How Safe is Your Indexed Annuity?

by FindYourAnnuity.com22. June 2012 09:36

The Legal Reserve System and the Multiple Layers of Safety

The key question is this: “How do I know that my money is safe? I want GUARANTEED income for life, safe, secure and void of risk. The Fixed Indexed Annuity provides just that. Consequently, each month, millions of dollars are being moved from stocks, bonds, mutual funds, variable annuities, ETFs, 401(k)s, and CDs into Fixed Indexed Annuities.

Why? The #1 reason is SAFETY. It is far better to avoid and eliminate any possibility of losses, than to try to make up for losses after the fact. This is the #1 rule in investing!

Having a principal guarantee makes fixed indexed annuities much safer than stocks, bonds, mutual funds, 401(k) plans and variable annuities, which do NOT have a principal guarantee. So, how does this safety work? On what is this safety based? The safety of Fixed Indexed Annuities is a multi-layered safety net that will give you great comfort. It begins with the insurance company assets and ends with a government guarantee.

Concerned about trusting an insurance company with your important retirement funds?

How safe is your indexed annuity? Should you trust an indexed annuity with your important retirement funds? What happens if an insurance company were to fail? These and other questions are vitally important and the answers may surprise you. Why even ask these questions? In the past investors simply trusted the third party, now after the financial meltdown beginning in 2008, questions must be asked... and answered.

The simple fact remains that retirees and retiring Baby Boomers today are looking for a way to guarantee that their money is safe, and that they will have enough income to last as long as they live. Income is the more important decision, far more important than having enough money.

"Income is King with the Baby Boomers."

So is the money safe in an annuity? Baby Boomers are very concerned about safety for one simple reason, "They Don't have Time to Make It Again!" Other than social security and earned pensions, most retirement investments are not guaranteed and are subject to variations of account values, volatility. How can they be assured their retirement accounts will last as long as they are needed?

Their worries are justified and the number one concern for retiring Baby Boomers is simple: safety. Is my money safe? So, how does this safety work? How are annuities actually guaranteed? The safety of annuities is like a safety net, a safety net to cover any possible occurrence.

Here is how it all works:

1. Insurance Company Assets:

The safety of an Index Annuity is based on the financial strength and claims paying ability of the company which issues the annuity. Annuities are regulated by each individual state Department of Insurance (DOI). The DOI regulates, audits, sets reserves of the insurance companies this assures the annuity purchaser of the solvency of the insurance company.

These highly regulated companies are also subject to strict capital reserve requirements which result in reserve level requirements. These capital requirements are higher than the capital reserve requirements for banks regulated by the FDIC.

Because of the high regulations required by each DOI the insurance companies must invest in solid safe and suitable vehicles. They invest in some of the most highly-rated and conservative investments available such as highly rated corporate bonds. In addition, a high percentage of their investments are in U.S. government bonds, U.S. Treasuries.

2.Protection from Creditors:

In many states, by law, the assets of insurance company policy holders cannot be attached by creditors of the insurance company. The amount that is protected and how it can be protected varies wildly form state to state (remember each state sets their own rules about annuities). The protection from creditors could be 100% or it could protecting only a few dollars per month. It is important to know what your state allows, always consult legal professionals or your state department of insurance.

It is always important to contact your local Department of Insurance of legal counsel before making any permanent decisions because each state has different rules and guidelines.

3. Surplus Capital:

Many insurance companies have on deposit funds in excess of the required 100% of benefits owed. Many insurance companies have in addition to their required reserves "surplus" capital Strong, well managed insurance companies could typically have from four to ten cents per reserve dollar in surplus capital.

Insurance companies function under a completely different system than does our banking industry and as such the reserves of insurance companies could exceed those required of the banking industry.

Solvency Ratio: This is the percentage of assets greater than liabilities. Divide the liabilities into the assets to determine the ratio.

When considering using an insurance company's products for your important invested assets, ask your local department of insurance about the company's solvency ratios. Anything above 105% means a well run and secure insurance company.

4. Strong Reserves, the Legal Reserve System:

Insurance companies must have on hand $1 in reserves for every $1 in benefits owed. 100% and nothing less. What does that mean? It means a system is in place to guarantee your indexed annuity is safe. A high level of safety is best served by a legal reserve system. A legal reserve system requires, by law, that a certain level of reserves be maintained by an institution at all times. The legal reserve system governs both banks and insurance companies, but the legal reserve systems for each is separate is different from the other.

Bank and savings & loan CDs are backed up by the Legal Reserve system, which is regulated by the FDIC (Federal Deposit Insurance Corporation). Banks are regulated under the laws governing depository institutions. In the United States, depository institutions must meet capital guidelines issued by the Board of Governors of the Federal Reserve System. (FRB) The amount of reserves required by the Federal Reserve Bank varies depending on monetary conditions existing worldwide. Normal adequate capitalization is around 8%, not the 100% required by annuity companies.

