Most advisors are in the dark when it comes to them.
Many financial advisors who either sell and/or
advise on the purchase of all types of risk management products are
still unaware of certain product nuances. Specifically, most advisors
know of and may have put clients in immediate fixed annuities and yet
may know little about "impaired risk annuities," or immediate annuities
in which the advisor negotiates a better-than-average payout for his
client based upon the client's below-average health.
How is that possible? Aren't annuity payouts fixed, based upon the client's age? Don't you just shop a half dozen insurers and, all else being equal, pick the one that offers the highest payout? Not if your client represents an "impaired risk."
Explains Errold Moody Jr., a San Leandro, Calif., financial advisor, "Impaired risk underwriting is a process by which physicians or underwriters evaluate the life expectancy of an individual based upon her health. Individual medical conditions are considered, and a variety of risk factors such as high blood pressure, heart disease or diabetes may be found to result in a reduced life expectancy. If your client isn't expected to live as long as the average person his age, then his annuity payout per dollar invested should be higher than for other clients his age exhibiting no extraordinary medical conditions."
Impaired risk annuities can benefit consumers by either reducing the premium for a specific stream of payments or by providing an increased benefit for the same premium. "What these companies are doing," says Steve Finkle, owner of National Brokerage Associates Inc. in Rockville, Md., an insurance and annuity broker, "is recognizing that significant impairments deserve to be looked at differently than a standard risk. The process works exactly the opposite of life insurance in that the less healthy you are, the better the payout you get [on the impaired risk annuity]."
Moody provides several examples. "Assume a woman age 70 wants a guaranteed $1,000 a month for retirement. She is not in good health. Based on her medical condition, she has a life expectancy of a 74-year-old. A regular annuity, assuming normal health risks, would cost $159,204. But due to her condition, it would cost this particular client only $142,560.
"Or assume a man age 65 has a single premium deferred annuity with a cash value of $125,000. If he buys a single premium immediate annuity with a ten-year certain and life option, he would get $1,048 based on his life expectancy of a man at age 70-the chronological age he approximates in his current condition. At a normal person's age of 65, he would have received $960."
What this means, for example, is that smokers, who would be penalized or "rated" if attempting to purchase life insurance, are at an advantage when purchasing a single premium immediate annuity. Says Moody, "A 65-year-old male smoker with a $100,000 investment might get $904 per month, versus the non-smoker at $800."
Where does one find these deals? "There aren't that many companies doing impaired risk annuities," says Finkle, "because they're highly exposed if they guess wrong." Insurance companies don't have the large pools of people for this product from which to generate accurate actuarial statistics. "The underwriting becomes a unique expertise," adds Finkle. He suggests advisors look for impaired risk annuities among those companies already doing structured settlements. "They employ the same kind of underwriting philosophy," says Finkle.
The companies doing this, he says, are GE, Allstate, American General and AIG. "They're big in structured settlements and in the impaired risk annuity areas. Jefferson Pilot just entered the market [recently], as well," he adds.
Although only a few companies are willing to offer impaired risk annuities, they've nonetheless been around for about 20 years. Finkle says advisors tend not to know about these products unless they're insurance-licensed. As an insurance broker, he sells these products primarily to insurance people who are more attuned to immediate annuities being something viable, whereas "many planners don't want their clients to purchase [immediate] annuities since the planners would rather manage the assets that might be liquidated to purchase the annuity. I don't necessarily disagree with that approach, particularly in today's interest rate environment, but if someone has significant health impairments, impaired risk annuities should be considered," says Finkle.
Keith Newcomb, an advisor with Full Life Financial LLC in Nashville, Tenn., says he hasn't yet used an impaired risk annuity for any of his clients, but that's only because there hasn't yet been a fit. "I sure have them in my toolbox for the right situation," he says. "If an annuity is suitable [for a given client] and if that client represents an impaired risk, then an impaired risk annuity will be the best deal. The only thing different is that the mortality table is adjusted to reflect the individual purchaser's shorter lifespan."
"Any client rated Table 3 or higher on life underwriting will qualify for an impaired risk annuity," says Newcomb. "According to underwriters I speak with, people in their thirties with known heart problems are qualifying for impaired risk annuities, even if those problems are attributable to lifestyle and diet. Bobby Darin [one of the most popular rock and roll teen idols of the late '50s who died during heart surgery to repair a faulty heart valve] probably could have qualified with his congenital heart defect," says Newcomb.
Although most clients with an immediate annuity need would be pleased with just getting a boost in their payout, there's also the occasional arbitrage opportunity with impaired risk annuities. Because underwriting is an imprecise process-different insurers may view differently the risks posed by the same individual-the opportunity for financial gain is sometimes possible.
Finkle describes a case in which a client with a life policy taken over from an employer sold the contract in the secondary life settlement market rather than surrendering it. "The policy had maybe $7 million of cash value and he was able to sell it for $10 million. His agent then came to us and said, 'Here's his medical info-let's shop it' and see what we can get on the impaired risk annuity side. One insurer agreed to rate the client from age 76 to age 83 so, instead of the payout he would have gotten at age 76, he got the payout for an 83-year-old male."
Finkle then shopped for life insurance for the client among companies specializing in underwriting medical problems. "We were able to buy a new policy with the same coverage as the old policy and use the proceeds from the immediate annuity to pay for it. The client wound up with a guaranteed death benefit and he wasn't out of pocket for the premiums. In fact, he pocketed $1 million-the different between the original life settlement and the cost of the annuity at a payout level that would cover the premiums on the new life contract." Finkle adds that this type of strategy isn't the primary use for an impaired risk annuity, but it's an interesting example of what can sometimes be done in unusual situations.
What makes this type of arbitrage work, says Newcomb, is the impaired risk. That is, if the client qualifies for an impaired risk annuity and he's got cash value life insurance he no longer needs, then the differential between the policy's cash value and a life settlement accordingly will be greater than for a client of normal risk. The relatively higher settlement proceeds are then available for a heftier immediate annuity purchase, whether for an arbitrage opportunity or simply to meet the client's cash flow needs.
Another arbitrage opportunity, says Newcomb, is that of using a reverse mortgage to purchase the impaired risk annuity for a client with a qualifying medical condition. "Suppose the equity in the client's house is her only large asset and potential means of meeting living expenses. She could do a lump-sum reverse mortgage and purchase an impaired risk annuity with the proceeds. Of course, you need to do the math and see if it works," says Newcomb. The implication is that the annuity payments-because they're factored up to reflect the client's medical condition-may be greater than the payments she would receive from a traditional, monthly-payment reverse mortgage.
Like Newcomb, Moody confesses he's not used an impaired risk annuity yet for any of his clients. "However, planners need to be aware of these vehicles should the need arise," he says. Strangely enough, says Newcomb, the subject isn't addressed anywhere in the insurance licensing procedures, or any other place except for the e-mails he gets from national brokerage firms such as Finkle's. "Advisors who fail to use these vehicles when they're the best option for the client could be sued for breach of duty," says Moody.
"When the time does come to place a client in one of these vehicles, planners will find companies willing to underwrite the client, but not all of the companies will necessarily be viable," says Moody. "Advisors will need to shop around [for the best deal], just as with life settlements."
David J. Drucker, M.B.A., CFP, a
financial advisor since 1981, sold his practice 20 years later to
write, speak and consult with other advisors under his new banner:
Drucker Knowledge Systems. Learn more about his latest books at