Limits on Annuities Annoy Investors

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Cash in a trap

Annuities are sold with the word “guaranteed” sprinkled through the marketing material. A set payment for life seems mighty attractive when many people are worried about having enough income in retirement and interest rates on savings and Treasury bonds are almost nonexistent.

Indeed, a report released this week from the Insured Retirement Institute said one of the top reasons people were buying annuities was guaranteed income. (The others were that their adviser recommended it and that the assets in an annuity grow tax-free.)

But it turns out that the definition of guaranteed may vary. As of Friday, Prudential Annuities has suspended the ability of policyholders with 14 types of benefits to make further contributions. And because the size of the annuity payment is based on how much is in the annuity, policyholders who had planned to add to their accounts will get payments that are far lower than they had expected.

Annuity experts predicted other insurers would take similar steps because they also made promises before the financial crisis that they now cannot keep.

“You’re going to see every major insurer out there who has products that are considerably higher than what the market would see today do this,” said Brian Fenstermaker, managing principal at Envision Consulting Group. “While it was a surprise, it wasn’t a surprise. We always figured these benefits that were very good wouldn’t be around forever.”

In Prudential’s case, it began selling these extra annuity benefits, known as riders, in 2006. With names like Highest Daily Lifetime Seven, they locked in the annuity’s growth rate. The Lifetime Seven annuity guaranteed annual growth of 7 percent of the highest balance.

So if the balance hit $100,000 at some point, the value of the annuity would grow at 7 percent a year from there, even if the balance later dropped. If the balance rose to, say, $110,000 the next year, the annuity would grow at 7 percent of that amount.

Any money already in the Prudential annuities will be protected at the guaranteed rate for people who eventually take annuity payments.

“It’s in response to the capital markets environment that we’re encountering,” said Bruce Ferris, senior vice president of sales and distribution for Prudential Annuities. “Those contracts were brought to the marketplace in a much different environment and are no longer sustainable. We’re making these changes in the interest of protecting clients to make sure we can make their payments.”

Not surprisingly, people who had been counting on adding more money to these annuities and increasing their eventual payments are not happy.

Steve, 54, a freelance advertising copywriter who asked that his last name be withheld for fear that his age could affect his ability to get work, said the change was a setback to his retirement plans. He said he opened a Prudential annuity with a 6 percent guarantee two years ago, when he realized that he had not been saving enough for retirement, and had been adding money to it as well as to a diversified mutual fund and a portfolio of corporate bonds.

“It was guaranteed, and it seemed like a no-brainer,” he said. “But I know nothing is guaranteed. I had also found a lot of threads online saying it was too good to be true, so I didn’t put all my money into it.”

In late August, he said, he received a form letter from Prudential that looked like junk mail. He said he read it only because his broker had told him that Prudential was not going to allow people to add any more money.

The letter notifying him was dated Aug. 23 but by the time he received it, he had less than three weeks to decide if he was going to add as much as he could to the annuity or come up with a different retirement plan. “It was a piece of paper folded in threes with a piece of tape that said presorted,” he said. “This is not the way you talk to your audience unless you want to make sure that they completely don’t understand it, and you don’t want them to open it. I know because I’m in advertising, and I create illusions like this for companies like Prudential.”

Prudential has the right to change the terms. In Steve’s case, a line on Page 66 of the prospectus, says this, “We may apply certain limitations, restrictions, and/or underwriting standards as a condition of our issuance of an Annuity and/or acceptance of Purchase Payments.”

Translated, that means that Prudential is permitted to do what it is doing.

Annuity experts said that Prudential was likely to be in the first wave of many companies to prohibit additional purchases of annuities with guarantees in the 6 to 8 percent range.

“These products were sold, not bought,” said Ronald J. Garutti Jr., a certified financial planner with Newroads Financial Group. “You could make it sound like the greatest thing since sliced bread if you didn’t go into the underlying what ifs. In this guy’s case, it was, ‘Now we let you fund money, in the future we may not.’ ”

Mr. Ferris of Prudential said that the decision to suspend future contributions was driven by the desire to protect current annuity holders and that the short time frame to make additional contributions was part of that. “If we allowed people to add large amounts to these contracts, it puts at risk our ability to insure and manage our liabilities,” he said.

I called Steve’s adviser, Eric L. Lyon at National Securities Corp in Boca Raton, Fla., and he said many of his clients were worried about the same restrictions on future contributions from other annuity companies. “It was in the contract that they have the right to stop or no longer allow future contributions,” Mr. Lyon said. “It’s in a prospectus that’s 150 pages long, but it was in there.”

So what can people do about the sudden change? The consensus from the annuity experts was that they should be happy with what they got while they got it. Moshe A. Milevsky, an associate professor of finance at the York University business school in Toronto, said while these good deals were going away, he was more worried that people would rush to put as much money as they could into an annuity with a high guarantee and come to regret it.

“I don’t want to create this fire-sale mentality,” Mr. Milevsky said. “I don’t want to give advisers the ability to say to their clients, ‘Give me more money now because it’s going to be shut down tomorrow.’ Then, the adviser gets a big commission, but the person may need that money in the future.”

Mr. Garutti equated what Prudential did to the swimming pool in his town closing on Labor Day, even though the weather was still nice. “I have to tell my son there is nothing I can do about it until Memorial Day, no matter how much you cry,” he said. “I don’t want to be callous, but you have to accept what happened and move on.”

While some people do add money each year to their annuities, many traditional annuity buyers buy an annuity with a lump sum, and the guarantee on that is still in effect.

But experts said that Prudential’s decision to stop people from putting new money into their annuities was not the worst of what was likely to happen across the industry. “They can get a lot more stringent,” Mr. Milevsky said. “Wait until they tell him they’re going to restrict his investment choices. Or they’re going to raise his fees.” Mr. Ferris said the company evaluated its benefits each day.

In the end, Steve decided to put an extra $20,000 into his annuity before the deadline, to bring his account balance to $75,000. He had planned to contribute until it reached $300,000 — a huge difference at a 5 to 6 percent payout.

“I get the situation Prudential is in, but they should be smarter,” Steve said. “If they’re not smart enough to figure out how they can keep doing something they offered two years ago in a bad market, I’m worried.”