Variable annuity features, their relevance to personal injury settlements.

In the first post on the variable annuity discussion and their relevance to structured settlements and personal injury cases i'd like to outline what these annuity contracts are, how their features might appeal to personal injury victims and how they pose an increasing threat to structured settlement's lock settlement proceeds that flow into annuity contracts.

Historical perspective. 

In the early 1990's variable annuity contracts emerged on the general financial planning scene as a combination of the traditional single premium deferred annuity contract, in which money was placed with the life market and held at various rates of interest with the objective being future conversion into annuity income. The primary attraction was relatively high rates of guaranteed interest, tax deferral on all income until disbursement and eventually conversion into guaranteed life time income with the principal and income broken into an exclusion ratio that returned portions of the original investment and income in each payment. This was a bedrock, conservative product that was a staple of insurance company sales in the 1970's, 1980's and 1990's. 

In the early 1990's companies became intrigued with combining mutual fund performance inside the tax deferred wrapper of the SPDA contract, and there was a rush of new products developed and sold through life insurance and financial planning channels. These captured equity market performance, offered allocations between money markets, stock funds, international accounts, bond funds, real estate, etc. The obvious benefit was diversification inside a tax deferred contract with a strong life insurance company managing the arrangement. The draw backs were market volatility, poor fund selections, excessively expensive surrender charges to get out of the contract, relatively expensive annual management fees and the fact that income out of a SPDA or variable contract is taxed at ordinary income rates, as opposed to typically lower capital gains rates. In fact, one of the biggest area's of SEC and NASD enforcement in the last 5 to 7 years has been in sales practices and abuses in promoting and selling these contracts, so they have received some deservedly bad press over the years as a result of these excesses by advisors looking to sell high commission products.

However, as with ever story and product, there is good and bad in any situation and it really does come down to looking for when a product is an appropriate match for a client, open disclosure of costs and commissions and selective use of the annuity in situations where you are looking for long term income at a future date and a desire to match market yields over that time frame.

Recent changes and innovations.

In the past year there has been a surge of creativity and product innovation that has propelled the variable annuity to the forefront of planning tools for people looking for some or all of the following features:

1. High guaranteed minimum accumulation rates on annuity account values.

2. Broadly diversified equity, bond and managed fund accounts.

3. Asset allocation models and automatic rebalancing of portfolios.

4. Life time income that they can't out live or out spend with the same guaranteed growth and income during the annuity payout phase.

5. Allows the annuitant to start their annuity income when THEY decide, not according to a locked in schedule.  

6. The ability to get the greater of the contractual annuity account minimum, typically 6%, the annual yield of the investment portfolio, with out any of the downside risk involved in equity and bond investments. 

7. Tax deferral on gains and income during the accumulation phase.

8. A death benefit that is paid income tax free to the estate of the annuitant.

9. Account liquidity with little or no penalty in the event funds need to be accessed, eliminating factoring.  

 These changes are in direct response to some of the more glaring weaknesses of variable annuities that the life insurance and investment community has had the fore site to finally address, those being the risk of a market decline coming at the worst possible time for the annuitant, the lack of interest people have in locking in to life incomes that can't participate in market increases over time, as well as excessive pricing and surrender charges that were a big part of the older variable annuity contracts.

So what is new and of greatest value to trial lawyers and their clients?

The biggest single benefit of these contracts to trial lawyers and their clients is the ability to couple a high guaranteed rate of interest on both annuity accumulation and annuity income, with comprehensive investment diversification that allows for continue growth if markets and equities exceed the guarantees. Essentially it is heads you win, tails you win.  

The biggest risk in designing a long term annuity plan is that the plan doesn't keep pace with inflation, market returns or locks the client into a fix program that doesn't provide sufficient flexibility. The variable annuity approach, when coupled with new guarantees, eliminates the primary risks and concerns of a structured payout. You have indexed accounts, market yields, guarantees and the ability to start income when the client needs it. Basically it answers virtually every concern most people mention in deciding whether or not to structure their personal injury award.

The other major benefit of the variable annuity is that the client owns the contract, or it can be owned by a trust if the client is a minor or incompetent.  While this does raise the risk that the funds could be used  for something other then the intended purposes, the fact is factoring is a pervasive part of our landscape now, and that the cost of factoring is far in excess of the cost of taking a partial withdrawal from an annuity contract.

To conclude part one of this review on variable annuity contracts and their use in settlement cases, it is important to first realize that the variable annuity contract has been substantially upgraded, with it's major negatives essentially eliminated. You now can get guaranteed accumulation, and lock in gains, coupled with guaranteed income that grows over time as well. The next few parts of this discussion will be a more detailed look at how the guarantees work, how the income is calculated and paid out, what the charges are, what the investment choices are and how the death benefits are handled.

If you have specific questions or issues you'd like me to address, please post them on the blog. 

Posted on March 5, 2007 and filed under Variable annuities.