life insurer in California in the 1980’s. At the time, their main selling point was above market returns. Unfortunately, their investment portfolio mostly consisted of junk bonds. They were closely tied to Michael Milken and his firm, Drexel Burnham Lambert. In the early 1990’s, many of the junk bonds got into trouble. This in turn had a negative impact on the First Executive portfolio.
First Executive was declared insolvent in April 1991 and was taken over by the California insurance commissioner. This is why I suggested anyone younger than about 40, likely would not have heard about them.
So you are saying: Yoda, who the heck cares about an insurance company that went belly up 21 years ago?
And the answer is anyone that owns or is considering buying an annuity. Fast forward to today (4/16/12) when a New York judge approved the liquidation plan. I would NOT have believed it possible to take this long, but never underestimate the turtle crawling speed of the US legal system.
A New York judge on Monday approved a plan to liquidate the long-insolvent Executive Life Insurance Co of New York and pay out most of the money owed to beneficiaries under the company's life insurance policies.
The plan proposed by Benjamin Lawsky, New York's superintendent of financial services, would pay out the remainder of about $900 million in Executive Life's estate, as well as another $730 million in contributions from state life insurance guaranty associations. Insurers also agreed to chip in about $70 million.
Lawsky's plan won approval by Nassau County Supreme Court Justice John Galasso, over the objection of a variety of Executive Life payees.
Galasso said it would allow for about 85 percent of the roughly 10,000 payees to receive full payouts on the present value of their annuity benefits.
I am NOT suggesting that any insurance company today is heading towards insolvency like Executive Life. However, several of the large insurance companies were in serious trouble like the TBTF banks in the credit crisis. Like the TBTF, they all survived, but I would NOT be optimistic about their outlook. Life insurers are being killed by the low returns across the bond front.
On a broader scale, I strongly dislike both the indexed annuities plus how they are pushed onto seniors. They are good products for a low percentage of situations, far less than how they are sold.
BOTTOM LINE is next time an annuity salesman tells you that annuities are guaranteed by state insurance funds, ask him to give you a history lesson on Executive Life.
Link to Reuter’s article: