When Analyzing Annuities, The Devil Is In The Details

In what I would think would be an obvious sales practice, a major insurance industry group has agreed to support regulation by the National Association of Insurance Commissioners (NAIC) to make sure annuities sold to all consumers are appropriate for their financial objectives.

Inappropriate annuity sales to senior citizens prompted the NAIC to recommend that states adopt regulations specific to that group of consumers in order to curtail deceptive sales practices. The Senior Protection in Annuity Transactions model regulation requires that annuity-purchase recommendations to consumers aged 65 and older be based on information about their financial situation, such as their investment objectives or tax status.

The regulation came about because many seniors didn’t understand or weren’t adequately informed of the details in their annuity contracts.

They didn’t know, for example, they could be assessed a “surrender charge” if they needed to withdraw money from an annuity too early. They didn’t know that the interest rate paid on their money could change.

“There are a lot of moving parts with annuities,” said Linda Lanam, vice president of annuities and market regulation for the American Council of Life Insurers (ACLI), a trade group of life insurance companies.

But it’s not just senior citizens who are confused about annuities. NAIC decided it wanted the model regulation for seniors extended to cover annuity sales to all consumers. The industry initially balked at the expansion.

But recently the ACLI issued a statement that it would urge the states in 2006 to extend to all consumers the protections contained in the model regulation.

“The process that was set out in that regulation made sense for all consumers,” Lanam said. “We should make this regulation a consumer protection regulation rather than a senior protection regulation.”

I sure hope all this talk and commitment to better consumer protections comes with some real action. And by that I mean increased efforts by the states and the insurance industry to better inform the public about annuities.

The problem isn’t that consumers, senior or otherwise, don’t have the mental capacity to understand annuities. They just don’t know what questions to ask because annuities, as Lanam pointed out, are complicated. It is the details of annuities that bedevil consumers.

The following is how NAIC describes an annuity in its brochure, “10 Things You Should Know About Buying Fixed Deferred Annuities”:

“An annuity is a contract in which an insurance company makes a series of income payments at regular intervals in return for a premium or premiums you have paid. Annuities are often bought for future retirement income. Only an annuity can pay an income that can be guaranteed to last as long as you live.”

One of the biggest appeals of an annuity is that you don’t have to pay income taxes on the earnings until you withdraw the money or receive payouts. For the right person, an annuity can be a good retirement income product. Unfortunately, many people purchase an annuity without understanding all its nuances.

The ACLI says it supports transparency in annuity sales. “I believe full disclosure will result in simplicity and a better product,” said ACLI president and CEO Frank Keating.

But consumers also have to become better informed. For example, here are just a few of the questions the NAIC says people should ask before buying an annuity:

Is my annuity fixed or variable? A fixed annuity earns a guaranteed rate of interest on the money you give the insurance company for a specific time period. Once the guarantee period is over, a new interest rate is set for the next period. Variable annuities typically offer a range of investment options. The return on a variable annuity varies depending on the underlying investment. That means your principal and earnings are not guaranteed. Some variable annuities can come with an option whereby your principal and interest are guaranteed, much like a fixed annuity. See why you really need to know what you’re buying?

If buying a fixed annuity, what is the initial interest rate paid and how long is it guaranteed?

What are the fees and charges? Specifically ask what are the surrender charges or penalties if you want to end your annuity contract early and take out all of your money. Remember, this is a product intended to be used for retirement income. So if you have any inkling that you may need your money in a few years, an annuity may not be right for you.

Does this annuity waive withdrawal charges if I am confined to a nursing home or diagnosed with a terminal illness?

What annuity income payment options do I have?

Is this annuity appropriate if I haven’t taken advantage of other tax-deferred retirement accounts such as a 401(k)?

For more information about annuities, go to www.naic.org. Click on the link for “Consumers.”

As more companies abandon traditional pension plans, it is vital that consumers understand products aimed at helping them save for retirement.

By Michelle Singletary