Should I Dump My AIG Policy?

This month, Kim Lankford answers your questions on insurance policies, IRA withdrawals, and buying investments now.

I have an insurance policy with AIG and I am concerned that the company may not be able to pay up if I have a claim. Should I be worried about the situation? Should I switch out of the policy and buy one from another company? Also, what about annuities issued by AIG? Are they safe? -- Heather Lingley, Melbourne, Fla.

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Dumping your AIG policy or annuity could be a bad move. Regulators have been hearing reports of agents and brokers trying to get people to drop coverage with AIG and switch to a policy with a new company. But that could be more beneficial to the agent, who could be paid a new commission. And you might have to cough up cancellation penalties, higher premiums or surrender charges. "Don't worry and don't make any rash decisions if you have a policy issued by an AIG insurance company," says New York State insurance superintendent Eric Dinallo. "All your covered claims will be paid and all your annuity checks will come."

AIG has several different lines of business, and they don't all deal with insurance. The insurance subsidiaries are subject to different rules, and states set strict capital requirements to make sure insurers have plenty of money to pay claims. As a result, those subsidiaries aren't suffering the same financial woes as the AIG holding company.

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A.M. Best, which rates the financial strength of insurers, gives AIG's major life-insurance subsidiaries an "A rating but under review with negative implications," which means that A.M. Best is keeping an eye on the situation. But right now, "the insurance subsidiaries have an excellent ability to pay claims," says Andrew Edelsberg, of A.M. Best. "We believe that policyholders will be paid in the long term." (Check A.M. Best ratings using the links from our insurance page.)

If you have a variable annuity, your investments are held in separate accounts that are invested in mutual funds. For instance, annuities from Vanguard, which are underwritten by AIG, are invested in Vanguard funds and wouldn't be affected by AIG's financial situation.

AIG is developing a plan to sell some of its assets, which are likely to include some of its insurance subsidiaries. In that case, your policy could end up with another insurer that's in even stronger financial shape. The new insurer can't change the premiums or other terms of your contract.

Insolvent insurers. What would happen to my insurance if AIG actually did go belly-up? -- J.F., St. Louis

First, the insurance department in the company's home stateÑNew York for many of AIG's insurance subsidiariesÑwould step in to try to rehabilitate the company. If the firm became insolvent, the state guaranty association would protect policyholders by continuing their insurance policies and paying claims, up to certain limits.

Those limits vary based on where you live. But every guaranty association must provide coverage for at least $300,000 in life-insurance death benefits per insured life; $100,000 in cash-surrender or withdrawal value for life insurance; $100,000 in withdrawal and cash values for annuities; and $100,000 in health-insurance-policy benefits. Plus, payouts on immediate annuities would continue without a break (to see your state's rules, click on the "State Association" links at Policyholders often receive even more than guaranty-association limits because their claims have priority over those of other creditors.

Mutual fund safety. Are mutual funds covered by the Securities Investor Protection Corp.? -- Linda Katz, Washington, D.C.

Not unless they're held in a brokerage account. But mutual funds are subject to strict regulations of their own.

Under the Investment Company Act of 1940, each mutual fund is organized as a company separate from the fund's management, and its assets are held by an independent custodian, usually a specialized bank. Even if the fund-management company goes bankrupt, its creditors can't touch the money in the mutual fund.

If your mutual fund shares are held in a brokerage account that goes bankrupt, they are protected by SIPC just as other securities are. A broker must segregate customers' investments from the firm's money. SIPC steps in if the broker fails and has misappropriated assets.

SIPC first tries to transfer investors' securities to another firm. If that doesn't work, SIPC attempts to rebuild investors' portfolios. SIPC first returns your share of the broker's remaining assets, then uses its own funds (up to $500,000 per account, including a $100,000 limit on cash) to buy the same shares that you originally owned.

Buy Fannie stock? Now that the federal government is supporting Fannie Mae, is this a good time to buy the company's stock? -- Michael Hall, New Orleans

No. True, the company is getting government support, but it's not coming cheap. On September 7, the Treasury Department put Fannie Mae into a conservatorship to save it from in-solvency. In return for an immediate injection of $1 billion and the promise of more help if needed, the federal government gets preferred stock paying 10% annually and the right to own 80% of Fannie Mae's common stock. Dividends for all other shareholders, both common and preferred, have been eliminated. (The same terms apply to Freddie Mac.)

In mid October, Fannie's common shares were trading for $1.08 (down from $69 a year ago) in hopes that shareholders won't be wiped out completely. But there's no guarantee of that. Nor is there any consensus on whether Fannie will emerge from the conservatorship or what form it will take. Investing now is too much of a gamble.

IRA withdrawals. My stomach just dropped as low as the stock market. I need to take $9,000 from my IRAs by the end of 2008, but I don't know which accounts to tap. I own Dodge & Cox Stock, Vanguard Star, Vanguard Dividend Growth and a Fidelity money-market fund. I plan to contribute the money to my church. Last year I took advantage of the charitable-giving tax break for required minimum distributions. Has that break been extended? -- Sarah Williams, Ponte Vedra Beach, Fla.

Yes, Congress did extend through 2009 the provision that allows some retirees to make tax-free contributions from their IRAs directly to a charity. Retirees age 70 and older are permitted to direct up to $100,000 of their required minimum distribution from an IRA to a charity without paying taxes. You can't double-dip and claim a charitable deduction for the contribution, but any money directed to a charity is not included in your adjustable gross income. A lower AGI may allow you to take advantage of other tax breaks and possibly reduce the portion of your Social Security benefits that is subject to income taxes.

As for which funds to tap first, the systematic approach would be to bring your holdings back to your targeted mix of stocks and cash. If, for example, your goal is to have 50% of your money in stock funds and the rest in money-market funds, the recent market unpleasantness means that you have far less in stocks. So you'd want to take the bulk of your distributions from your money fund. On the other hand, if watching your stocks plunge leaves you less inclined to take risks, you may want to sell some of your stock holdings.

Stable-value funds. In my 401(k) plan, I have money in Promark Income fund, a stable-value fund. How risky is this type of fund? Also, is this a good substitute for some of the bond portion in a diversified portfolio? -- Steven DeRyke, Jacksonville, Fla.

Stable-value funds sure are a lot less risky than being in the stock market. And so far, they've done a great job of maintaining their stability. David Babbel, coauthor of a study on these funds, says none has ever experienced a decline in value.

Promark Income fund, run by General Motors Asset Management, returned 5.1% over the past year through September 30 and an annualized 5.6% since its inception on December 31, 1998. A spokesman says the fund invests in a full spectrum of fixed-income instruments, including money-market funds and corporate bonds. As with all stable-value funds, principal is guaranteed by a "wrapper" from an insurance company. In this specific case, three double-A-rated insurers guarantee the fund's value.

Babbel says three safeguards "act as a pretty good safety net to keep stable-value stable": the funds' own investment guidelines, the accounting standards the funds use, and the insurance company's credit-quality requirements.

Babbel's study, which examined these funds from their inception in 1989 through 2007, found that they typically outperformed money-market funds and intermediate-term government-bond funds while delivering a guaranteed quarterly return. So you could use Promark Income for a portion of your bond investments. Keep in mind, though, that with global financial markets in turmoil, any promise of 100% stability has to be taken with at least a tiny bit of skepticism.

My thanks to Mary Beth Franklin, Joan Goldwasser, David Landis and Manny Schiffres for their help this month.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.