Variable Annuity Guaranteed Income Benefit Risks

Interesting Article in the Wall Street Journal today about Variable Annuity’s Guaranteed Benefits. Variable annuities provide nice tax deferred growth, their rates of return aren’t bad if they have great sub-accounts, which are accounts similar to mutual funds. Variable annuities don’t guarantee rates of return, nor do they guarantee the principle unless the annuity holder chooses the fixed or money market account, values totally rely on performance (this is unlike fixed annuities which do). However, many variable annuities offer future guarantees to provide income even if the underlying performance is poor. Many older variable annuity owners wishing to use their variable annuities for retirement income, find that their values are low, will instead choose to take their money by using the income options such as annuitization or a guaranteed income benefit, they might be called GIB or GWB for guaranteed withdrawal benefit. The income might range somewhere between 4% – 7%.  Considering how low-interest rates have been on savings and bonds, and low returns of stocks, this income might be very attractive to variable annuity holders.

How are insurance companies financially able to make their income promises? The companies offering these products invest the fees they charge and purchase hedging instruments, such as stock options, and have reserves to help them pay these guarantees. The companies reserve’s investments and the variable annuity sub-account performance also play a role. Lastly, if the company is publicly traded, the stock price may also affect their ability to meet the promises. The article cited above raises concerns about ING, since their stock value has decreased 4.7%, and it is expected that more variable annuity holders will choose to take their money in income, for the reasons stated in the previous paragraph.

Purchasers of annuity products may be wise to consider the financial strength of the insurance company by looking at rating from multiple rating agencies such as A.M. Best, Fitch, Moody’s and Standard & Poor’s, and do other research. In addition it may be wise to purchase annuities from more than one company, this is especially true if investing a large amount.

If an insurance company becomes insolvent, is there a government agency that guarantees principle?  There is no federal guarantee like FDIC, but most states have set up agencies to protect policy holders (within limits), however there is one big hitch, they don’t back variable annuities.