INS312 Chapter 24
Nature of Annuities
+ Comparison with life insurance - Annuity is "insurance in reverse" - "Upside-down" life insurance - Living "too long" vs. Dying "too soon" - Different mortality table used for annuities and life insurance. Annuitants live longer. - Safety built in to annuity mortality tables by adding to life expectancies of annuitants (lowering mortality rates). Opposite for life insurance.
Number of lives covered
+ Single + Joint + Joint and survivor
Joint life annuity
- "first-to-die"- pays until first of two (or more) annuitants die. +Not commonly used. - Joint-and-last survivor annuity: pays until both annuitants die. + Very common Estate option. - Can combine with other refund options, like joint and survivor, 10 years certain. - Can choose payout with lesser amount for survivor - eg. Life annuity with 50% survivor
Deferred Annuities
- Accumulation period (deferral) + Upon death, greater of gross premium without interest, or cash value (before annuitization begins) * whichever is LARGER. + Cash surrender provision : terminate contract, withdraw full cash value (minus surrender charges) . - Liquidation period + Annuitization (payout period) + Can elect to commence before or after specified date.
Actuarial Considerations
- Annuity mortality tables different than life insurance (Better longevity - lower mortality) + Focus on surviving lives and longevity. + Improving mortality is bad for annuities. + Women enjoy greater longevity. + Sick people don't buy annuities, healthy people do (adverse selection).
Annuity units (Variable annuities)
- Exchange accumulation units for annuity units at liquidation. + Number of units is fixed and revalued annually, reflecting current experience. + Number of units results from company assumptions regarding mortality, expense and market value. + Income payable determined by multiplying number of units times current annuity unit value.
Immediate
- First payment comes 1 full payment period after purchase.
Deferred
- First payment comes more than 1 full payment period after purchase. + Often purchased with periodic payments over time.
Variable Annuities
- Guarantees popular today- GMIB, GMAB, GMWB. +Some companies leaving market or reducing guarantees, due to low interest and cost of derivatives backing the guarantees.
Time when payments begin
- Immediate - Deferred
Pure annuities
- Lifetime benefit only, no refunds or benefits after annuitant dies. + Largest payment (smallest premium).
Classification of Annuities
- Method of premium payment + Single premium + Installments -Nature of insurer's obligation (time when payments stop) + Pure annuity (straight life, life-no refund) + Refund annuities - cash and installment - Type of Benefits + Fixed dollars + Variable dollars (accumulation and annuity units)
Equity Indexed Annuities
- Participation rate (percentage of index increase) - Cap rate (maximum crediting rate) - Crediting floor (minimum crediting rate): minimum rate is guaranteed - Many methods for calculating contract value at end of term - Indexes: S&P most common (many others) - SEC regulation- Rule 151A - Dodd-Frank financial reform ruled this is not a variable product subject to SEC regulation
Structured Settlements
- Payouts in personal injury and wrongful death cases. - Annuity can provide lifetime income for the injured party, using a human life value approach. - Annuity provides financial security to injured party, benefits can match needs, funds are managed and payments guaranteed.
The Annuity Principle
- Pooling: those dying early pay for those living longer - Law of Large Numbers: reflect assumed mortality of premium calculation -Mortality, Interest, Expense: elements of premium (similar to life insurance) - Periodic payments + Fixed time (annuity certain no life contingency) + Life contingency (life annuity) + Payments consist of both principal and interest
Immediate Annuities
- Pure annuities - Refund annuities
Refund annuities
- Return some or all of purchase price. + The longer the guarantee or expectation of payments, the smaller the payment (larger the premium). - Life certain (10-years certain) - Installment refund (full cost recovery over time) - Cash refund (full cost recovery as lump sum)
Accumulation units (Variable annuities)
- vary by market performance (appreciation or depreciation). + like Net Asset Value (NAV) or share prices of stock. + total market value divided by number of shares.
"Pooling" is a factor in life insurance but has no importance in annuities.
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A characteristic (disadvantage) of a joint-an-last survivor annuity is that it must be purchased with a single premium
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If Joe and Maria purchase a joint-and-survivor annuity and Joe died after 5 years, payments would continue to Maria until her death and to her beneficiary after Maria's death.
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Payments from an immediate straight life annuity will continue for at least 10 years after the death of the annuitant
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A life annuity certain is always more expensive per dollar of income than a straight life annuity, all other things being equal.
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A life annuity certain will pay a designated number of payments whether the primary annuitant lives or dies
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A pure (or Straight) life annuity provides the maximum amount of income per dollar of outlay (premium).
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Annuities can be used to both accumulate funds and then to liquidate those funds over an annuitant's remaining lifetime.
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Life certain (10-years certain)
— More expensive than straight life annuity