The popular single-premium deferred annuity hits turbulence
It's nice when a product comes out that is loved by both the companies that sell it and the people who buy it. Until this year, that was the case with the single-premium deferred annuity. From 1980 to 1982, SPDAs were the hottest item on the shelves of an insurance industry beleaguered by inflation, policy loans that often weren't being repaid, and conversions of whole life to term. The billions of dollars pouring into SPDAs not only helped rebalance insurers' books, they also spawned several imitators, some of which were issued by firms that were not originally insurance companies.
For the people sinking money into them in $10,000 multiples, the SPDA seemed an excellent way to earn tax-sheltered interest at rates that seemed reserved for taxable investments. It has not been uncommon to hear quotes of 12, 13, or 14 percent - all building tax-free until retirement.
But this year, the bubble seems to have burst, leaving people to wonder if this investment alternative is safe and if it is, how to find one that won't turn up in a news story six months from now.
The biggest news story in this area this year was Baldwin-United, a financial conglomerate that sold some $3.7 billion in SPDAs before it declared bankruptcy, leaving policyholders at least temporarily unable to retrieve their money. At least some of the money may be permanently lost.
The other bit of news came in October, when Merrill Lynch & Co., announced it would stop selling annuities offered by the Charter Security Life Insurance Company and four other insurers. Merrill Lynch still hasn't explained its reasons for the announcement, although it did say it evaluates each insurer on the basis of the diversity of products offered, its ability to handle substantial new business, the competitiveness of its products, the public's perception of the company, and ratings by the A. M. Best Company, an independent firm that rates insurers much like Moody's or Standard & Poor's rates municipal and corporate bonds.
In addition to Charter, Merrill Lynch has stopped selling annuities issued by Capitol Life Insurance Company, Old Republic Life Insurance Company of New York, John Alden Life Insurance Company, and Executive Life Insurance Company. Merrill is continuing to sell annuities from other companies and is considering adding others.
Charter, for its part, insists its annuities are safe, and no other brokerages have suspended sales of these firms' products. Even Merrill Lynch somewhat mysteriously said it still considers the money in Charter's annuities is secure.
Another brokerage, the Dean Witter Reynolds unit of Sears, Roebuck & Co., also took a more conservative posture regarding Charter annuities, announcing it was changing its method of handling the Charter product so as to make them less attractive to sell.
In general, though, most financial planners consider the SPDA a safe investment, if the company is selected properly and if the individual follows one basic investment rule: diversify.
A person buying an SPDA pays a single large premium in one year. One problem has been that people would put all their money - perhaps $50,000 - with one company. Others divided between only two firms. Although a slightly lower yield might result from putting the money in five annuities with five companies, the risk of losing more than 20 percent of the investment is considered very low.
Selecting five relatively safe companies will take some work. ''Until Baldwin hit, one would have said any insurance company was safe,'' said Bruce M. Dayton, chairman of Multi-Financial Services, a financial planning firm in Weston, Mass. ''That's not the case now. But if you buy an annuity from an insurance company that's just in the insurance business, you'll probably be better off.'' Neither Baldwin-United nor Charter started in the insurance business.
Most planners prefer insurance companies where SPDAs are just a small portion of the business, so that if the company should get into financial trouble, they can at least protect their customers' principal, if not all the interest.
This may be one place where a consensus is valuable. Get the opinions of several brokers and insurance experts on which are the most stable, financially sound companies, with the best record of meeting their insurance obligations. The rating by A. M. Best can serve as an additional guide.
Once you have selected an insurance company or group of them for your annuity , there are some other things you can find out to give yourself the best return at retirement. When a person retires, says Richard McDonald, a financial planner in Salem, Mass., the insurance company will look at how old that person is, figure his life expectancy from that date, and make payments from the annuity based on that estimate and the interest rate paid throughout the pre-retirement period.
Although it is not possible to know what an annuity might pay you 10 or 20 years from now, Mr. McDonald says, you can ask the insurance company what an annuity purchased 10 or 20 years ago would pay today, assuming past rates of interest and current estimates of life expectancy. The agent or broker might not have this information immediately at hand, but he should be able to get it from the company.
By asking what interest rate is used to ''impute the payout,'' McDondald notes, you may find that while the annuity advertises something like a 12 percent interest rate, the rate used to figure the payout may just be about 9 percent. The difference, depending on how much time you have between the time you buy the annuity and your retirement, may be a few hundred dollars every month in payments during retirement.