Annuities are financial products promising a specific income stream. Income streams start either immediately or at some future point in time. Insurance companies sell annuities to consumers, guaranteeing the income structure. An annuity does not have carry Federal Deposit Insurance Corporation coverage. Protection is offered by the company selling the product with some guarantees offered through state guaranty associations.
You probably wouldn't think twice about getting a fire, flood or theft homeowner's policy to protect you in the event of home loss. The same is true with life insurance. People insure millions of dollars worth of assets every day through insurance companies who promise to pay benefits at the time of loss. The insurance company provides the guarantee in the same fashion as it provides a guarantee for supplemental income sources purchased in annuities. Buying an annuity buys the guarantee from the financial strength of the insurance company. Trusting the insurance company is imperative.
How to Trust Insurance Companies
Insurance companies are rated for financial strength and benefits paying consistency. Companies such as A.M. Best, Moody's and Standard & Poor's are independent ratings companies, each with their own proprietary method of determining an insurance company's financial security. While each method is unique, all use a combination of cash on hand, security of investments purchased for long-term growth and the amount of possible claim dollars required at any one given period of time. Each company uses a tiered rating system, similar to their counterparts, starting with the A-tier and moving down to the D-tier. Like school grades, the A-tier is rated most stable. In each tier, there are three sub-divisions. Buying an annuity in the top tier or top division of the B-tier is generally thought of as a safe, solvent investment.
What Is Insured?
Not every aspect of every annuity is insured by the insurance company. The common component insured is the income guarantee upon annuitization. Annuitization takes the cash value and creates a lifetime income stream from it. The insurance company guarantees this income once annuitization starts. Fixed annuities also guarantee the fixed rate of return that adjusts annually. Many also guarantee the principal invested. Variable annuities invest in fluctuating mutual funds and have no guarantee on investment returns.
When Insurance Companies Fail?
It is possible in times of economic crisis to have insurance companies fail. Each insurance company is covered by state guaranty insurance coverage through the state insurance commissioner. Each state varies with most coverage for annuities starting at a minimum of $100,000. This is problematic if investors placed more than $100,000 in the account. However, it is important for investors to understand that when one insurance company fails, another stronger company may buy the insurance company out with its assets and contracts. While the contract terms may not be exactly the same, this method often preserves most, if not all of consumer assets.