Is your annuity safe?
Despite the financial crisis, insurers are meeting their obligations.
(Fortune Magazine) -- With their guaranteed payouts and protection against market downturns, annuities have long enjoyed a reputation as a refuge in times of turmoil. But after AIG (AIG, Fortune 500) required government assistance (three times so far this year) to stay afloat and several life insurers saw their stock prices sink 70% or more over the course of two months, annuity owners might understandably be nervous.
After all, you invest in an annuity because you want your money to be absolutely, positively safe. So how secure is it?
As anyone who's ever dealt with these complex insurance products knows, questions about annuities defy simple answers. But let's start with at least a bit of reassurance. Although life insurers are certainly struggling, to date not one major company has bitten the dust as a result of this crisis, which is more than you can say about banks and investment firms.
In fact, even AIG's highly publicized woes stemmed from problems with its parent holding company, not its insurance subsidiaries, which remain solvent. And even if an insurer were to implode, state regulators have a decent record for arranging takeovers of troubled insurers or transferring annuities and other policies to healthy companies.
In a worst-case scenario, a state insurance department could be forced to liquidate an ailing insurer. If that happens, the level of protection you receive depends on how much you've invested and the type of annuity you own.
When you buy a fixed annuity, you're turning over your money in return for interest payments much as with a CD or, if you "annuitize," for the promise of lifetime payments. Either way, your cash becomes part of the insurer's assets.
If an insurer is shuttered and those assets aren't sufficient to meet obligations to annuity and other policyholders, a network of state guaranty associations kicks in. That protection varies by state, but the associations typically cover at least $100,000 in cash and withdrawal values for annuities. You can check your state's coverage limits at nolhga.com.
With a variable annuity, you've most likely invested your money in one or more "subaccounts," which resemble stock or bond mutual funds. These subaccounts are segregated from the insurer's assets and cannot be tapped by the insurance company or its creditors. That money is therefore insulated from the insurer's financial problems.
Depending on which subaccounts you've invested in, of course, the market value of your variable annuity could very well have taken a sizable hit this year. But that's your responsibility; guaranty associations don't reimburse investment losses.
These days, however, many variable annuities also come with a variety of optional guarantees, including promises to pay a certain amount of income regardless of how the markets perform. Since these riders are obligations of the insurer, they are covered by the state guaranty associations.
Speaking of guarantees, not surprisingly insurers have recently found that the hedging costs of providing them has spiked now that the financial markets have gotten so volatile. As a result, some insurers are scaling back guarantees or raising the price they charge for them. If you've already signed up for a guaranteed benefit, the insurer can't take it away.
Variable-annuity contracts typically do give insurers some leeway to raise fees on various guarantees, even for current annuity owners, although doing so would be highly unusual. To see what wiggle room, if any, your insurer has, check your variable annuity's prospectus.
It's understandable, of course, if the mere thought of having to deal with state guaranty associations and such makes you want to just bail out of your annuity. But be careful. If you cash out soon after buying, you could pay an early surrender charge of 7% or more.
And if you sell an annuity held in a taxable account, you'll also pay ordinary income taxes on any gains, plus a 10% penalty if you're under 59 1/2. So before you exit, see what penalties and taxes may apply. And then weigh the cost of getting out vs. the risk of staying in. 
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