Retirement Planning

Chapter 14 – Contract Clauses

  As with all types of contracts, it is very important to read the entire document. It has been said that insurance contracts "are the number one unread best seller."  It is easy to see where this saying came from. Few people actually read what they buy, whether it is the contract for the new car they just financed or the medical policy they purchased from Blue Cross/Blue Shield.

  When a consumer says they are unhappy with an insurance contract, the contract is often said to contain "fine print." Actually, the size of print in an insurance contract is regulated by state authorities. The consumer simply has not read (or not understood) ANY of the print.

  Most buyers want to be able to listen to the selling agent and buy based upon his or her presentation. Of course, this puts a lot of pressure on the agent to fully explain each policy sold and then hope that the consumer understood the explanation.

Bail-Out Clauses

  There are a number of contract clauses in an annuity that can affect the size of the account. One of these clauses is called the Bailout Clause. This clause allows the annuitant or policy owner, under specific conditions, to cash in their annuity without paying the surrender charges that would normally apply. Often the Bailout Clause is tied to the current rate of interest being paid. When this is the case, the contract usually states that if the current interest rate (at the time of surrender) is lower than the initial rate by a specific percentage amount, the insurance company will then waive any surrender penalties if the annuitant or policy owner chooses to cash in the annuity. It is a way of promoting their products with a guarantee on interest rates.

  Some insurance companies still have a fee or administration charge attached to their bailout clauses, while other companies do not. Rather than simply offering a surrender if interest rates go too low, some contracts offer a choice between surrendering the contract or getting up to one-half of one percentage point more on the money in the annuity account.

  There are, of course, differing opinions, but many professionals feel that bail-out clauses simply offer a false sense of security. Insurance companies are not going to put themselves in the position of losing money. Some bail-out clauses are, in fact, so restrictive that it is unlikely a policyholder would even use it.

Market-Value Adjustments

  Although other factors almost certainly have a greater influence on an annuity's performance, in theory, market-value adjustments are a way for an insurance company to share both their profits and losses with their policyholders. This is because when interest rates fall, the market value of the insurance company's assets, which are commonly bonds, rises. This is not always an easy concept for the consumer to grasp and the explanation can be confusing, even for insurance agents. If a policyholder cashes in their annuity during a guaranteed period when interest rates are down, the company will increase the annuitant's or policy owner's accumulation value. Therefore, the insurance company is sharing the gain on its assets with the policyowner. Any surrender charge is still applicable, but this added value does help to offset it. Of course, the reverse is also true. When the interest rates rise, the value of the company's assets decreases. A policyholder who cashed in at this time would share in the losses.

  Market Value Adjustments may give an insurance company more flexibility to invest in areas that promise a higher return, which would allow them to credit policyholders with higher returns also. At least, so the theory claims.

Persistency Bonus

  Persistency bonuses are used fairly often in contracts. This clause encourages their policyholders to keep their annuities for longer periods of time by offering an increased return at set time intervals or at some specific time-period. The additional amount is added directly to the contract's accumulation value.

  How this type of clause works will vary with the contract. There might be a five or ten percent of the premium used, or the percentage might increase gradually as the years go by.  Some of these clauses will offer higher rates at the beginning of each new guarantee period. Normally these rates are higher than those received by new customers.

Partial Withdrawals

  Annuities have many excellent features, but they are not meant as a continual source of cash.  Annuities are designed to be long-term investments. For this reason, unlike life insurance contracts, an individual cannot borrow against the accumulation value in a non-qualified annuity contract. A non-qualified annuity is one on which taxes have already been paid on the contributions. A qualified annuity may be borrowed against because taxes have not been paid on the contributions. A qualified annuity is used as a retirement plan and is usually referred to as a tax-sheltered annuity (TSA).

  Most insurance companies do allow their policyholders to take out partial withdrawals from non-qualified annuities without penalty. These may be referred to in the contract as "free partial withdrawals." These withdrawals, even if allowed, come with restrictions. The conditions will vary, but it is common for the company to restrict them to once per year or to a certain dollar amount or percentage amount. They may have both restrictions (once per year AND a specific percentage or dollar amount). It is not unusual for the insurance company to also apply an administration charge, often $25. Most contracts commonly allow a partial withdrawal of up to 10 percent of the accumulation value without incurring a surrender charge. Even if 10 percent per year is allowed, however, the company may require that it be taken only once per year in order to avoid additional charges. This would be true even if the total taken in two or more withdrawals did not go over the 10 percent.

End of Chapter 14

2017