Surrender Charges
    & Principal Guarantees

Insurance companies have an extremely difficult task. They must manage the unknown. No one knows how long they will live, whether the will become disable or whether they will need access to their asset because of a terminal illness. Insurance companies management the financial aspect of these uncertainties while protecting our cash value deposits and providing their policyholder’s with a competitive interest rate. Sometimes they conduct this fiscal juggling act extends over several decades and through a variety of economic conditions.

Part of managing the unknown is being obsessive about what is known. When the insurance company receives a deposit on a 10 year account on which they have promised to pay say 5.75%, the first thing they do is purchase 10 year bonds of the appropriate quality to cover their interest rate promise and lock in their own institutional profit. In other words, they take as much uncertainty out of the transaction as they can and they reserve for the rest of their obligation.

One way to control uncertainty is to control liquidity. To allow depositors to come in and out of their annuity virtually at will, would destroy the nature of the insurance saving institution. It would be more of a saving bank, than an insurance company and it would not be able to perform its primary function, providing financial protect for individuals from die to soon or live too long.

Additionally, an insurance company has expense when they acquire a deposit, and these expenses must be recouped the life time of the deposit. For these reasons, annuity policies and life insurance policies have surrender charges. As a general rule the longer the surrender period, the higher the potential return. This rule is only valid for the first 10 to 15 years depending on the product. The same is true of bonds in general. Historically, the longer the maturing, the higher the return. A longer surrender period allows the insurance company to purchase longer maturity bonds and thereby provide a higher return. It also amortizes the acquisition cost over a longer period, which means a lower charge to annual earnings.

Surrender charge range from just a few years to over 15, with the most common in the seven to twelve year range. Most surrender charges are a percent of the total annuity account and almost all decrease over time.

The table below shows three examples of policy surrender values commonly found in fixed-indexed annuities:

Bonus interest can also affect the surrender charge. Some policies add bonus interest to the premium at purchase. These bonus amounts are normally offset by higher surrender accounts. Some people shun bonus interest products for this reason, but often if you subtract out the bonus interest from the increased surrender, the bonus annuity is sometimes, actually a more favorable purchase. see Premium Bonus - Free Money?