Annuity Fine Print: Guarantees Aren t Always Guaranteed

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1 Page 1 of 5 Dow Jones Reprints: This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit See a sample reprint in PDF format. Order a reprint of this article now JULY 8, 2009, 11:31 A.M. ET Annuity Fine Print: Guarantees Aren t Always Guaranteed By LESLIE SCISM For many years, variable annuities with guaranteed minimum returns had a bad reputation for being loaded with fees and traps. And besides, why pay anything for a guarantee against investment losses when stocks inevitably marched upward? Those guarantees looked a lot better after last year s market slide. Then investors started checking the fine print and learned their guarantees might not be as secure as they thought. Under some provisions, the insurance company that issued the guarantee can cancel it, or sharply reduce its annual payout. Now some consumers are starting to complain, and at least one big brokerage firm is working out procedures with insurers to try to protect its clients from inadvertently undermining their own guarantees. Higher Stakes The same kinds of criticisms came up during the last market downdraft in 2000 to 2002, when these guarantees were still fairly new. But the stakes are higher now. Tens of billions of dollars of contracts with these provisions are in the hands of consumers, according to industry analysts and financial advisers. And the market s nose dive makes those guarantees much more important to investors. Why? Because of the way these products are structured. On the surface, these guaranteed products look a lot like regular variable annuities, where you invest in a range of stock and bond funds. But unlike regular variable annuities where you can take your money out either as a lump sum or an annual payment, based on the performance of the funds these products guarantee you a check of a minimum size every year for the rest of your life. If your investments do well and return more than the guaranteed minimum amount your checks are pegged to the annuity s actual account balance. But if the investments return less than that, as many did last year, the guarantee kicks in, providing checks at the guaranteed level. So, as things stand now, many investors are counting on their guarantees to make up for the losses in their underlying mutual funds. There are two big types of dangers that could leave you without a guarantee. One affects certain contracts sold from the late 1990s until as late as about Newer contracts often contain safeguards to protect investors from inadvertently losing their protection under that provision. But the new contracts contain a different provision that could lead to problems.

2 Page 2 of 5 Let s look at the older provision first. This affects contracts that require a waiting period often about 10 years after the account is opened before the owner can start collecting annual income checks. In these contracts, insurers say they have the right to terminate the guarantee if the underlying investment accounts don t contain enough money at any point during the waiting period to cover the annuity s yearly fees. These often run more than 2.5% of the account balance, according to financial advisers. Investment losses alone wouldn t likely cause an account balance to go to zero, because many of the fees are based on the fund balances; as the balances shrink, so do the fees. The problem generally would arise if owners are exercising their right to make certain cash withdrawals during the waiting period something that lots of people may need to do as the economy staggers along. If investors don t leave enough in their alreadyshrunken accounts to pay the annual fees, the guarantee unwittingly could be lost. The market s recent rally has taken off some of the pressure but if stocks plunge again, the troubles will come back. Let s say you put $100,000 into one of these older contracts, and within a year or so that shrinks to $42,000. If you withdraw $6,000 a year 6% of the guaranteed amount of $100,000, a percentage many existing contracts permit then the account could go to zero within seven years, before taking into account the fact that annual fees also are being subtracted. A market rebound would make things better by boosting your balance; another slide would make things worse by eating into the balance. HERBERT WRESCHNER A New Take Insurers began to redesign these initial offerings as the bear market of ground on. By about 2003, they were starting to add what is commonly called a no-lapse-guarantee feature: Customers whose fund balances go to zero during the waiting period are allowed to immediately start their lifetime stream of guaranteed-minimum income payments, albeit at a potentially lower annual amount than if they had waited. But even if you have a no-lapse-guarantee provision, you can unwittingly take steps that terminate this feature, says Vanessa Marcos, variable-annuity product manager for Raymond James Financial Inc. In some contracts, this no-lapse guarantee is terminated if the customer makes an excess withdrawal, she says. All it takes is one excess withdrawal for that [feature] to go away, leaving the client no better off than those holding older contracts lacking such a safeguard. What is an excess withdrawal? In many contracts allowing 6%-a-year withdrawals, or $6,000 if the benefit base is $100,000, taking out $6,001 in any single year would be an excess withdrawal. Excess withdrawals also can badly damage another type of older guarantee, one that doesn t require a waiting period. Scott Stolz, president of Planning Corp. of America, the insurance general agency of Raymond James, gives this hypothetical: A customer s benefit base stands at $1 million, while market losses have shrunk his fund balance to $600,000. Rather than the $50,000 annual withdrawal permitted by the contract, the customer, feeling cash-strapped, pulls out $55,000. As a result, the benefit base drops from $1 million to $545,000 the account value less the withdrawal all

