Variable annuities are a type of life insurance contract that people can own directly or hold in brokerage accounts. Neither the federal government, nor any federally backed entity, offers any type of insurance coverage to protect variable annuity owners in the event that the issuing insurer, or the brokerage firm holding the annuity, goes bankrupt. There are some protections in place that enable variable annuity owners to reclaim funds put at risk by bankruptcies.
Variable annuities work similarly to group pension plans. Contract owners make either one-off or periodic premium payments that are held in the contract for between four and 10 years. Annuity funds are invested in underlying mutual funds that offer the contract owner the opportunity to experience long-term growth. At the end of the accumulation phase, annuities are either annuitized, which means the funds are disbursed as life-time monthly payments, or taken as a lump sum.
State insurance regulators have guaranty funds that are funded with premium payments from insurance companies. The guarantee funds reimburse insurance contract holders who incur losses when insurance firms file bankruptcy. Guaranty fund coverage levels vary from state to state, but most variable annuities are afforded some coverage by guaranty funds. The Securities Investor Protection Corporation insures securities, including variable annuities, that are held in accounts at SIPC member firms. The SIPC covers securities up to $500,000 per account owner, per broker house. The SIPC only pays out if the brokerage firm, as opposed to the insurer, goes bankrupt.
The SIPC does not protect investors from losses that occur due to investment holdings losing value. If a brokerage firm files bankruptcy, the SIPC appoints a trustee to sell its assets. The trustee reviews claims of brokerage customers who had accounts at the firm. The trustee approves SIPC insurance payouts that equal the value of variable annuities accounts at that time, rather than the value of the annuities at the time of the firm's bankruptcy. Since variable annuities contain mutual funds, the values change on a daily basis.
Benefits of Variable Annuities
Most variable annuities enable investors to buy insurance riders called, guaranteed minimum income benefits, that increase the income value of the account on a yearly basis, even if the underlying mutual funds lose value. Insurance companies use the hypothetical income value to determine the amount of the lifetime payments. Additionally, variable annuities include life insurance that protects the beneficiaries of the account owner in the event that the owner dies prematurely.
Every type of investment contains some type of risk. Variable annuities come with principal risk, but federally insured products are not without risk. Many people who invest primarily in certificates of deposit accounts struggle to overcome inflation risk. The low rates on CDs do not always keep up with inflation over long periods of time. Additionally, the Federal Deposit Insurance Corporation only covers bank products up to $250,000 per person. The SIPC provides twice the level of coverage.