Tuesday, September 3, 2013

Annuities—Times are a-changing!!

Americans have invested approximately $661 billion in an estimated 6 million variable annuity contracts with benefit guarantees (according to insurance industry researcher Limra in the April 20-21, 2013 Weekend Investor section of the Wall Street Journal). Such products were sold with the promise of a guaranteed retirement benefit that could be “reset” higher if the underlying investments perform well. These products also carried higher fees than the normal “immediate” annuities that started annual payments in exchange for a lump sum contribution.

The decline in long term interest rates has impacted some of the insurance companies who provide such annuities in a negative manner—so much so that the companies are changing provisions of the contracts sold in previous years. Some of these changes include limiting the investment options within the annuity, prohibiting additional contributions to the contract, raising contract fees, and even buying back (or offering alternatives for switching) the contracts themselves. We are experiencing client questions about such changes. Question: would an insurance company want to change a contract that was performing (i.e. making them money) at expected or better rates? The answer is usually “NO.” Therefore, when an annuity contract owner is offered an “opportunity” to switch or modify an annuity contract, it should be viewed quite carefully.

If you hold an annuity contract, there are several things which you should definitely do:

  • Read the correspondence—Insurance companies usually give advance warnings of changes they are making to annuity contracts. That warning may come in a letter that looks like “standard document language” i.e. many pages with lots of small print; do not ignore what that letter is telling you. Some of the proposed changes may have a negative impact on your contract.
  • “Reset” Opportunities- Some annuity contracts offer “guaranteed minimum income benefits” (GMIB) which can be reset over the life of the contract. That benefit level may change based on the investment performance of the underlying investments. That reset change may also allow for a change (increase) in the fee charged for the GMIB option. Weigh the cost/benefit carefully.
  • “Trade-In the Contract”-Some insurers are offering to buy back the “old” contract in favor of a “new” offering. The new contract may not (usually does not) contain terms as favorable to the annuity holder as the old contract in terms of fees and/or benefits. Keep in mind that an advisor may be working on commission and such a trade-in could result in new commissions for the advisor.

Annuities are complex products. They usually carry fees that are higher than investing in the underlying investments directly and the sales commissions can restrict access to the funds invested subject to conditions outlined in the prospectus. One should never invest in an annuity without completely reading the prospectus and understanding the nature of the investment. We, at Paragon Advisors, do not use products that are commission based; hence we have very little need for such products. We will be glad to assist you in evaluating any contract (or proposed changes thereto) you may have.
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