3 Page 3 of 5 because the customer took out $5,000 too much. He notes that while newer contracts generally have lesspunitive terms, excess withdrawals in these can still carry a punch. Warning Customers Mr. Stolz says Raymond James has been working with about a dozen big insurers on procedures that would require them to notify us if the client requests an excess withdrawal. The insurance company would still process the request, since they have to do what the client wants, but they would give us a window during which we could talk to the client and then have the withdrawal reversed if we can get the client to change his or her mind. Thus far, all but one insurer has indicated it expects to be able to accommodate Raymond James, he says. Mr. Stolz believes the insurance industry could have done a better job disclosing to financial advisers and consumers the harm that excess withdrawals can cause. The brochures typically say something like, If you make an excess withdrawal, you could reduce the amount of future withdrawals see the prospectus for details, he says. Some insurers have scripts for service-center staff to use to warn policyholders or agents when they call about such withdrawals, he adds. But some insurers computer systems can t even recognize that it is an excess withdrawal when they process it. Catherine Weatherford, chief executive of NAVA Inc., an association of companies involved in the annuity industry, says insurers have done a good job providing information, customer service and transparency. But the recession has shown things we can do better, and toward that end her group is posting consumer tips at navanet.org. She recommends that advisers reach out to clients to review contract terms and to caution against withdrawals that may alleviate short-term money problems but might harm a guarantee s long-term value. Ohio National Financial Services Inc. s Ohio National Insurance Co., a big player in variable annuities that in 2006 added a no-lapse feature to its waiting-period contract, says it tries to keep consumers in the loop. It says its policy is to make every effort to notify owners and their registered representatives if a requested withdrawal would result in the loss of benefits. Elizabeth Forget, an executive at MetLife Inc., a top annuities issuer, says that MetLife service-center workers strive to alert customers if they re going to make a withdrawal that may jeopardize the guarantee. She adds, though, that some customers do make withdrawals by mail without such conversations taking place. A single excess withdrawal doesn t automatically void the no-lapse feature, available since 2003, but would reduce the benefit base, she says. An Alarming Discovery Some investors are beginning to complain about provisions that could lead to canceled guarantees. Herbert Wreschner, 60 years old, a retired lawyer and investment banker in Montville, N.J., recently discovered that the guarantee on one of his two guaranteed-minimum income-benefit contracts could be canceled if there isn t enough in his account to cover fees. I didn t buy a guaranteed contract to ever have to approach the possibility that in the future I d have to make [additional] contributions to cover fees, he says.

4 Page 4 of 5 Mr. Wreschner s contracts were issued by AXA SA s AXA Equitable Life Insurance Co., another top seller of variable annuities in the U.S. He hasn t gotten any indication that his guarantee might be canceled, but he still worries about the possibility. It defeats the purpose of a guarantee if there are circumstances under which the consumer could potentially send this thing into termination, he says. Mr. Wreschner bought his annuities in 2002 and 2006 but says he learned of the termination possibility only about six months ago in a conversation with a sales representative at a rival firm offering a different retirement-income product. Mr. Wreschner says he immediately called the adviser at AXA who sold him the contracts to clarify the situation, and the adviser confirmed the termination possibility. Back at his home, Mr. Wreschner pulled out his annuity documents. He scrutinized the materials, he says, concluding that the risk doesn t appear to be spelled out in the materials he received at the time he bought the 2002 contract, though supplemental materials sent to him in 2003 and the separate 2006 contract do caution about the need to avoid a zero fund-account balance during the waiting period. (The 2006 product includes a no-lapse-guarantee provision, which AXA Equitable says it has provided to buyers since January 2005.) Mr. Wreschner has talked and corresponded with representatives of AXA Equitable. In an April 8 letter, he termed the contract, prospectus and summary materials he received in 2002 at best misleading and more probably far worse because they didn t mention the termination possibility. In an April 17 letter, AXA Equitable Associate General Counsel Gerald Carroll Jr. wrote that the insurer firmly disagreed with his assertion that the contracts are in any way misleading. In another letter, he said the possibility of a contract termination is inherent and does not need to be expressly stated. When the charge for insurance coverage is unpaid the insurance terminates. Also, Mr. Carroll wrote that Mr. Wreschner s question is quite academic, because the investment in his 2002 contract stood at hundreds of thousands of dollars. While we cannot predict market performance, we would suggest that it might be some time, if ever, before the issue of zero account value arises from the annual deduction of benefit charges. He added that not taking withdrawals will help preserve account value. These responses don t satisfy Mr. Wreschner. For one thing, he says he was intending at some point to begin withdrawing money from his funds, as per contract terms. I pray to God there isn t another leg downward in the stock market, he says. But you know what? I wouldn t bet the ranch on it. An AXA Equitable spokesman declined to comment on Mr. Wreschner s experience beyond the letters, saying that the insurer s products provide excellent benefits that are explained in detail to our clients, yet we are always looking for ways to improve our products and services, and customer feedback is a valuable part of that process. Mr. Wreschner thinks AXA Equitable should send letters to customers spelling out the potential dangers. In his correspondence with the insurer, he said such notification was needed because people may unknowingly be putting excess pressure on their contracts by withdrawing needed funds to live on, or investing in overly

5 Page 5 of 5 aggressive equity choices that are most vulnerable to declines. --Ms. Scism, a news editor for The Wall Street Journal, can be reached at leslie.scism@wsj.com. Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit