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August 17, 2009 at 08:00 PM
With short-term Treasuries and bank certificates of deposit offering rates only slightly above sea level, 
the 3.5% to 6% guaranteed returns offered by today’s fixed annuities have been very attractive.
Further, since there is no tax on interest until annuity proceeds are distributed, the tax-adjusted return for fixed annuities is more like 4.5% to 7.5%. That’s not bad in today’s scary investment environment.
But there is more to fixed annuities than rate; there is value. How to determine this value is the subject here.
Historically, comparison shopping for FAs has been limited to a quick look at new money rates and on broker compensation.
The focus on rates is understandable since FA provisions are pretty similar across the industry. Most have 10% free withdrawals and waiver of surrender charges for nursing home confinement and terminal illness, for instance. While fixed indexed annuities offer a little more variety–different indexes, participation schedules and multiple fund accounts, for instance–when it comes to distinguishing one five-year, guaranteed-rate FA from another, rate is usually the top factor.
However, because annuity crediting rates are a function of the performance of the general account assets of FA carriers, looking at the rate without looking behind the curtain to see what supports the rate could prove to be a costly mistake.
General account investment portfolios generally consist of corporate bonds, government securities, commercial mortgages and a handful of other very conservative investments. In recent months, much has been written about the beating insurers have taken on their bond portfolios. Some big insurers have written billions of previously highly-rated bonds off their books, and they all have internal watch lists of dozens more bond issues that may join the ranks of fallen angels before the sagging economy flushes out all the losers.
Many analysts believe the next shoe to drop in the sub-prime stumble may be commercial mortgages. That’s important to annuity professionals because a number of big insurers have sizeable commercial mortgage portfolios; these could suffer significant increases in defaults as tenants are unable to pay their rent and property values continue to tumble. What looked like a good loan at 65% loan-to-value at mortgage issued two years ago doesn’t look nearly as solid when loan-to-value goes up to over 100% with falling property values.
What is the message for fixed annuity brokers? In the Wizard of Oz, Dorothy had to look behind the curtain to figure out that the Wizard wasn’t exactly as advertised. Brokers need to do the same to help customers determine which FA provider offers the best value, not just the best price. Here are some determining factors:
