It has become almost an urban legend that no one has ever lost money in a fixed annuity because an insurance company failed. The reality is, in the last 30 years there have been five times where not everyone was paid 100 percent of their account value. However, every annuity owner has been covered up to the limits of their state guaranty association.1
In 1941 New York created the first life insurance and annuity guaranty plan, but no one followed for 30 years. Why was there opposition to guaranty plans? Some felt a guaranty plan rewarded incompetent management, meaning well-run carriers would pay for the mistakes of the bad ones. By 1983 only 35 states had life/health guaranty associations that provided a funding mechanism to cover the insureds of insolvent life and annuity carriers. However, in 1983 Baldwin-United failed, putting 300,000 policyholders at risk, and that prompted the remaining states to reconsider their opposition. (It should be noted that when it was all over not only did every Baldwin-United annuity owner get all of their principal back, but the annuity owners earned yields of 4 to 7 percent.) A few years later, in 1990, when it became apparent that Executive Life was going to crash, California finally created their own guaranty fund. The last state to create a guaranty association was Louisiana in 1992.
Did the creation of guaranty associations result in more mismanaged carriers? A study2 released this year says maybe, finding a slightly higher fixed annuity growth rate in firms with lower financial ratings in states that had guaranty funds than those that did not in the period from 1985 to 1992. I am inclined to say that the existence of guaranty funds was not responsible for this growth, because agents are proscribed in every state from using the existence of a state fund in marketing fixed annuities. Additionally, my personal experience is that consumers tend to discount the benefit of a guaranteed fund (it also should be noted that, unlike banks with FDIC insurance, the states do not have an actual pot of money to draw from if a carrier fails, but instead assesses remaining firms to pay any guaranteed covered losses).
Events over the last 20 years have shown that guaranty funds are less likely to be needed, and this is largely due to changes in insurance carrier supervision. Risk-based capital (RBC) regulations were implemented in 1994. The reason for them was to get a better handle on any potential problems and to let the state step in more quickly if there appeared to be a problem. The formula looks at interest rate risk, business concentration risk, credit risk, and risks particular to the products being offered, such as underwriting risk on life or health policies. Although the process is static, the formula is not, and it has evolved to reflect changing times. For example, in response to the real estate bubble, NAIC tweaked their model to more accurately assess the quality of residential mortgage-backed securities in an insurer’s portfolio. The result? Although 21 annuity carriers went into state reorganization between 1985 and 1994, only 10 annuity carriers have done so since.
The bottom line is that when European insurers were rocked by the millennium bear market and then jostled again by the 2008 financial crisis, the U.S. regulated life/health insurers were able to easily weather the storm. All in all, the annuity industry is well-positioned to withstand the financial challenges to solvency that may occur in future years with state guaranty associations backing them up.
Footnotes:
1. Marrion, J. 2011. Fixed annuity carrier safety. Advantage Compendium. 3; 2.
2. Grace, M. et al. 2015. Market Discipline and Guaranty Funds in Life Insurance. Social Science Research Network, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2597052.
