Annuities Gain in Popularity But Questions Remain For Many Who Have Bought Them

By Jon Rose


After two years of turmoil in stock markets many savers and retirees have lost their nerve and turned to life insurance firms to help reduce the risk of investing. Among the top products that they have bought in recent years are annuities. These come in various forms yet all are based on a similar idea, that for a premium (either one lump sum or investments over many years) a life insurance company promises to make payments to the client for a set period of time or for the rest of their lives. The most basic of these is what is known as an immediate annuity, in which a client pays a sum and buys a lifetime worth of payments. In recent years annuities have become ever more sophisticated and clients are now offered other varieties such as variable annuities. These make payments depending on the performance of underlying stock markets. They also generally have an element of insurance that protects against huge falls in stock prices and promise minimum payments for life to help reduce the risk of being invested in markets.
Yet annuities have been criticized for some time now for being products that pay large commissions to financial advisers, lock clients in for long periods and limit the potential gains that clients may make if stock markets do well. Commissions are often set at about 7% of the value of the sum invested, which creates a huge incentive for financial advisers to sell these investments even when they are not the best fit for their customers. In some cases elderly retirees have been locked into investments that can not be cashed in without penalties for 20 years or more. The high commission also creates a huge hurdle that needs to be overcome in terms of returns as clients are effectively giving away almost a year's growth before they have even started.
The commission structure also leads to high surrender charges since insurers wish to recover the sums they have paid to sales agents if policies are cashed in. Surrender charges may often be more than 10% of the value of the policy in early years, and although they diminish over time, they may still persist for many years. And although variable annuities offer some potential for investment gains, these are usually capped in exchange for the security of having a minimum payment guaranteed. Annual fees on these products are, unfortunately, also high at about 3.5% to 4% a year, which further reduce the investment return.
Among organisations that have highlighted some of the dangers is the consumer panel of Britain's Financial Services Authority, a financial regulator, which warned in 2009 that many consumers were not aware of the costs or risks or annuities linked to stock market indexes. In 2007 too several insurance regulators in the United States spoke out against some insurance firms which had been selling variable annuities to elderly clients who did not realize they were buying long-term investments.
Clients already holding annuities that are not suited to their circumstances face a dilemma. If they surrender them they may face steep surrender charges but holding them may also not be an appealing prospect. In recent years a nascent market in annuity securitization has begun to emerge. Companies buy annuities from their owners at a discount (though often for more than the insurance firm that sold it would be prepared to return) and then bundle them into packages. These are then turned into securities that can be sold on capital markets. This offers the potential for relief to some holders of annuities, although sound advice from a skilled adviser and quotes from several buyers should be sought before the decision is made to sell.
Jon Rose is the pen name of a financial journalist who has covered business and financial markets for 15 years and has an interest in personal finance. You can read other articles he has written about annuity selling and investing sensibly.

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