Maybe your retirement investment options include deferred annuities for use in the latter years of retirement life, something to provide a cushion if you live longer than you think. Before you make a selection among annuity companies, you need to check out the renewal rate track record of each company. Two deferred annuities, identical in all aspects, that offer the same contract terms, can diverge as time passes as to their annuity rates. This can happen because of the pursuing issues.
Deferred annuities are under the regulation of each state's department of insurance and these regulations set boundaries on the investment portfolios of insurance companies so that each company can meet its obligations with respect to deferred annuities, immediate annuities and life policies. The rules covering investment for deferred annuities ensures that the company offering the product invests the bulk of the portfolio in fixed income securities-bonds, mortgages, preferred shares.
When researching potential opportunities in deferred annuities, you might come across two companies that offer the same attractive contract terms. Both contracts offer the same initial interest rate, identical minimal guarantee rates, the same surrender charge amounts and time frames, and finally, identical withdrawal features. Nonetheless, once the initial rate period offers expired (typically after the first 12 months), each company will be liberated to set a renewal rate in its own investment discretion. You need to understand the standards a company will consider when it sets annuities rates.
The earnings an annuity company obtains from its bond portfolio depends on the quality of the securities and their average maturity. These two factors are related to risk and, as a result, affect the yield. The general rule is that greater risk coincides with higher yield.
In most cases, the better the bond quality, the lower potential risk of default. However, the highly rated bonds also yield lower interest which means that an insurance company focused on such bonds has less to pay out on its deferred annuities. Yet another factor that impacts chance is time to maturity. Bonds with a lengthier maturity period usually generate more than bonds with shorter maturity periods. One can receive information on the quality and duration of the bond portfolio held by the insurance company by simply asking for it. We have found that "Vital Signs" reports, available from the annuity agent, provide a very good and easy to understand summary of this information.
Companies with portfolios carrying greater risk obtain higher yields provided that the risk is prudent and manageable. As an example, some insurance companies will invest in commercial mortgages. These typically yield more than binds of similar maturity and if well-selected, allows the company to earn more and pay better rates on deferred annuities.
For instance, we can take into account two annuity companies with bond investment portfolios that have different average maturities however offering the same deferred annuities in all other respects. We can hypothetically state that both yield 5%.
The following table illustrates that annuity company A, that owns bonds with lengthier maturity, will be trapped in the event that interest rates go up and can only offer a 5% renewal rate (were they to sell the long term bonds, they would take a loss and have less principal to reinvest). However, if interest rates fall, it could easily maintain the 5% payout. Company B, which has short maturity securities, must buy new securities as the short maturity bonds mature. The brand new rate it offers will reflect the particular prevailing interest rates at the time of renewal. This may either be beneficial or not for those holding the company's deferred annuities according to the direction in which interest rates move.
|
Annuity Company A |
Annuity Company B |
|
|
Average Bond Maturity |
15 yrs |
8 yrs |
| Current yield |
5% |
5% |
|
Renewal rate under rising prevailing rates |
Selling would cause loss of fund's value - offer 5% again |
Almost matured –must buy and offer higher rate |
|
Renewal rate under falling prevailing rates |
No need to sell , offer 5% again |
Almost matured - must buy and offer lower rate |
A few deferred annuity companies might provide a high 'teaser' initial rate and recoup related losses by offering significantly reduced renewal rates. By reviewing the actual renewal rate history of companies and the portfolio holdings, you will be able to pick out the company offering the greatest return on your investment.
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