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Did You Know That Annuities Have State Guarantees?

One of the open secrets of the annuity world is that there are state guaranty associations that will replace at least part of your guaranteed annuity income if your insurance company goes belly up and can’t make the lifetime payments it promised you.

If you don’t believe me, just go to www.nolhga.com, the website of the National Organization of Life and Health Insurance Guaranty Associations. All of the states, plus Puerto Rico and the District of Columbia, have insurance guaranty programs that belong to this group. Every state program offers at least $100,000 in coverage; many states cover up to $250,000 and a few provide up to $300,000. New York State offers $500,000. Click here to find out how much your state covers.

In most life insurance company failures—and they aren’t common–the state guaranty association oversees the transfer of the assets and obligations of the failed insurer to a financially healthy insurer, and covers the policyholders during the transfer period. Transfers used to take years; now they take months, according to NOLHGA.

The guaranty associations only cover “general account” guarantees, and only up to the “withdrawal or cash value” of the annuity. If you bought a single-premium immediate income annuity in a state that covers $100,000, you would be entitled to any difference between what was already paid and $100,000.

Are variable annuities covered? That depends. The money in a variable annuity usually sits in “separate accounts,” and resides in tax-deferred mutual funds. That money isn’t part of the general fund of the insurer, and therefore can’t be claimed by the insurer’s creditors. In other words, the shareholder’s ownership is undisputed and the money requires no guarantee.

But what about variable annuities with lifetime income guarantee riders? These contracts generally promise policyholders that if their own money (in the separate accounts) runs out before they die, the insurer will pay them their accustomed payment from its general account until they die. The state guaranty associations, I have been told, will make good on that obligation if necessary.

As I mentioned above, state guaranty associations are an open secret. There are two reasons for that. First, very few big insurers fail. And before they do, they are usually sold to other insurers. So guaranty associations don’t need to swing into action very often. Second, annuity salesmen aren’t allowed to tell you about the state guaranty associations.

I’m not sure who enforces the “don’t ask, don’t tell” rule—probably each state’s insurance department—but it has an important purpose. If consumers knew about the guarantees, they might buy policies from financially weak insurers, which often offer better prices than financially strong insurers (whose costs may be higher because they hold more reserves). The presence of the guarantee could encourage all insurers to hold relatively fewer reserves, letting the state guaranty system, in effect, hold it for them.  That’s called “moral hazard,” and it’s the bane of the insurance world.

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