If you're thinking about an annuity purchase, keep these 9 things in mind when evaluating the financial strength of the annuity issuer.
This article was originally posted on Forbes.com and can be viewed here.
If you’re thinking about the purchase of an annuity, it’s always important to understand the implications of the insurer’s financial strength rating. And, it’s particularly important in volatile times and when we are in the midst of a recession, like we are now.
Annuities should be bought for their guarantee. And that guarantee is only as good as the claims-paying ability of the insurer (i.e. their financial strength). In this article, I’ll discuss the most important things you need to know about annuities’ financial strength ratings.
1 – There are 4 Major Rating Agencies And They Look At Mostly The Same Factors To Determine Ratings
There are three big rating agencies — Fitch, Moody’s and S&P. There is a fourth rating agency that focuses specifically on the insurance industry, A.M. Best. A.M. Best is important because there are many insurers that are not rated by one of the big three agencies but are rated by A.M. Best. Each rating agency uses a slightly different lettering system and has a different number of tiers. You can see a side-by-side comparison here.
2 – Higher Ratings Often Mean Lower Rates
There’s no such thing as a free lunch. All else equal, insurers rated A++ by A.M. Best, for example, will need to hold more capital to earn a higher rating, which reduces their ability to offer you a high payout. Sometimes you’ll find the highest payout annuity to also be the highest rated, but it’s rare. Make sure to weigh the additional pickup in rate with lower rating. There’s no right answer about which choice to make, and often it comes down to the magnitude of the difference and how tolerant of risk you are.
3 – Annuities Are Not FDIC Insured
Bank deposits are insured for an individual up to $250,000 per accredited financial institution at the federal level through the Federal Deposit Insurance Corporation (FDIC). Annuities are not insured by any federal entity. If you’re going to buy an annuity, it’s worth understanding the protection offered by your state: both the coverage limits and how the guaranty fund works. It will vary state to state. You can start by looking up your state here.
4 – Don’t Buy An Annuity Without A Financial Strength Rating Or One That Isn’t Covered By The State Guaranty Fund
The vast majority of annuity issuers have a financial strength rating and are covered by the state guaranty fund. But not all, so it’s worth always making sure.
5 – The System That Dolls Out Financial Strength Ratings Is Conflicted
Financial strength ratings are paid for by the companies receiving the ratings. This “Issuer Pay” model represents an inherent conflict of interest, one that was widely criticized in the aftermath of the financial crisis. Despite some attempts to create a better system, specifically one where the rating agencies were something more akin to public utilities or one where investors themselves paid for the ratings, nothing has materialized to improve the system. So, in short, it’s the best we’ve got. You can read more about the controversy here.
6 – It’s Hard To Avoid The Conflict Of Interest
Given the inherent conflict of interest in the Issuer Pay model, there have been attempts to build a viable “Subscriber Pay” rating agency. One attempt is Weiss Ratings. The downside is organizations like Weiss don’t have access to non-public information, and their level of sophistication to understand what are often very complex balance sheets is limited. The traditional “Issuer Pay” rating agencies benefit from access to the management team and are often privy to financial projections and the insurer’s product roadmap.
7 – It’s Best To Place Longer Term Annuity Contracts With Highly Rated Insurers
On the Blueprint Income platform, we have no income annuities with ratings below A. For fixed annuities, we have no insurers with a rating below B+. The reason for the difference is that fixed annuities are shorter-term investments (a maximum of 10 years for products on our platform) and have more liquidity than income annuities. An immediate annuity, longevity annuity or Personal Pension (all types of income annuities) investment can be a many-decades-long promise, and a longer time horizon introduces more risk of insurer insolvency, all else equal.
8 – Insurers Publish Their Financial Strength Ratings On Their Websites
If you want to see all major annuity issuers’ financial strength ratings in one place, you can visit this page on Blueprint Income. This page shows each insurer’s A.M. Best ratings, but the details page for each insurer has the ratings from all 4 agencies. Here are some examples of financial strength ratings summaries from across the industry: Fidelity & Guaranty, Guardian, MassMutal, New York Life, Pacific Life, Principal, Securian, and Western & Southern.
9 – COMDEX Is Not A Rating Agency
A Comdex ranking is a composite score that takes into account the ratings of the four major rating organizations for insurers — A.M. Best, Fitch, Moody’s and S&P. Think of it like an aggregated score on a 100 scale that you can use as a short-hand for how the insurer’s financial strength is perceived across the industry. Note that insurers with ratings from only one agency (typically AM Best) will not have a Comdex ranking.