Profile Facts: life annuity

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Tuesday, October 26

Life annuity

A life annuity is a financial contract in the form of an insurance product according to which a seller (issuer) — typically a financial institution such as a life insurance company — makes a series of future payments to a buyer (annuitant) in exchange for the immediate payment of a lump sum (single-payment annuity) or a series of regular payments (regular-payment annuity), prior to the onset of the annuity.,

Life annuity in United States,

The payment stream from the issuer to the annuitant has an unknown duration based principally upon the date of death of the annuitant. At this point the contract will terminate and the remainder of the fund accumulated forfeited unless there are other annuitants or beneficiaries in the contract. Thus a life annuity is a form of longevity insurance, where the uncertainty of an individual's lifespan is transferred from the individual to the insurer, which reduces its own uncertainty by pooling many clients. Annuities can be purchased to provide an income during retirement, or originate from a structured settlement of a personal injury lawsuit.,

History of Life annuity,

The instrument's evolution has been long and continues as part of actuarial science. Medieval German and Dutch cities and monasteries raised money by the sale of life annuities, and it was recognized that pricing them was difficult. The early practice for selling this instrument did not consider the age of the nominee, thereby raising interesting concerns.These concerns got the attention of several prominent mathematicians over the years, such as Bernoulli, de Moivre, Huygens, Halley and others. Even Gauss and Laplace had an interest in matters pertaining to this instrument.

Continuing practice is an everyday occurrence with well-known theory founded on robust mathematics, as witnessed by the hundreds of millions worldwide who receive regular remuneration via pension or the like. The modern approach to resolving the difficult problems related to a larger scope for this instrument applies many advanced mathematical approaches, such as stochastic methods, game theory, and other tools of financial mathematics.

Phases of an annuity

There are two possible phases for an annuity:

* The accumulation phase in which the customer deposits and accumulates money into an account, and ;

* The distribution phase in which the insurance company makes income payments until the death of the annuitants named in the contract.

It is possible to structure an annuity contract so that it has only the distribution phase; such a contract is called an immediate annuity.

Annuity contracts with a deferral phase—deferred annuities—are essentially two phase annuities, but only having growth of capital by investment in the accumulation phase (now the deferral phase), with no customer deposits.

The phases of an annuity can be combined in the fusion of a retirement savings and retirement payment plan: the annuitant makes regular contributions to the annuity until a certain date and then receives regular payments from it until death. Sometimes there is a life insurance component added so that if the annuitant dies before annuity payments begin, a beneficiary gets either a lump sum or annuity payments.

Life annuity Decision to defer or not

The option to defer purchase of an annuity (income drawdown) has the benefit of investment flexibility, offset by the risk of falling annuity rates as the life expectancy of the surviving individual rises (mortality drag). Interest rates and inflation can affect the decision to purchase, as they are reflected in the annuity rates, and also affect secure investment potential by varying bond yields. Inflation deteriorates the buying power of an annuity and can therefore be a concern.,

Types of life annuity,

With the complex selection of options available, consumers can find it difficult to decide rationally on the right type of annuity product for their circumstances.,

Fixed and variable annuities,

Annuities that make payments in fixed amounts or in amounts that increase by a fixed percentage are called fixed annuities. Variable annuities, by contrast, pay amounts that vary according to the investment performance of a specified set of investments, typically bond and equity mutual funds.

Variable annuities are used for many different objectives. One common objective is deferral of the recognition of taxable gains. Money deposited in a variable annuity grows on a tax-deferred basis, so that taxes on investment gains are not due until a withdrawal is made. Variable annuities offer a variety of funds ("subaccounts") from various money managers. This gives investors the ability to move between subaccounts without incurring additional fees or sales charges.

Guaranteed annuities

With a "pure" life annuity an annuitant may die before recovering the value of their original investment in it. If the possibility of this situation, called a "forfeiture", is not desired, it can be ameliorated by the addition of an added clause, forming a type of guaranteed annuity, under which the annuity issuer is required to make annuity payments for at least a certain number of years (the "period certain"); if the annuitant outlives the specified period certain, annuity payments then continue until the annuitant's death, and if the annuitant dies before the expiration of the period certain, the annuitant's estate or beneficiary is entitled to collect the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that in exchange for the reduced risk of loss, the annuity payments for the latter will be smaller.

