Beware Of Troubled Insurers

Insurers are under stress. Their stock portfolios lost a bundle in the bear market, and yields on their bond portfolios are way down. Many set low premiums in the 1990s to increase market share, or they promised benefits they cannot deliver today. The result is a number of safety rating downgrades for annuity and life insurance companies.

Conseco garnered most of the negative headlines. It is one of the largest annuity companies and has suffered executive turnover and a host of financial problems. Lesser-known companies also have had problems, including Bankers Life & Casualty and Allmerica Financial. Fitch Ratings reduced the ratings of 35 insurers, most of which sell annuities, in one day last September. In 2001, 40 insurance companies failed.
Expect the safety downgrades to continue this year, especially with interest rates at such low levels.

The ratings initially affect mostly new purchasers. Some brokers won’t sell products of companies with the lower ratings. Also, the benefits and guarantees of annuities will be reduced. For example, many insurers are dropping or eliminating the guaranteed returns. Most currently guarantee 3% annually.

Owners of existing fixed deferred or immediate annuities also need to pay attention. A ratings downgrade could be a sign that an insurer or annuity company is on the road to failure. In addition, ratings downgrades or other bad news can lead existing holders to liquidate their annuities, causing the insurer more distress. If the insurer fails, there are sparse state insurance funds to help annuity owners if an industry bail-out cannot be arranged. After an annuity issuer’s failure, benefits can be reduced and the money locked up for a few years.

Annuity owners should not panic. Especially, don’t be overly swayed by warnings from agents and brokers.  They might want to earn commissions from selling a new annuity to replace your existing one. While annuity issuers do fail, it doesn’t happen often. Baldwin-United failed in the 1980s, followed by Executive Life in 1991 and Confederate Life in 1994. When smaller annuity issuers fail, larger companies usually absorb them. Also, a ratings downgrade doesn’t mean failure is imminent. A.M. Best considers any company rated below B+ to be “vulnerable.” That means it has a one in 50 chance of becoming insolvent within three years. A new policy should be purchased only from an insurer with an A- or better rating. The issue now is what to do if an annuity issuer falls below that level.

The first step should be to check on the safety ratings of your insurer. There are five ratings agencies for insurers. An insurance broker or agent should be able to provide the ratings for any insurer whose policies or annuities it sells. Many public libraries also carry at least some of the rating services. The box lists the web sites of the five raters and the lowest grade that each rater considers “secure.”

When the safety rating makes you uncomfortable, there are a couple of options.
An annuity can be liquidated or switched for a new one. Liquidation can be expensive. Taking the account in a lump sum means paying income taxes on the accumulated income and gains. The taxes can be avoided with a  Section 1035 tax-free exchange of the annuity for a new one.
Whichever route you take, there might be a surrender penalty or withdrawal fee. You have to decide if leaving the uncertainty of the issuer’s financial condition is worth the certainty of paying the withdrawal penalty.
Variable annuity owners don’t face the same problem.

The money in a variable annuity’s investment accounts is segregated for you so it is safe regardless of what happens to the insurer. A different potential problem with variable annuities is the promise that at the owner’s death the beneficiary will receive at least the owner’s investment regardless of the account’s value.

With the bear market, insurers are increasing reserves for this benefit. Since the payments aren’t due until an annuity owner dies, it is too soon to tell how much this will cost insurers. As long as the stock market stays well below its peak levels, the insurers have to increase reserves and the rating agencies will reduce the ratings of some of the insurers.