Here We Go Again: Misdirection For Retirement

On today, Sunday 5/13, I prayPlease God, make the stupid stop!

With traditional safety nets such as company pensions and Social Security dwindling, many of the 78 million baby boomers are left trying to answer one question: “Who’s going to pay my retirement paycheck?”

Annuities are one investment that more and more prospective retirees are considering. These financial products are created by the insurance industry, and offer a lot more flexibility and advantages than other investments. Here are a few reasons why you should think about adding them to your retirement plan…..

And the article continues…..

There’s a very serious missing element however: There is no discussion of the risk of business failure and the losses you may suffer if it happens.

Annuities are insurance products.  You need to put very large amounts of money into them in order to obtain reasonable monthly payouts.  That would be ok if you knew the money was safe.

The problem is that you don’t.

There is no national program to guarantee annuities.  There are, however, state-by-state “guarantee” funds of various sorts, most of which have similar limits and provisions.

Let’s take Florida.  Florida has the FLHIGA, created by Statute.  It says about annuities and limits of coverage:

Annuity Cash Surrender: $250,000 for deferred annuity contracts per contract owner
Annuity in Benefit: $300,000 per contract owner

Incidentally, Florida recently increased the limit through House Bill 159 in 2010 — it was formerly $100,000 (as was FDIC insurance.)

That sounds like a lot, especially with the increase.  It isn’t.  To receive $2,000 a month, for example, the typical fixed annuity will require $500,000 of contribution.

You’re only covered for half on cash value and if your expected payout period is 20 years (65-85) you’re only covered for about 60% of the benefit payout amount as well!

But it gets better.

Are you a State agency?
No. The guaranty association is a private entity, with its membership made up of all the life and health insurers licensed in the state (in fact, under state law an insurer must be a member of the association to be licensed to do business). The association was created by the legislature to serve as a safety net (subject to statutory limits) for residents should their life or health insurer fail. By creating the association, the legislature was able to ensure continued coverage to residents affected by their insurer’s failure. The association does work in cooperation with the Insurance Department in fulfilling its role of protecting residents whose insurance company is being liquidated.

So what happens if there’s no money in the guarantee association?  For example, let’s assume for the sake of argument that a whole bunch of insurance companies go under, and the reserves available to pay the claims are insufficient.

Now what?

Well, it’s a state-created agency, so you’d assume they’d have taxing power (although they call them “assessments”) and they more or less do.  However, there are limits on the assessment power in the statute, which means that it’s entirely possible for enough insurance companies to be able to fail and the fund to not only be unable to pay but also unable to assess in sufficient amount to cover the deficiency.

And if this happens because reserves are inadequate, even if the fund knew it and under-reserved with knowledge of the deficiencythey’re immune:

631.727 Immunity.—There shall be no liability on the part of, and no cause of action of any nature shall arise against, any member insurer or its agents or employees, the association or its agents or employees, members of the board of directors, the Chief Financial Officer, or the department or office or their representatives for any action taken by them in the performance of their powers and duties under this part. Such immunity shall extend to the participation in any organization of one or more other state associations of similar purposes and to any such organization and its agents or employees.

Isn’t that special?

This is contrast to the FDIC which, at least in theory, has the backing of the Treasury on a “full faith and credit” basis, and in addition has the Prompt Correction Action Law which (again, in theory) should prevent the insolvency of the FDIC.

Oh, and as for the powers on prevention, the Florida agency’s enabling statute doesn’t use the word “shall” when it comes to examinations — they instead use the word “may” — so they’re off the hook for any potential malfeasance (despite their statutory immunity) anyway before it occurs.

Be careful folks.  Annuities have their place in a retirement planning scenario but remember that you are in effect betting on the continued solvency of a private company to make the payments, and that any “government backstop” is both state (rather than federally) operated and has no resort, generally, to the treasury of the state itself.

These products are frequently touted as having more return than a long-term CD or similar, and in today’s ZIRP market that’s true.

But there is no such thing as a free lunch, and these products are not an exception.  There are risks, they tend to be under-discussed and not well-disclosed, and diving into such a product without carefully considering what happens if the firm fails and the guarantee fund is insufficient, either because you have purchased more than limit of coverage or the fund is short and cannot pay, could result in an ugly surprise when you are least able to afford it.

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