Joint annuities

Multiple annuitant products include joint-life and joint-survivor annuities, where payments stop upon the death of one or both of the annuitants respectively. For example, an annuity may be structured to make payments to a married couple, such payments ceasing on the death of the second spouse. In joint-survivor annuities, sometimes the instrument reduces the payments to the second annuitant after death of the first.

Impaired life annuities

There has also been a significant growth in the development of Impaired Life annuities. These involve improving the terms offered due to a medical diagnosis which is severe enough to reduce life expectancy. A process of medical underwriting is involved and the range of qualifying conditions has increased substantially in recent years. Both conventional annuities and Purchase Life Annuities can qualify for impaired terms.,

Annuities by region,

Life annuity in United States,

With a "single premium" or "immediate" annuity, the "annuitant" pays for the annuity with a single lump sum. The annuity starts making regular payments to the annuitant within a year. A common use of a single premium annuity is as a destination for roll-over retirement savings upon retirement. In such a case, a retiree withdraws all of the money he/she has saved during working life in, for example, a 401(k) (tax-advantaged) savings vehicle, and uses the money to buy an annuity whose payments will replace the retiree's wage payments for the rest of his/her life. The advantage of such an annuity is that the annuitant has a guaranteed income for life, whereas if the retiree were instead to withdraw money regularly from the retirement account (income drawdown), he/she might run out of money before death, or alternatively not have as much to spend while alive as could have been possible with an annuity purchase.

The disadvantage of such an annuity is that the election is irrevocable and, because of inflation, a guaranteed income for life is not the same thing as guaranteeing a comfortable income for life.,

life annuity in United Kingdom,

In the UK the conversion of pension income into an annuity is compulsory by the age of 75, and has led to a large market for annuities of various types. The most common are those where the source of the funds required to buy the annuity is from a pension scheme. Examples of these types of annuity, often referred to as a Compulsory Purchase Annuity, are conventional annuities, with profit annuities and unit linked, or "third way" annuities. Annuities purchased from savings (i.e. not from a pension scheme) are referred to as Purchase Life Annuities and Immediate Vesting Annuities. In October 2009, the International Longevity Centre-UK published a report on Purchased Life Annuities (Time to Annuitise) which argued that the PLA market might benefit up to 1.3 million individuals in the UK. Yet, less than 160,000 life annuities are in force with the number of policies having fallen by 65% in 10 years and new business in 2008 amounted to fewer than 1000 sales of life annuities

In the UK it has become common for life companies to base their annuity rates on an individual's location. Legal & General may have been the first company to do this.,

life annuity Internationally,

Some countries developed more options of value for this type of instrument than others. However, a recent study reported that some of the risks related to longevity are poorly managed "practically everywhere". Longevity insurance is now becoming more common in the UK and the U.S. (see Futures) while Chile, in comparison to the U.S., has had a very large life annuity market for 20 years.

Future of annuities

It is expected that the aging of the boomer generation in the US will increase the demand for this type of instrument and how it might be optimized for the annuitant; this growing market will drive improvements necessitating more research and development of instruments plus increase insight into the mechanics (including dynamics in more than the sense of the dynamical system) involved on the part of the buying public. An example of increased scrutiny and discussion is that related to privatization of part of the U.S. Social Security Trust Fund.

See also

LendingTree ,

Disability ,

Asset-backed security ,

Lump-sum ,

Distortion (economics) ,

In actuarial science, the actuarial present value ... ,

Structured Settlements in the United States,

(source:wikipedia)

Structured Settlements in the United States

A structured settlement is a financial or insurance arrangement, including periodic payments, that a claimant accepts to resolve a personal injury tort claim or to compromise a statutory periodic payment obligation. Structured settlements were first utilized in Canada and the United States during the 1970s as an alternative to lump sum settlements. Structured settlements are now part of the statutory tort law of several common law countries including Australia, Canada, England and the United States. Structured settlements may include income tax and spendthrift requirements as well as benefits and are considered to be an asset backed security. Often the structured settlement will be created through the purchase of one or more annuities, which guarantee the future payments. Structured settlement payments are sometimes called “periodic payments” and when incorporated into a trial judgment is called a “periodic payment judgment." This is also called a coupon for a regular bond.

