Friday, September 5, 2008

Avoid Annuities due to Insolvency Risk

Simply put, Annuities are Loans to Insurance companies by their customers. Right now, I think it is a mistake to purchase an annuity (variable or fixed) from any insurance company. When you purchase an annuity, you transfer funds to the carrier in return for a promise from the company to pay you in the future according to the terms of the contract.

Key Concepts about Your Loan to your Insurance Carrier:

  1. Insurances Companies can and do go out of business. Like banks, car companies, or any other firm, they are susceptible to mistakes by management and financial realities. In the past few years, AIG, once the strongest insurance carrier on the planet, lost something like $50BILLION in market cap.
  2. The longer it takes for you to "collect" on your annuity, the more risk you have.
  3. Most Life Insurers invest a large portion of their assets in fixed income securities. Traditionally, this has been a sound, well thought out strategy. Unfortunately, the credit crunch and subprime crises means many of those "assets" could depreciate and leave the carrier unable to pay you. For example, a well run Insurer I have experience with states it has:
  • $90+ Billion in Assets
  • Asset Backed Securities: 9%
  • Residential CMO/Mortgage Backed Securities: 4%
  • Commercial Mortgages: 6%
  • Commercial Mortgage Backed Securities: 15%

Although the insurer has a good reputation and solid rating from AM Best, it would have a significant problem if those assets became impaired.

While great ratings (AM Best, Fitch, and S&P) matter, they are not perfect. If you don't believe me, ask someone who bought AAA rated mortgage backed securities in 2006.

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