Brokers Fear Annuities May Not Honor Guarantees

With about two dozen insurance companies downgraded by one or two notches to a negative outlook during the first quarter, brokers who sell variable annuities are beginning to wonder if those insurers will be able to honor the annuities’ guarantees.

Merrill Lynch, which is one of the biggest distributors of annuities, found in a survey that 71% of its brokers think insurers are offering too many guarantees and, on top of it, 32% said they fear the insurers don’t even understand those risks, The Wall Street Journal reports. In 2007, only 68% of the brokers were wary of insurers’ risks and 17% were wary of their understanding of those risks.

Most of the insurers have been downgraded due to steep losses in their investment portfolios, but in some cases, the downgrades were due to guarantees. Insurers developed a dizzying array of guarantees about five years ago, many of them incredibly generous; one steps up the account value by 7% each year.

Recently, insurers have begun scaling back on their guarantees, even at higher prices. Others have stopped selling annuities with guarantees until they can reconfigure and better hedge their risk models. And many are offering far less equity fund investments, replacing them with index funds.

A spokeswoman for The Hartford explained: “[We have] ceded a lot of market share over the last several years because we felt that the annuity arms race was so strong and so aggressive. [We are now trying] to ensure that we are derisking our annuity business to substantially reduce the risk and capital strain.”

Certainly, insurers took charges of as much as $2 billion in the fourth quarter due to poorly performing variable annuities with guarantees, and throughout 2008, insurers had to boost their capital reserves by more than $15 billion to ensure they will be able to honor those promises.