Does a Fixed Annuity Have an Expense Ratio?

by Leslie McClintock

The term "expense ratio" is typically used to refer to a percentage of assets under management paid to a fund or annuity subaccount adviser to compensate the fund's management for the time and expertise in picking securities on behalf of the fund shareholders. But fixed annuities don't have separate account management. Instead, they are claims on the general fund of the insurance company. As such, they don't generally have "expense ratios." But they do have other expenses that can, in some circumstances, add up to more than a typical fund or subaccount expense ratio.

Mortality and Expense Charges

Mortality and expense charges -- also called "M & E" charges -- are the result of the insurance company's expenses in marketing, distributing and administering the annuity that are passed on to annuity contract holders. This charge also helps build the company's cash reserve so that the company has the assets to guarantee its obligations to annuity owners regardless of market events.

Surrender Charges

Fixed annuities also typically impose a surrender charge on any annuities withdrawn within a certain number of years of the sale of the original contract. This is because the annuity owner does not pay a commission to the annuity salesperson; the insurance company does. The insurance company imposes the surrender charge to ensure that it recoups the cost of selling the annuity if the annuity owner wants out early.

Exceptions to Surrender Charge Periods

Some annuity contracts allow the annuity holder to withdraw up to 10 percent of the annuity contract value per year without incurring a surrender charge. You may be able to annuitize the annuity, or convert it to a stream of income payments, without incurring a surrender charge. You may also be able withdraw free of surrender charges in the event of death or disability, depending on the terms of the contract.

Variable Annuity Fees

You would normally encounter expense ratios in variable annuities, rather than fixed annuities. Variable annuities also have sales expenses that are passed on to the contract holder, and so generally charge M&E; expenses on top of the expense ratios in the annuity subaccounts. The combination of the M&E; and expense ratio charges can take a chunk out of annuity returns in flat markets; but the account holder can also buy a variety of guarantees that protect his balance against market downturns. Annuities tend to be safer than other securities for this reason but don't perform as well as uninsured securities during bull markets.

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