The Risk of Annuities - WSJ.com
By JANET PASKIN
Variable annuities are hot among baby boomers, thanks to new variations on the products that promise a steady stream of income regardless of how their underlying investments perform.
But some industry watchers and insiders fear that, in a bid to attract that boomer business, companies have made promises they can't afford to keep.
Guaranteed Income
Over the past decade, annual sales of variable annuities have more than doubled, to about $200 billion in 2007, according to NAVA, the industry's trade association. There are more than 1,100 different annuities on the market, up from 295 a decade ago.
A big reason for the recent growth is the fact that the industry has relaxed some of the old restrictions on its income-for-life promise.
The money used to purchase one of these new annuities gets invested in a handful of mutual funds picked by the customers. Whenever they choose, the investors can start receiving a minimum monthly payment for life. If the investments take off, the payments could grow higher. But they will never fall below a certain minimum.
And with the new products, investors can choose at any time to withdraw the money or pass it on to heirs. With traditional annuities, once investors start receiving payments, they can't get their initial investment back.
Too Much Risk?
In the eyes of some industry watchers, however, this is too generous a set of benefits. Critics wonder where the money to fund the payouts will come from if the underlying investments don't pan out.
Insurance traditionally works by gathering a large group together, so risk is spread around. Premiums from one customer can go toward the payout to another. But with the newer annuities, a falling market would presumably hurt all the customers at the same time, leaving the insurers' accounts short of funds to make payments.
This has already happened in one case, involving a British insurer that sharply reduced its payments to customers after the company's investing strategies failed.
Moshe Milevsky, a finance professor at York University in Toronto who has studied annuities for decades, says he likes the new products, but believes that even with their high fees, their prices don't cover the cost of protecting investors in a crash.
"These companies are going to have to think more carefully about risk," he says.
Credit-rating agencies are worried as well. Three years ago, credit analysts at Moody's raised red flags, writing in a report that "many companies have not done an effective job of quantifying risk" that the insurance companies were taking on in "plausible" worst-case scenarios.
Today, says Moody's analyst Scott Robinson, "we still have the same concerns."
Making Assumptions
Insurers point out that no U.S. company has ever defaulted on an annuity payment. They are aware, though, that they're in new territory.
Glenn Lammey, chief financial officer at Hartford Life, says that the new annuities simply don't have a long enough track record for companies to know what to expect.
"We make assumptions -- and that's the risk to us," Mr. Lammey says
