7 Lessons On Strategies
The Rich Use To Buy Annuities
Lesson #3
The Safety of Fixed Annuities
Table Of Contents
Safety Net #1 - Insuring Your Assets
The importance of insuring your retirement portfolio with fixed annuities
Safety Net #2 - Company Ratings
The role of rating agencies and A.M. Best's Financial Strength Ratings
Safety Net #3 - Insurance Industry Regulations & Reserve Requirements
State insurance commissioners, reserve requirements, and comparison with FDIC
Safety Net #4 - Historical Track Record
Stability and strength of the insurance industry over time
Safety Net #5 - Surrender Charges
Understanding the benefits and drawbacks of surrender charges in annuities
Debunking misconceptions about AIG and the safety of the insurance industry
Learn about the multiple “safety nets” you get with fixed annuities, and why even in this unpredictable economy, fixed annuities from a reputable insurance company can still offer one of the best safety track records of any
financial product over the past 150 years.
Safety Net #1 - Insuring Your Assets
You insure your house, your car, your health, and your life – why not your retirement portfolio? Especially since your retirement portfolio’s ability to stay safe and generate income during retirement is what allows you to afford to maintain all those other insurances to begin with.
When your money is invested with a fixed annuity, your principal and interest are contractually guaranteed in writing and backed up by the full strength and claims-paying ability of the insurance company. By using an insurance company with a high strength rating (which we will cover next), that means in most instances you are backed by a company with billions or even trillions of dollars in assets and reserves that may also be between 50 and 150 years old.
Safety Net #2 - Company Ratings
All insurance companies are heavily scrutinized by the four major independent rating agencies: Fitch, Moody’s, Standard and Poor’s, and A.M. Best. Each rating agency differs slightly in their criteria and manner in which they assign a letter grade to an insurance company.
Founded in 1899, A.M. Best is the oldest of the four agencies and tends to be widely recognized as the most trusted and accurate. A.M. Best's Financial Strength Ratings (FSR) represent the company's assessment of an insurer's ability to meet its obligations to policyholders. The rating process involves quantitative and qualitative reviews of a company's balance sheet, operating performance and business profile. This includes comparisons to peers and industry standards, and assessments of an insurer's operating plans, philosophy and management.
The ratings scale includes 15 different ratings:
A++, A+ (Superior)
A, A- (Excellent)
B++, B+ (Good)
B, B- (Fair)
C++, C+ (Marginal)
C, C- (Weak)
D (Poor)
E (Under Regulatory Supervision)
F (In Liquidation)
Safety Net #3 - Insurance Industry Regulations & Reserve Requirements
All insurance companies are regulated by individual state insurance commissioners. The job of these state commissioners is to be constantly reviewing, monitoring and auditing the internal investment holdings, reserve requirements, and overall strength and solvency of the company. Each state requires that every life insurance company doing business in its state must have enough liquid assets to cover the insurer’s current and future obligations, plus a little extra. When you deposit money at your local bank, the banker may only be required to hold between 5-15% of your deposit in reserves. The rest can be used and lent back out for profit.
When you invest with a fixed annuity, the company is required by law to set aside a minimum of $1.04 for every $1.00 of principal that you deposit. That means 104% of your deposits are held in reserves instead of only 15% with most banks, and many insurance companies actually have much more than just the minimum reserves. It is not uncommon for larger insurance companies to have anywhere from $1.18 to $1.60 or more for every $1.00 they have in obligations.
In contrast, the FDIC has $50 billion in reserves to cover over $4 trillion of bank deposits. That normally works out to approximately 1.2% in reserve coverage. However, at the time of this writing the current reserve ratio has since dipped below 1%. This makes insurance companies legal reserves and the protection they offer even more impressive. This is more than 100% protection compared to less than 1% in the FDIC.
Safety Net #4 - Historical Track Record
Just the North American insurance industry alone is comprised of around 2,000 individual companies, who collectively own, control or manage more assets than all the banks and oil companies in the entire world combined. It has been said that if there were ever a financial collapse in this country, the insurance industry would be second only to the U.S. Government to fold, and that is only because the government has the ability to tax and print money.
