What If My Annuity Company Can't Pay My Lifetime Income? by Scott Stolz, CFP, RICP (week 33)

 

Last week I shared my theory as to why it’s possible to get for guaranteed lifetime income from a fixed indexed annuity (FIA) versus either a single premium immediate annuity (SPIA) despite that fact that the FIA can be cashed it at anytime and a SPIA cannot (Understand Your Options Before Committing a Large Sum to Providing Guaranteed Income For Life by Scott Stolz, CFP, RICP (week 32).  I explained that some insurance companies are counting on a significant percentage of the policyholders to use these policies inefficiently by either waiting until an advanced age to begin taking the income or cashing the policy in.  Either of these choices would mean the insurance company would never have to pay the guaranteed income amount out of its own pocket.  The company would essentially only distribute the policyholder’s own money back to him or her.

But what if this assumption turns out to be wrong?  What if everyone actually starts taking the income in their 60’s?  Or for that matter, what if medical advances allow a significant number of people to start living beyond the age of 100, thereby putting the insurance company on the hook for income payments for much longer than they originally assumed?  When you buy an annuity for lifetime income, you are counting on that income for your lifetime – no matter how long that is.  What happens if the insurance company blows it and they can no longer pay you?  That could be a real problem for your retirement income plan.

The good news is that each state has a state guarantee association that is set up to reimburse annuity policyholders for any money they are due, but the insurance company can’t pay.  The amount of this insurance varies from state to state, but it’s typically $250,000.  But what does that really mean?  After all, the insurance company is not going to all of a sudden have no money to pay claims.  They and the insurance regulators will know there is a potential shortfall well before the company can no longer meet its obligations. 

The other good news is that the failure of annuity companies is rare.  In fact, the last major annuity company to be taken over by regulators (put into rehabilitation) was Executive Life Insurance Company thirty-five years ago. 

Based on previous actions by state insurance regulators, here are the most likely steps regulators would take:

1.      The state insurance regulators will take over the insurance company and immediately freeze policy withdrawals in order to avoid a run on the company by existing policyholders.  Exceptions will be made for payments due to death, disability, and income requirements.  In other words, if a policyholder can demonstrate that the payment they are already receiving is a necessity, they will likely continue to get it.

2.      The state insurance regulators will begin to assess other annuity companies in order to provide funds to fill any shortfall in the troubled insurance company’s balance sheet.  All annuity companies agree to be part of the state guarantee association in order to help bailout any companies that have financial difficulties.  They do this because it’s in the best interest of every company to have a financially stable industry. 

3.      Once any bleeding is stopped, the state insurance regulators will start to look for another insurance company to take over the company and assume all of the existing liabilities.

In short, I personally have few concerns that one way or another the income guaranteed by my annuities will be paid.  However, there is one thing I’m not so sure about.  I don’t plan to start taking the income from my annuities for another 2 years.  Therefore, if one of my carriers were to go into rehabilitation tomorrow, it would be difficult for me to make the case that I need the income.  In addition, remember that income from lifetime income benefits on an annuity are really guaranteed systematic “withdrawal” payments.  If the state regulators froze all withdrawals, would I be able to start taking these lifetime income payments? 

There were no lifetime income benefits back in 1991, so the Executive Life example can’t guide us on this issue.  However, I think the answer is “yes.”  I believe the regulators will make a distinction between those that are asking for regular income versus those that simply want to get some money.  The best glimpse we have into this is the 2024 rehabilitation of PHL Variable Insurance Company.  PHL was mostly a life insurance company, but they did write some variable annuities with lifetime income benefits.  In that case the regulators did indeed allow those that were receiving “recurring payments” to continue to receive them.  Policyholders that wanted to start “recurring payments” did experience some delays and limitations.  I don’t doubt that these policyholders will eventually get what they were promised.  They just might have to wait a little longer and/or get less income than expected until a new insurance company assumes the liabilities.

Summary

Bank deposits are insured by the Federal Government through the FDIC.  Banks proudly tout this FDIC insurance to give their depositors peace of mind.  While annuities are backed by the State Guarantee Association, this is much different than a Federal Government guarantee.  But the reason there is no federal guarantee for insurance companies is that it has never been necessary.  Even during the great depression only 60-70 insurance companies failed compared to over 9,000 banks.  Why?  Because insurance companies have the advantage of having very long-term obligations.  A life insurance policy is a promise to pay years down the road.  An annuity pays income over decades.  In contrast, bank deposits are much more short-term and are therefore less predictable.  That makes banks inherently more unstable than insurance companies. 

Anything can happen. It’s not about eliminating risk, it’s about managing risk.  Personally, I’m much more concerned about the risk of managing a retirement portfolio to pay me an income for life than I am about the risk that the insurance company can’t make payments thirty years down the road.  Therefore, I’ve chosen to outsource my longevity risk to them.