Is Your Annuity Safe?

EDITOR'S NOTE: This article was originally published in the November 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.

Ever since American International Group's financial troubles became news, we've been inundated with questions from readers about the safety of their annuities. The company underwrites the popular Vanguard immediate annuity, in addition to annuities with AIG Retirement, AIG SunAmerica, Variable Annuity Life Insurance Co. (VALIC) and other names.

Regulators say AIG insurance policies and annuities are safe for now, and consumers have protection if AIG's insurance subsidiaries became insolvent. AIG has many lines of business, but the insurance subsidiaries are subject to special rules. States require insurers to set aside enough capital to pay claims and make annuity payouts.

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AIG's life-insurance subsidiaries currently have an A rating from A.M. Best. Still, the ratings firm says the subsidiaries are "under review with negative implications," which means it's monitoring the situation. "At this point, the insurance subsidiaries have an excellent ability to pay claims," says Andrew Edelsberg, a vice-president in A.M. Best's life/health ratings division. You can check A.M. Best ratings at kiplinger.com/money/insurance.

The safety of an annuity depends in part on the type of product. Payouts from a fixed annuity or from an equity-indexed annuity come from the insurer's general account. So if you hold one of those annuities, keep an eye on the insurer's financial strength.

If you have a variable annuity, the money is segregated from the insurer's assets and invested in mutual funds in your own account. However, if your variable annuity has a guaranteed minimum benefit, that benefit is paid from the company's general account; the benefit, though not your account balance, could be jeopardized if a company became insolvent.

Before a company ever reached that point, you would still be protected. AIG, for example, would probably sell some of its subsidiaries to other insurers, and you could end up with a stronger company.

State guaranty associations would jump in if the insurer became insolvent. These associations must provide at least $300,000 in life-insurance death benefits, $100,000 in cash surrender or withdrawal value for life insurance, and $100,000 in withdrawal and cash values for annuities. Sixteen states have limits of $300,000 or $500,000 for annuities.

Peter Gallanis, president of the National Organization of Life and Health Insurance Guaranty Associations (www.nolhga.com), says people generally get more than the state limits. In most cases, the insurer pays from its reserves and the state covers any gap. He also says that immediate-annuity payouts would continue without a break.

If you're thinking about buying an annuity that is larger than the state coverage, consider purchasing several smaller ones from several insurers. Each company would be covered by the state separately.

Costs of Switching

Regulators warn that agents looking for commissions have been trying to persuade owners of AIG annuities to switch out. "If someone tells you to replace any policy because AIG is in trouble and may not be able to pay your claim, that is not only untrue, it is against the law," said Eric Dinallo, New York's insurance superintendent, in a statement to policyholders.

If you cash out the annuity, you'll have to pay taxes on your earnings, plus an early-withdrawal penalty if you're under age 59 1/2. You can make a tax-free exchange to another annuity, but you may have to pay a hefty surrender charge.

Owners of a variable annuity with a guaranteed minimum benefit should tread carefully. These annuities promise returns of 3% or more no matter how your investments perform. To qualify, you may need to keep the annuity for several years or take the money as a lifetime income stream. If you move the annuity to another insurer, you would lose the guarantee. "Understand how the contract works before taking out your money," says Glenn Daily, an insurance adviser in New York City.

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