Is it safe? The AIG crisis could affect Annuities

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April 13, 2009 Monday 08:55 AM EST

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HEADLINE: Is It Safe? AIG Crisis Could Affect Annuities

BYLINE: Gavin Magor, TheStreet.com Ratings Senior Health Insurance Analyst.

Gavin Magor joined TheStreet.com Ratings in 2008, and is the senior analyst responsible for assigning financial strength ratings to health insurers and supporting other health care-related consumer products, including Medicare supplement insurance, long-term care insurance and elder care information. He conducts industry analysis in these areas. He has more than 20 years' international experience in credit risk management, commercial lending and analysis, working in the U.K., Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.

TSC Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.

As American International Group (AIG:NYSE) fights to stem billions of dollars in losses and survive the worst economic decline since the Great Depression, investors should think hard before buying the insurance company's annuities.

The government, viewing AIG as too important to fail, has committed more than $200 billion to prop up the ailing company, which lost a record $61.7 billion in the fourth quarter. AIG has worked hard to reassure worried consumers, reminding them that its insurance subsidiaries are "well capitalized." The National Association of Insurance Commissioners even offers a resource page on its Web site to let consumers know that AIG annuities are safe, even if the company becomes insolvent.

AIG annuities, insurance policies that serve as investment vehicles, might seem like a safe place to stow money until retirement, but the company is prone to instability this year and investors might want to consider other options. While its insurance units are capitalized now, they could face problems later this year if premium revenue continues to slow.

On the face of it, AIG seems like a solid company. It had more than 6 million annuity contracts at year-end totaling $131.7 billion, and policy reserves of $184.6 billion to support them. It took in $53 billion in premiums in 2008, returning 16% in pre-tax operating profit compared with the 13% average loss of its peers.

AIG kept expenses under control and paid commissions that were 30% lower than average. Among its bond holdings, 5.9% were junk status, compared with to 6.4% for the industry.

Annuity sales rose during the first half of 2008. That quickly changed during the second half, when many policyholders cashed in their plans fearing the company might collapse. AIG ended the year with a 2.7% surrender rate, up 42% from 2007 and more than double the 1.1% average for the market.

AIG maintains its capital and surplus positions by collecting premiums. If the company loses more policyholders or fails to attract new investors, it could face problems. This year has been so volatile that AIG probably lost more policyholders.

AIG's life insurance units took in $53 billion in premiums and lost $24 billion. The losses far exceed the group's $15 billion in net capital and surplus. In contrast, Hartford Financial Services(HIG:NYSE) lost $4.5 billion and kept $6 billion in capital, and MetLife (MET:NYSE) lost $632 million and took in $18 billion.

The Treasury Department said last week it would extend bailout funds to life insurance companies. The government stands behind AIG, but it might consider selling its units to keep the company going and protect policyholders. However, the government might struggle to find an owner who doesn't want to change policyholders' contract terms. At the least, customers might have to work with a new company.

It's important to buy annuities only from financially sound companies. If the company fails while you're paying into your annuity, you will receive the value of the account. However, if the firm becomes insolvent while you're collecting income from your policy, you'll receive only what's covered by guaranty associations, an amount that varies by state.

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LOAD-DATE: April 14, 2009