Annuities and Risk

Annuities are contracts purchased by an investor from an insurance company in exchange for payment on a specific date, over a specific period of time, and usually at specific rate of return. With any financial investment a certain amount of risk is expected with annuities as with other investments. The risk of annuities depends on the type of the annuity chosen by the investor and also includes the long term stability and health of the insurance company the investor is making the purchase from.

It is important to note that annuities are not backed up by the FDIC and some may not be registered with the SEC. However, certain states may have special annuity coverage funds if the company issuing the annuity goes under through “guarantee associations.” The amount of coverage varies depending on which state you live in. For example the state of Washington seems has the highest protection of $500,000. If the insurance company which the annuity was purchased from is not able to cover their obligations, usually other insurance companies step in and buy out the company and redeem some of the investments. This practice preserves the health of the entire industry.

A fixed annuity is a contract that determines a specific rate of return over a particular period of time. The level of risk may be considered lower than other annuities because its health is not necessarily based on market fluctuations, but rather more stable insurance pools. The drawback for some investors is that the Rate of Return for fixed annuities is not as dramatic as other investments. A variable annuity on the other hand, allows the investor the ability to determine the level of risk. By allowing the investor to determine the percentage of his payments into subgroups, the risk can either increase or decrease. For example, if you decided to purchase a variable annuity and place 75% of your payments into a higher risk mutual fund and the rest into a lower risk fund, the overall risk of that annuity may increase. The level of return would ultimately depend on the performance level for each of those funds chosen as a percentage of your portfolio. Variable annuities also allow you to invest a percentage of the funds into a fixed mutual fund as one would in a traditional fixed annuity account. This provides an increase level of freedom for the investor to diversify his portfolio.

Index annuities are based entirely on the performance of the equity market. The level of return would primarily be based on whether the market goes up or down and would inherently have a bit more risk than a fixed-deferred annuity or a variable annuity. As other annuities, index annuities can provide good long term investments if we consider the historical levels of market performances that trend upward through the years.

In addition, savvy investors find annuities as often attractive investments because they can weather through significant market volatility, falling interest rates, and deferred tax obligations based on any earnings due to interest over time. The best way to understand the risk associated with each annuity is to thoroughly read the prospectus and investigation the rating of the issuing company.