Insurance Companies Chip Away at Variable Annuities

As insurance companies bend their own rules, investors have yet another reason to run when they hear the word “annuity.”

In the years leading up to the Great Recession, many people regarded variable annuities with guaranteed living-benefit riders to be the best of both worlds — a tax-deferred retirement vehicle that allowed annuity holders to profit from market upswings while the safety of a guaranteed minimum income stream protected them in case of a downturn. Insurance companies believed such riders would not be a burden on their bottom line for a variety of reasons, including the insurers’ ability to hedge their position with financial instruments and the profit they expected from policyholders paying fees to surrender their contracts early.

The system was very logical on paper. However, reality set in for the insurers in the wake of the 2008 financial crisis. Hedges became more expensive. Insurance companies felt the pinch of the extreme low-interest-rate environment. More customers wanted to cash in on their policies’ guarantees.

Something had to give.

Unfortunately for many variable annuity holders, the rules of their contracts meant that something was their annuities. Companies including The Hartford and AXA Equitable are in the process of restricting the mutual funds available to annuity holders, pushing investors to scale back their accounts’ volatility (and thus their potential returns). Certain companies are offering incentives, such as lump-sum payments, to annuity holders who voluntarily waive their guaranteed benefit riders.

Even when insurers honor their annuity holders’ guaranteed benefits, policyholders often find that they don’t receive what they expected. For instance, a guaranteed rate of return might only apply to the accumulation phase of an annuity. Once the contract begins to pay out, the insurer could credit the account with a much lower rate of interest.

None of these actions violate the law or the rules of the annuities in question, but that doesn’t mean they are good news for investors. What should investors do?

If you don’t already have a variable annuity

Give some careful thought as to what you want from your investment. Odds are that other vehicles can better meet those needs.

Variable annuities offer a limited range of investment products which, in many cases, are narrowing even further. The few investment options on the list are often disproportionately expensive and tilted toward the insurer’s own products. Annuity contracts also lock you in with steep surrender charges.

If you are looking for tax deferral, you should max out your contributions to IRAs and company retirement plans before considering other options.

If you are looking for guarantees, consider that the promises of an annuity are only as strong as the company that makes them. A conservative, low-fee mutual fund portfolio is not a promise, but it will give you a greater opportunity for long-term growth. Think twice before you trust an insurance company’s guarantees.

If you have a variable annuity

Be vigilant in keeping up with any “offers” or notices from your provider. It may not always be clear at a glance that communications from the company are urgent, so read any material you receive carefully. If you have not heard anything from the insurer, be proactive and ask if any changes are slated to affect your annuity.

Do the math or seek the help of a financial adviser to be sure you understand what the changes mean, especially if you have a choice between a lump-sum payout and giving up a guaranteed benefit rider.

Also, be on guard for rising fees. Because annuity contracts often have harsh penalty charges for early surrender, it’s vital to consider the long-term impact of keeping the contract on the new terms against the loss you may face from getting out early. If you are nearing retirement, it may make sense to take distributions sooner rather than later as the potential for large gains within your annuity diminishes.

As annuities become a zero-sum game, insurers are trying to ensure annuity holders make choices that work out for the company’s bottom line. Annuity holders need to make sure they’re doing the best they can for their own retirement accounts.

Benjamin C. Sullivan, CFP, is a financial planner and portfolio manager with Palisades Hudson Financial Group in Scarsdale, New York. He can be reached at ben@palisadeshudson.com.

Palisades Hudson (www.palisadeshudson.com) is a fee-only financial planning firm and investment advisor with $1.2 billion under management. It offers investment management, estate planning, insurance consulting, retirement planning, cross-border planning, business valuation and appraisal, family-office and business management, tax preparation, and executive financial planning, Offices are in New York, Georgia, Florida and Oregon.