Pyramid of Safety

By James Alden

In the "Pyramid of Safety" Matrix..

Annuities are the Foundation Stones

If you were to make a list of all the asset classes in the inventory of financial products available in the U.S. marketplace, it is safe to say (no intended pun here), that annuities rank right at the foundation of the traditional pyramid of safety. Let's get to the anecdotal proof, especially as insurers compared to banks, in just a moment, but first let's examine why this is the case.

The first reason why annuities have proven themselves to be so safe is because insurers typically are rated by institutional rating agencies and consumers smartly choose to effect their choices by studying these ratings (see the blog article, "Rate the Raters...").

The second reason why annuities are so safe is that, if you study this website to any degree, you should be able to recognize that the annuity per se is not really an investment. In fact, in terms of a clear definition of the word itself, that is exactly the case. It is not an investment, it is a contract.

Like all contracts, there is an explicit written guarantee that is honored and maintained by the company that writes the policy. In the case of an annuity the insurance company is legally obligated to maintain this written guarantee. This legal obligation is enforced by the insurance department of the state in which the company is writing business.

These state insurance departments force insurance companies to keep reserve requirements in excess of what the companies written obligations (annuity contracts) state. Each state has their own requirements on this matter.

If you do some research on your own state you should see certain levels of state oversight. The California Department of Insuranc e does a great job conveying to the public their scope of regulatory oversight, enforcement actions, as well as the documentation of insurers, agents and agencies.

These laws keep insurers very safe when compared to other forms of financial instruments. Insurers must make regular reportings to the state.

Think about this for a moment.

Instead of your funds being subject to pure helter skelter market forces, there are laws that require minimum levels of fiduciary responsibility on an insurance company's part.

The main reason why annuities are at the foundation of the "Pyramid of Safety", as shown to the right here, is because by definition they are legal contracts that are enforced by the state in which the company does business.

A third consideration regarding the safety of an insurance company is the idea of re-insurance. Since insurers set aside reserves to uphold the guarantees written in the contracts they sell, in some cases they may choose to purchase an insurance policy from another insurance company in order to reduce exposure to loss. This is known in the business as reinsurance. Often these reinsurance arrangements are disclosed in the company's brochures and marketing material, so it is worth finding out (especially if you have a lower rated company) if there are any reinsurance agreements in place .with your company

Finally, there is also a State Guaranty Fund which also protects consumers in the rare occurrence of an insurer not being able stay sufficiently solvent. This guarantee fund is usually a used as a last resort since normally an insurer would simply change hands to another larger company in the event of a pending insolvency. Insurance companies pay annual premiums to the State Guarantee Fund that can accumulate and remedy any potential insolvencies in the future.

There are, however, limits on how much money the Guaranty fund will protect policy holders and these limits vary state by state. There is a great source of information on the various guaranty associations right here: https://www.nolhga.com/

By the way, the State Insurance Departments not only regulate insurance companies, they also regulate insurance agents, and in some cases, agents are prohibited from even mentioning the existence of the Guarantee Association. The reason for this is that a consumer must be encouraged to choose an insurer not based on the existence of the Guarantee Fund, but on the "claims paying ability" of the insurer, often indicated by the various rating agencies. So always study the ratings to help you choose your insurer. Do not rely on the existence of the Guarantee Fund.

So on to the anecdotal proof of how safe insurers are and how that safety compares, say, to their main market rival, "El BANCOS" !

The FDIC website actually publishes the (ongoing) list of failed banks in this country. As of this writing, there were over 500 since the year 2000.

The Weiss Rating Agency also compiles an ongoing list of failed banks, credit unions and insurance companies on their website. Here is their list of failed insurers . Keep in mind, as of this writing (May 2020), I counted only about 39 life and annuity carriers (since the referenced list includes health care companies, property casualty companies etc.)