Lessons from the Baldwin annuity failure

They're picking up the pieces of the Baldwin-United Corporation. Brokers, lawyers, and regulators are working out solutions aimed at restoring the millions of dollars invested in single-premium deferred annuities (SPDAs) offered by Baldwin-United and six of its insurance subsidiaries. It appears they will restore all the $4.2 billion in principal and most of the interest lost by 165,000 investors as a result of one of the worst financial service debacles in this decade.

Last week, insurance regulators and attorneys general from 37 states agreed to coordinate efforts to recover losses suffered by holders of Baldwin-United annuities. The officials will file civil lawsuits or take administrative action aganist brokers who sold the policies.

A few weeks earlier, 12 of the largest brokerage houses announced a $135 million settlement of class-action suits filed by Baldwin customers. Three other brokerages are negotiating to buy the insurance units of Charter Corporation, an oil service company that introduced SPDAs but was later forced to file for bankruptcy.

Now, these same people are asking what lessons have been learned and how people can avoid putting their retirement savings into annuity products from companies they're apt to read about in the newspapers one day.

The SPDA, on which earnings on a lump-sum deposit grow without current taxes, was a ''creation of the brokerage industry'' in the late 1970s, says C. R. Harmon, president of Harmon Financial Management Inc., a financial planning firm in Newton, Mass. Although brokers may have invented it, the SPDA was warmly embraced by insurance companies and other firms that could see handsome profits from being able to hold $20,000, $50,000, $100,000 or more for several years, even with the very respectable interest rates they offered.

The problems came, Mr. Harmon and others say, when companies like Baldwin began using SPDA assets to prop up nonrelated ventures. Partly for this reason, brokers and financial planners are learing to be more skeptical about insurance company ratings provided by A. M Best's, the independent firm that assigns letter ratings, much as Moody's and Standard & Poor's rate corporate and municipal bonds. At the height of its annuity sales, Baldwin-United had an ''A'' rating from Best's, only one step below the top rating of A+.

Even with a high rating, ''you have to do your own digging,'' says Mary Malgoire, a financial planner in Washington. ''You can't just trust the recommendation of an agent or broker. ... I feel pretty strongly that anyone who cannot investigate a company and get an independent evaluation should not invest in these.''

In an interview, she and her partner, David Drucker, agreed that the SPDA is basically a good product - provided it is sold by a company with experience in annuities (preferably an insurance company) and provided SPDA assets are totally ''segregated,'' or kept separate from the rest of the company's business. This requires the investor to look into the company occasionally, look at annual reports, and find out how and where SPDA assets are invested.

You should, of course, get this information before purchasing the annuity and you should expect the broker or agent to help. ''Put some responsibility on him'' to provide this information, Mr. Drucker said.

Although people should not rely only on the Best's rating, Ms. Malgoire says, as long as the ratings are being used you might as well go for the top: ''Look only at A+-rated companies.''

Perhaps, Harmon says, you should not be buying SPDAs at all, especially considering the tax consequences. Unlike some other retirement-saving products, the income from an SPDA is not eligible for 10-year forward averaging at withdrawal. This means you cannot dilute the taxable effect of the payments by spreading its effect over 10 years.

Instead, Harmon points out, all income from the SPDA is taxed as ordinary income in the year you make the withdrawal. With some SPDAs promising to quadruple your investment in 15 to 20 years, that tax bite could wipe out any advantage you gained from having your money tied up so long.

Before putting money into an SPDA, Harmon believes people should ask what they are saving for. If it is retirement, some of that money could go into an individual retirement account, or a Keogh if you have self-employment income. Or you might see if your employer offers a 401(k) salary reduction plan. Both IRA and 401(k) income are eligible for 10-year forward averaging.

You might also consider municipal bonds or a tax-exempt bond fund. ''The yields on these are very close to the yields on annuities,'' Harmon says. ''Yes, you have market risk, but you don't have tax risk. With SPDAs, you have tax risk and corporate risk.''

In the long run, the current process that appears to be restoring at least the initial investment of Baldwin-United and Charter customers is a primary reason the SPDA should not be abandoned completely, says Daniel Perkins, vice-president for marketing at Integrated Capital Services. Integrated recently began selling a fully segregated SPDA that allows investors to choose any or all of four investment options offered by Wellington Management Company, a well-regarded mutual fund. One option is a fund that only invests in US government-backed securities, now paying 121/2 to 13 percent.

Before joining Integrated Capital, Perkins held a similar position at Merrill Lynch & Co., where he was in charge of marketing Baldwin's SPDAs.

''No policyholder ever lost a dime in these products,'' he asserts. ''Can people who bought what were supposed to be guaranteed bonds from Washington Public Power say the same thing?''

Perhaps not, but many Baldwin and Charter customers lost a lot of sleep and had to worry about their investment for over a year. To avoid this, a thorough checking of financial goals and the companies selling products to meet these goals seems well worth the effort.