Tuesday, November 13, 2012

Hartford to Buy Out Annuities

The Hartford just announced to investors and analysts that they are seeking regulatory approval to make offers to a small number of annuity owners to swap the income guarantees on their contracts for boosts to the amounts that they have invested in underlying stock and bond funds.

A variable annuity is an insurance contract that delays payment of income until the investor chooses to receive them. There are typically two phases: a savings phase and an income phase. Earnings within the contract are tax deferred until withdrawal, similar to a 401K plan. Similar to a 401K plan, there is a 10% early withdrawal penalty if funds are taken out before the age of 59 and 1/2. If an annuity is held within a retirement plan, it is considered a "qualified" annuity and distributions are completely taxable. If held outside of a retirement plan, it is known as "non-qualified" and only earnings are taxed. Withdrawals are made on a earnings first, basis last principle. Variable annuities come with an assortment of insurance options, all of which add to the cost of investment in the contract.

The basic insurance benefit associated with variable annuities is the death benefit. It assures the beneficiaries of the annuity guaranteed payment if the contract owner dies before annuitizing the contract. There are several options for this, each with different costs associated with it.

Among the living benefits, which include annuitizing your investment to receive guaranteed minimum income, the benefit to discuss here is the Guaranteed Lifetime Withdrawal Benefit (GLWB), which does not require annuitizing, and therefore handing over control, of your investment. The guarantee is a set percentage of your investment, which increases the longer you delay payment. The company may agree to pay you 5% at age 55, but might increase it to 5.5% or 6% if you wait until age 70 or 80. Coupled with death benefits, insurance companies make money off these contracts based on the underlying fees charged to clients because they don't get to keep the account balance like an annuitized contract e.g. an immediate annuity.

The Hartford is seeking permission to ask variable annuity owners to give up their guarantee of lifetime income probably because the projections on how the market would perform, which the guarantees the Hartford were giving as part of their VA products were based, were way off. A lot of analysts were expecting a correction of some sort but very few thought we'd have the magnitude of a recession like we did in 2008-2009. Even with hedging programs in place, it's difficult to maintain a level of guaranteed payment to investors under contract until they die (defined benefit plans, anyone?).

The Hartford is offering a boost to the amount of money in accounts held by owners of these contracts in exchange for canceling the guaranteed lifetime withdrawal.

The people who would most likely benefit from accepting this offer are people who are close to death and the expected value of the future guaranteed payments are less than the boost the Hartford is offering. It is likely by this stage, surrender charges have disappeared and they can try to roll over this account into a traditional mutual fund company in similar investments and save on fees.

The people who are worse off accepting this offer are those that are expected to take the guaranteed withdrawals for decades in retirement and the expected value of these future payments outweigh the boost the Hartford is offering.

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