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Are you one of the millions of Americans that has a portion of their retirement assets in annuities? If so, you MUST read this.

Thanks to their hefty brokerage commissions, annuities have become one of the most widely sold and marketed financial products in the US today. Variable annuities have upfront sales costs which range from 4-9% of the total contract size.  That money goes directly into the pocket of the agent who sold it to you (ex: If you put $1 Million into a variable annuity, the broker would receive between $40,000 and $90,000). That’s why your money is often locked up for a certain number of years. The Insurance company needs to make sure they can collect their annual fees from you so they can recoup the upfront commissions they paid to the agent/broker. Should you decide to break your contract, and withdraw your money early, you’ll be hit with a hefty “Surrender Charge” that can be as high as 8-9% (Again, so they are assured of recouping the upfront commission).

Often times these products are sold to conservative investors (Especially Seniors) because of the so-called “Guarantees” they offer. Clients are told by their advisors, that the principle is protected, the income is guaranteed and the investment is risk-free. None of those statements are true. Don’t believe me? Dig up the old file and look for a copy of the prospectus. You can’t miss it. It’s a 300-500 page document. Why would such a simple product need a 500 page book to explain all of the features? Because there is nothing simple about it which becomes more evident when you actually try to read it. Somewhere buried in the prospectus is a section about “Risks.” It is in that section that you will find phrases such as “Investments have risks associated with them,”  “Not FDIC Insured,” “No protection against market loss,” and my favorite “NOT GUARANTEED.”

The fact of the matter is that any and all “Guarantees” made by the insurance company to you are backed by the insurance companies ability to pay you. If you bought a corporate bond issued by Metlife, AIG, or The Hartford would you think that these bonds were “Guaranteed”? Of course not. So why would an annuity contract, backed by the same companies be any safer?

Yes, there are pools of monies set aside by states and Insurance companies in the event that one should be unable to make good on it’s obligations. This backstop does offer the public some protection if one company were to fail. But what if they all fail? What if the problem is systemic, and not just company specific?

Insurance companies often stipulate that the investments within the variable annuity have a certain allocation to bonds. They do this to limit THEIR risk, not yours. A diversified portfolio consisting of stocks, bonds and cash over any 10 year period has rarely lost money. If they force you to stay invested for the long term, via the surrender charge penalties, and force you to be diversified, 9 times out of 10 the portfolio would be worth more than you started with 10 years earlier.  In such cases, the insurance company is happy. They collected fees from you for 10 years to insure against something that didn’t happen. The problem is that THIS TIME IS DIFFERENT.

We are in the midst of a great unwinding not scene since the great depression. The depression of 2008 will likely be worse than that of the 1930s. None of these companies in their risk analysis, had anticipated this. Portfolios of stocks and bonds have been devastated, home prices have crashed, and layoffs are exploding. People are going to be cashing in very soon.

Insurance companies will likely experience an end game scenario in which they are forced to make good on their guarantees and compensate the annuity owner for market losses. They don’t have the money. I expect to see the domino’s, which began with AIG, continue the fall.

The following charts suggest that I am not alone in my thinking. The dominant Insurance companies that sell annuities (AIG, Hartford, AXA, Prudential, ING) are in a free fall. AIG was the first casualty. Hartford may be next along with the rest.

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2. Forecast 2009: There Will Be Blood
3. Campbells Soup Safer Credit Risk Than US Government
4. AXA Warns as Cost of Annuity Hedging Skyrockets
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