By Jane Bryant Quinn
Sunday, December 14, 2008
A popular type of variable annuity -- the one with guaranteed "living benefits" -- may be the riskiest product ever sold by the insurance industry. Risky to the health of the insurance carriers, that is. The guarantees are costing them far more than the premiums they charge, and their stock prices have plunged.
If you bought one of these annuities, you will collect your promised, fixed, minimum income benefits even though your investment may have lost 40 percent in market value. Your future benefit, however, may not rise as you expected. Fortunately, there's a backdoor way to increase your payout -- more about that later.
The product in question is called a variable annuity with a guaranteed minimum withdrawal benefit, or GMWB. Your money goes into a mix of stock and bond "subaccounts" (that's annuity- speak for mutual funds). You're promised a minimum payout -- say, 5 percent of your original investment annually for life -- and a higher payout if the value of your subaccounts rises by more than a certain amount. You can access your money, so you don't lose control. Anything left of your investment when you die can be left to heirs.
For consumers, it's a pricy package but an attractive one. The guarantees grew even more extravagant last summer, as the carriers "one-upped each other by adding enhancements," said Kevin Loffredi, publisher of Annuity Intelligence Brief, which follows annuity contract changes.
It's ending in tears. In September, the insurance raters A.M. Best and Fitch moved the life-insurance industry into its negative-outlook column. In October, Moody's and Standard & Poor's did the same. A.M. Best has downgraded 30 life and annuity companies so far this year.
Several companies have announced slightly higher prices or reduced guarantees on their future GMWBs, but it may not be enough. "There's no reasonable fee that will cover all these benefits," said Garth Bernard, a Boston-based principal in the insurance consulting firm Retirement Income Solutions Enterprise.
In the meantime, the industry is proposing to handle its problems the old-fashioned way: by putting lipstick on its books.
As the value of GMWB annuities tumbles, the carriers are required to increase the reserves they hold against these products as a way of assuring that customers will be paid. Raising reserves, however, could starve their working capital at a time when they're also writing down toxic mortgage assets. The companies say they're already holding plenty of reserves, so they're asking the states, which regulate the industry, to loosen the rules.
The National Association of Insurance Commissioners will discuss the proposed changes this month. Iowa Insurance Commissioner Susan Voss calls some of the reserves "redundant" and suggests that NAIC will go along.
Bad idea, said Etti Baranoff, associate professor of insurance and finance at Virginia Commonwealth University in Richmond. Reducing reserves is a "neat trick, to make net worth look better, but it won't work," she said. "You want to avoid more failures. This isn't the time to loosen regulations."
Cosmetic improvements to the balance sheet won't help the carriers with the ratings companies. "We typically don't adjust ratings up or down as a result of accounting changes. We wait for the underlying economics to play out," said Andrew Edelsberg, a vice president of life/health at A.M. Best in Oldwick, N.J. Douglas Meyer, managing director of Fitch's U.S. life insurance group in Chicago, added that "it would concern us" if the insurers wound up holding less capital.
If you have one of the GMWB annuities, your future income rights are guaranteed. For every $100,000 invested, you can typically withdraw $5,000 a year for life, starting at age 60 or 65.
That's the good news. It's also the bad news, for the bulk of the GMWB buyers. You probably intended to hold the annuity for several years before starting withdrawals. Over that time, you expected its value to have grown by enough to pay more than the minimum $5,000 a year.
Now that can't happen until your investments recover everything they lost, plus each year's costs, and costs are compounding at a annual rate of almost 3.5 percent. Your annuity will be underwater for a long time.
Luckily, there's another way to increase your payout, said Colin Devine, managing director of Citigroup Investment Research. Here's his idea, using a $500,000 annuity with a 5 percent annual withdrawal rate:
Start your withdrawals right away, taking $25,000 a year for 10 years. If you're 60 and older, you can do it without reducing your lifetime income guarantee. Withdrawals are a tax-free return of principal when an annuity has no earnings.
Flip those annual withdrawals into new GMWB annuities. Stock prices are low, so there's a good chance that the value of the new annuities will increase, paying you a future 5 percent income on a rising base. At the same time, you will continue to collect $25,000 a year from the first annuity for life. Check to be sure that this strategy doesn't interfere with the annuity's death benefit, Loffredi added.
You might also consider flipping the withdrawals into stock-owning mutual funds.
Insurance companies didn't expect the buyers of GMWBs to start withdrawals right away, and they didn't hedge for it, Devine said. "They're going to need the reserves they're asking the insurance commissioners to let them reduce."
If you're buying an annuity, buy from a large, AAA-rated company. "I don't think any life insurance companies are going down the tubes," said Steven Schwartz, life-insurance equity analyst at Raymond James & Associates in Chicago. But still. . . .
Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis contributed to this column.