Even at the time of this writing, the insurance industry is trillions in the black in contrast to the government, which we all know is trillions in the red. The insurance industry also has by far the best strength and stability record of any financial institution over the past 150+ years. Even Babe Ruth, the legendary baseball player, was able to financially survive the Great Depression because the majority of his retirement savings were in fixed annuities. He never lost a dime in his fixed annuities, while many of his teammates went bankrupt from the market crash.
Safety Net #5 - Surrender Charges
When you invest your money in a fixed rate annuity, you typically lock into a “term” of years like with a bank CD. Also, like CD’s, the annuity usually carries surrender charges if you were to liquidate more than 10% of your balance annually prior to the end of your contract’s maturity. Some people believe that this is a disadvantage of annuities, however, the reality is that this offers additional safety for several reasons.
First, this prevents there from ever being a “run” on the insurance company like there are sometimes a “run” on the banks. It makes people think twice about liquidating their annuity principal ahead of schedule in the event of a national crisis, thereby protecting all the other policyholders of the company who do not wish to liquidate. When someone liquidates an annuity during the middle of their contract, this forces the company to liquidate the same portion of their internal bond portfolio within the company’s general account. The surrender charge assessed by the company protects the company from taking on losses, therefore protecting the strength and financial soundness of the entire company and their policyholders.
Surrender charges can also be used as a benefit to help ensure that proper time, planning and consideration is taken when moving money around during retirement, and can help guard against making impulsive or reckless financial decisions. Half the battle when it comes to proper planning is in dealing with our natural human behavior and in trying to maintain a disciplined approach to investing. If there is a concern about liquidity for emergencies, the reality is most annuities allow far more flexibility for taking penalty-free withdrawals each year than even most bonds and CD’s. Also, the most obvious answer is to simply not put all your money in annuities - something that we never encourage someone to do anyway. As long as you have a properly funded emergency cash account that has been set up and allocated to provide a sufficient amount of liquid “emergency” money, investing in annuities that have surrender charges is not only acceptable, but can be extremely advisable especially when considering the other powerful benefits annuities can offer during retirement.
AIG: The Real Story
Ever since the government bailout of AIG, people have been citing it as an example of how the insurance industry is just as unsafe as the rest of the financial services industry, and that it represents an argument against the desirability of fixed annuities and insurance.
The belief is that if the largest, A++ rated insurance company on the planet can be brought down, any other insurance company can as well. However, when you “pull back the curtain” and understand what really happened at AIG, you may begin to believe, as we do, that if anything, the AIG debacle is actually an argument FOR the safety of the insurance industry, not against it. How is that possible? Remember, AIG was a multi-services financial company, not just a pure life insurance and annuity company. They had banking, lending, and brokerage divisions that may have carried the same name, but were completely separate entities from the pure life insurance and annuity division.
During his interview in front of congress in March of 2009, Fed chairman Ben Bernanke was asked how the problems at AIG could have been allowed to get this bad, how the regulation of AIG’s internal investment activity could have failed this significantly, and wasn’t it the New York state insurance commissioner’s job to have kept the internal problems at AIG from getting so bad.
Bernanke’s response was absolutely correct. He told congress that the divisions of AIG that were heavily leveraged in the defaulting sub-prime mortgaged-backed securities and credit default swaps were limited to the banking, lending, and brokerage divisions, which fell outside the jurisdiction of the New York state insurance commissioner’s regulatory authority.
He went on further by saying that the proof of this was in the fact that at the time of his testimony before congress, the insurance and annuity division within AIG remained the only stable and profitable side of the entire company, that the regulatory standard already in place within the insurance industry had prevented the insurance and annuity division from participating in any of the risky decisions of the rest of the company, and that the other divisions were not allowed by law to “raid” the huge reserves contained within the annuity division in order to help cover the mistakes throughout the rest of the company.
It has been widely speculated that had the government bailout of AIG not taken place, the insurance and annuity division would have likely spun off and started operating under a separate name and entity. However, all the life insurance and annuity policyholders of that company would have continued to receive uninterrupted service, benefits, and guarantees of their contracts.