The result of these differences in "reserve" deposits is leverage. Obviously if your reserve is 8% instead of 100% you would be more leveraged than you would be with a higher percentage of deposit.

Because annuity companies are regulated at the state level, 50 different DOI are examining and auditing the same companies financials. An insurance company must honor the insurance laws, rules and regulations of each state in America in which it wants to do business. These laws, rules and regulations are complex and, because they are individual to each state, severely limit the types and kinds of investments that insurance companies can make. Insurance companies are required to keep the majority of customer funds in extremely conservative instruments such as U.S. government bonds and the most highly-rated corporate bonds. It is up to each sate DOI to determine the solvency of insurance companies doing business in its state.

As a comparison to other "no risk" deposits, bank Certificates of Deposit (CDs) are guaranteed by the legal reserve system maintained by the Federal Deposit Insurance Corporation (the FDIC), in amounts of up to $250,000 per depositor per institution.

Other investment possibilities such as stocks, bonds, mutual funds, etc. do not have any legal reserve requirements, their value is based on the volatility of their individual market sectors.

Red Money or Green Money?

Another way of understanding the difference between safety of deposit and the volatility of an investment is looking at each as a color. Savings deposits could be looked on as "Green Money” and an investment would be known as “Red Money”. Neither Green Money nor Red Money is “right” and the other “wrong.” Each has its place as an asset class. But it is very important to not confuse the two. For retirement investing, it can be a crucial distinction, and can spell the difference between having enough income to last ALL of retirement, or running out of income before death.

Stockbrokers and investment managers will talk all day about “asset allocation” and “diversification.” However, ALL of their talk and focus is diversification within the Red Money sphere. They know NOTHING about Green Money options, and often give incorrect information when asked about Index Annuities. They have little knowledge of Index Annuities, tend to glibly spout phrases they are told to say (“high fees and no liquidity”) which is incorrect. Correctly understanding the differences between Green Money and Red Money can be VERY helpful in guaranteeing and generating the income retirees need in retirement.

IFcome or INcome?

Think of your funds in color, red is danger and green is safety, now ad IF and IN.

Red Money Investments can rise in value and fall in value. They have both upside and downside potential. Red Money Investments can lose value because they are NOT backed by a 100% capital reserve. Even small losses can be very harmful to retirees. Large losses can certainly threaten your entire retirement savings plan.

Green Money Deposits can only go up! They are not designed for dramatic growth, but steadily rise in value over time. Very importantly, savings vehicles are backed up with a legal reserve system to protect the value of those savings up to the legal limit.

Income from Red Money Investments is NOT backed up with a legal reserve system. Therefore it can rightly be called “IFcome.” “IF this happens, or IF that happens,” I have income. It might be there. It might not.

Income from Green Money Deposits IS backed up with a legal reserve system. That’s why we call it “INcome.” It is guaranteed by the legal reserve system.

5. Re-Insurance:

Insurance companies do not take unnecessary risks, period. Over the years systems have been created to allow insurance companies to share risks so one company does not stand the liability of a loss on an entire claim. The idea of re-insurance dates to England in the 1700s when Lloyds of London began insuring shipping commerce. To "spread" the risk Lloyds would use a group of investors to share in the profit and the losses. As the insurance industry grew, the same concept was adopted between insurance companies. Each would bear the burden of a large loss with another.

Even simple term life insurance policies issued today are really a shared liability (and profit). The idea or re-insurance has allowed the industry to grow and flourish while at the same time become extremely competitive. Client assets held by an insurance company are backed by the strongest and most conservative investments, supported with cash reserves, backed by state guarantee associations, most are also backed up by the re-insurance philosophy

6. State Guarantee Associations:

Every state now has a Guarantee Association, funded by mandatory contributions of the insurance companies, and varying in fund limits from state to state. The states have established a uniform system of laws, rules, regulations and mutual cooperation that every state strives to adhere to through the national Association of Insurance Commissioners (NAIC).

Annuities are not all the same type of insurance product. There are differences in how funds in an annuity is guaranteed.

Two specific classes of annuities are exempted from the State Guarantee Fund; Variable annuities and Fraternal Life Insurance Company issued annuities.

Variable annuities are securities and therefore omitted from any state guarantee. Insurance companies which issue variable annuities are not responsible for any losses in your annuity. The reason is simple, when you invest in a variable annuity, your assets are not at the insurance company, they are invested in accounts managed by investment professionals. These assets are subject to market movement and volatility..

To find out more about the limits and benefits of the State Guarantee Fund in your state simple call your local State Department of Insurance.

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