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Variable annuities’ financial backstop

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“What happens if the insurance company goes bankrupt?”

That’s probably not the most common objection to investing in variable annuities (VAs) but it’s a concern for some prospective buyers.

The good news is that historically, insurance companies don’t fail much. Peter Gallanis, president of the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA) in Herndon, Virginia, notes that several insurers failed in the late 1980s and early 1990s.

Subsequently it’s been a different story, however. “But, since those companies got into trouble, I don’t think there has been any company of any size or any company that most people even in the business, let alone general consumers, would have heard of that has failed that has written any significant portfolio of annuity business of any sort,” he says. 

That doesn’t mean a VA-issuer can’t go bust, of course, but it’s worth understanding the built-in safeguards that protect investors. At the sub-account level, the investor has an interest in the separate account’s portfolio. Amounts allocated to non-guaranteed investments—stocks, bonds, alternatives, etc.—are subject to market risk, of course, and the VA-owner bears the price volatility risk.

If the assets are valued properly and their markets function normally, though, there are tangible financial assets supporting the investor’s units. Amounts held in a VA’s fixed account fund are considered part of the insurer’s general account and are guaranteed by the insurer. 

The role of state guaranty funds

Should a VA-issuer encounter financial difficulties, the insurance regulator in the issuer’s home state would work with the company to find another insurer to take over the failing business.

If that effort fails, the state guaranty associations (GA) step in. Its state’s statutes set each GA’s coverage levels, Gallanis says. Most states closely follow the National Association of Insurance Commissioners (NAIC) model and provide $250,000 or more in annuity coverage.

If an annuity’s present value at the time of the insurer’s liquidation is less than $250,000, then “then all of the benefits that are provided by a covered annuity are protected by the guaranty association,” he explains.

“You’ll continue to receive all your benefits as though there had been no failure of the company and the guaranty association had never been triggered.”

Present values above $250,000 are protected based on the ratio of assets to liabilities—the liquidation ratio—at the failed company. These ratios have averaged about 75 percent historically and tend to be even higher for larger insurers, which are closely monitored. 

VAs’ have become more complex with the growth of guaranteed living benefits but the concept of calculating a present value for contractual, guaranteed benefits still applies.

Bill O’Sullivan, senior vice president and general counsel with NOLHGA, explains that at the inception of the insolvency, that is, on the date the guaranty association becomes activated to provide coverage, the association, with the help of actuarial and legal experts, analyzes the insurer’s contracts’ terms.

That analysis determines the VAs’ present value and the resulting coverage. Fortunately, no VA contracts have gone through the liquidation process.

Nonetheless, the NAIC has spent considerable time working with insurers on valuation methods because the valuations are needed for the companies’ reserves and financial statements as well as liquidation planning, says O’Sullivan. 

The NOLHGA website has additional details and links to the states’ guaranty associations. The sites’ educational material may help resolve some prospective VA buyers’ concerns about their funds’ safety.