Insurers Raise Fees on Variable Annuities

Many insurance companies radically underestimated the cost of hedging their guarantees in a market meltdown. Now that the markets have crashed, some investors will find they’re paying a lot more for the same product.

As SmartMoney has reported, this is one way that annuities are failing to live up to their big promises. The guarantees attached to the products – minimum returns of 6% per year or better, market upside, no chance of loss and a lifetime income stream – were designed to attract people in retirement or close to it.

And it worked, attracting $650 billion in assets in the last five years. But the guarantees are only as good as the insurance company’s ability to hedge them, and even when the markets were rising, some insurance company executives admitted their strategies hadn’t been tested by real-life crisis conditions. Now some estimates suggest that hedging costs have doubled in the last year, and insurers are passing those costs along to their customers.
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For example, an investor might purchase a $100,000 annuity that pays a guaranteed 6% annual return for 10 years, or market returns — whichever is better. The fees for a product like that might look something like this:

• 1.3% annually on the current balance to cover the underlying investment
• 1% annually on the current balance for the insurance wrapper (called the mortality and expense charge)
• 1% of the original purchase price to cover the guarantee

The fees now rising are all in that last category — charges that cover guarantees. At the Hartford, the fees of three different kinds of guarantees are rising, from the current charge of 0.35% to 0.75%.