DennisBeaverMay 24, 2008 (Original publish date) • By Dennis Beaver

“My parents are both over 60 and close to retirement. Before the real estate bubble burst, they sold farmland — which had been in the family over 50 years — for more than two million dollars. It was purchased by a real estate developer, but within months of the deal going through, he filed for bankruptcy. Today those 160 acres are owned by a bank.”

“Mom and Dad were incredibly lucky at that time, going from a couple who wondered if they could retire to tremendous financial security. However, now I am worried they are at risk of making a completely wrong investment with a great deal of that money,” Daniel wrote.

“They have always been conservative, keeping what little money they could save at a large investment company, in CD’s and other very safe investments. With the addition of money from the sale of that farmland, their stockbroker has been drooling over how to start earning commissions. Now, he wants them to buy a One Million Dollar Annuity! He tells them it is great for their retirement and claims it is safer than any other place they could park those funds themselves.”

“I have read about annuity scams and frankly believe that people at their age should steer clear of annuities. We all read your column, respect your advice and would appreciate discussing this with you.”

I phoned my readers and discovered their son was absolutely justified in being concerned. As our nation’s financial health is very much unsettled, insurance salespeople and stockbrokers are now capitalizing on fear, selling “safety” in the form of annuities from the nations “strongest” insurance companies.

But there is no insurance company too big to fail. Over the years some have indeed failed, costing annuity owners millions of dollars.

Annuities 101

Here is how an annuity works:

You pay an insurance company a lump sum of money — or make yearly contributions — it is invested, grows and is paid back to you at an agreed upon date, far into the future. The big selling point is that annuities generally pay for your lifetime, so it is a source of money you can’t outlive. They are often described as your own private pension plan. But they are generally not a good idea for anyone over 55 and here’s why:

“It takes 20 to 30 years to realize tax and investment benefits, and the yearly fees charged by the insurance company can easily amount to 4 percent yearly taken away. This eats up tax benefits, and then there is the risk of inflation, as well as the risk of a bankruptcy of the annuity company.”

“If you need to access your money earlier — a medical emergency, for example — the surrender charges could be up to 10 percent,” Melissa Gannon, told me when we discussed these issues. She is Vice-President of Insurance and Bank Ratings for Ratings, Inc.

“An annuity is an expensive insurance product and must be suitable to the person buying it. For example, a variable annuity could be the worst thing for someone over 55, as you are really just telling the insurance company to take your money and invest in the stock market. If we hit several years of a down market, and you retire, you could wind up losing thousands of dollars with that annuity at the time you need the money the most,” she points out.

“You Are Paying for Safety”

Melissa knows all too well what can happen to the policyholders when a huge company fails.

“In 1990 the largest insurance failure in history was Executive Life Insurance, based in California. More than “hundreds of millions” were lost by policyholders, many of them older Americans. When an insurance salesperson or stockbroker tells you his insurance company is stronger than anything you could put your money into, this is not true,” she points out.

“It isn’t true for the simple reason that an insurance company invests in the things all investors put their money into: the stock market, real estate, government bonds, corporate bonds, and in some cases, bonds based on sub-prime mortgages which have fallen in value enormously.”

If An Insurance Company Fails?

“Every state has an Insurance Guarantee Association which steps in should an insurance company fail. Depending upon the state you are in and the type of annuity purchased, you might only get a maximum of $100,000 from the Guarantee Association. So, if your readers bought a one million dollar, fixed annuity from their stockbroker, and the insurance company failed, they could lose $900,000! Again, life insurance companies are subject to the same realities of survival in business as any company. There is always some risk, and before investing, you must do your homework,” she stressed.

Homework 101 allows anyone to download a free financial report-card on banks and insurance companies. For an annuity purchaser, you need to know its financial strength and claims-paying ability.

What is different about is that they are NOT paid by the companies who they rate. Unlike AM Best, Moody’s, Standard and Poor’s and Fitch, is not in a potential conflict of interest situation. In fact, their predecessor company, Weiss Ratings, was one of the first to alert the nation to the dangerous position Executive Life Insurance was in prior to its failure. I interviewed Martin Weiss in the months leading up to that monumental event. He was so right it was scary.

Finally, Melissa had this advice when an insurance agent or stockbroker is in your home. “Be nice, feed them cookies, take all of their advertising materials and politely walk them out the door. Review their proposal with a fee only financial planner with no interest in what you buy. In general, and this is my opinion, annuities are not a good investment. Period.”

Dennis Beaver practices law in Bakersfield and enjoys hearing from his readers. Contact Dennis Beaver.