Clients who have purchased variable annuity (VA) products containing lifetime guarantees need to watch their mail in the upcoming weeks and months because a recent study by Moody’s indicates that insurance companies issuing these guarantees will soon be seeking substantial modifications to outstanding contracts. Though these guarantees are what attracted many clients to VA products in the first place, the inability of insurance companies to accurately predict contract owners’ behavior has now put these features at risk. Clients today need to remain alert to modification proposals issued by their insurance companies, or they could find that the guarantees they are relying upon no longer exist.
The problem with these VAs
Variable annuities offering guaranteed benefits experienced a surge in popularity during the 2009 financial crisis as investors looked for products that offered equity-like returns without the corresponding risk. Variable annuities allow these investors to choose between several investment options and can provide guaranteed lifetime income benefits.
Because these products offer an investment component, coupled with the safety net of guaranteed income benefits and tax-deferral, many clients have found them to be an attractive portfolio product that they have kept despite recent rebounds in the equity markets themselves.
The problem with variable annuities that contain guaranteed lifetime income benefits today is that insurance companies have done a poor job of predicting contract owners’ behavior with respect to outstanding contracts. Many companies significantly underestimated the number of owners who would maintain these products even though the markets have rebounded in past years.
According to a recent Moody’s special report, this underestimation means that insurance companies will face billions of dollars worth of charges against earnings in the coming years because those companies will be required to maintain higher than anticipated reserve levels. This means that clients need to watch out for potential attempts by insurance companies to modify their existing contracts.
Insurance companies’ remedies
Many insurance companies have already attempted to modify outstanding contracts, and some have sent notices informing clients that they will actually lose their guarantees if they fail to respond to the proposed modifications. For example, according to The Wall Street Journal, one insurance company, The Hartford, is requiring its variable annuity contract holders to move at least 40% of investments into bond funds to avoid losing their guarantee features. If the client fails to respond to the notice, the guarantee will eventually be revoked even though the client has already paid for the guarantee feature.
Some insurance companies have taken a different course and offered to buy back the guarantee portion of clients’ variable annuity contracts. These buyback campaigns began late in 2012 and some insurance companies continue to offer the buyback.
In exchange for allowing guarantees to lapse, clients will be offered an increase in their annuity funds themselves, increasing insurance companies’ short-term costs, but eliminating the long-term risk created by the guarantees.
While some clients may be tempted at this option, clients should be advised of the downside — namely, losing the lifetime income guarantees that may have first attracted them to the product.
Because of the large dollar amounts at stake, the Moody’s report indicates that many more insurance companies might be making attempts to modify existing annuity contract guarantees in the future. Therefore, clients need to be made aware that it is more important than ever that they carefully review any notices they receive from annuity providers — and seek professional advice when necessary.
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