Structured Settlements in the United States

The United States has enacted structured settlement laws and regulations at both the federal and state levels. Federal structured settlement laws include sections of the (federal) Internal Revenue Code. State structured settlement laws include structured settlement protection statutes and periodic payment of judgment statutes. Medicaid and Medicare laws and regulations affect structured settlements. To preserve a claimant’s Medicare and Medicaid benefits, structured settlement payments may be incorporated into “Medicare Set Aside Arrangements” “Special Needs Trusts."

Structured settlements have been endorsed by many of the nation's largest disability rights organizations, including the American Association of People with Disabilities and the National Organization on Disability.

In April 2009, financial writer Suze Orman wrote in a column that structured settlements "provide ongoing income and reduce the risk of blowing a Lump sum through poor financial choices." In response to a reader's question, she added that financial security can be improved "if you use the structured payouts wisely.",

Structured Settlements Definitions,

A definition of “structured settlement” can be found in Internal Revenue Code Section 5891(c)(1) (26 U.S.C. § 5891(c)(1)), which states that a structured settlement is an "arrangement" that meets the following requirements:

* A structured settlement must be established by:

o A suit or agreement for periodic payment of damages excludable from gross income under Internal Revenue Code Section 104(a)(2) (26 U.S.C. § 104(a)(2)); or

o An agreement for the periodic payment of compensation under any workers’ compensation law excludable under Internal Revenue Code Section 104(a)(1) (26 U.S.C. § 104(a)(1)); and

* The periodic payments must be of the character described in subparagraphs (A) and (B) of Internal Revenue Code Section 130(c)(2) (26 U.S.C. § 130(c)(2))) and must be payable by a person who:

o Is a party to the suit or agreement or to a workers' compensation claim; or

o By a person who has assumed the liability for such periodic payments under a qualified assignment in accordance with Internal Revenue Code Section 130 (26 U.S.C. § 130).

It is important to note that the language immediately prior to Internal Revenue Code Section 5891(c)(1) states that the definition that appears there is "for the purposes of this section". Internal Revenue Code Section 5891 entitled "Structured Settlement Factoring Transactions" deals with the excise tax imposed on the "factoring discount" (see IRC 5891(c)(4)), when there is a purchase of structured settlement payment rights and the exceptions to the excise tax. A number of structured settlement industry commentators have been observed attempting to broaden the express language that appears in the Internal Revenue Code.,

Structured Settlements Legal Structure,

The typical structured settlement arises and is structured as follows: An injured party (the claimant) settles a tort suit with the defendant (or its insurance carrier) pursuant to a settlement agreement that provides that, in exchange for the claimant's securing the dismissal of the lawsuit, the defendant (or, more commonly, its insurer) agrees to make a series of periodic payments over time. The defendant, or the property/casualty insurance company, thus finds itself with a long-term payment obligation to the claimant. To fund this obligation, the property/casualty insurer generally takes one of two typical approaches: It either purchases an annuity from a life insurance company (an arrangement called a "buy and hold" case) or it assigns (or, more properly, delegates) its periodic payment obligation to a third party ("assigned case") which in turn purchases a "qualified funding asset" to finance the assigned periodic payment obligation. Pursuant to IRC 130(d) a "qualified funding asset" may be an annuity or an obligation of the United States government.

In an unassigned case, the defendant or property/casualty insurer retains the periodic payment obligation and funds it by purchasing an annuity from a life insurance company, thereby offsetting its obligation with a matching asset. The payment stream purchased under the annuity matches exactly, in timing and amounts, the periodic payments agreed to in the settlement agreement. The defendant or property/casualty company owns the annuity and names the claimant as the payee under the annuity, thereby directing the annuity issuer to send payments directly to the claimant. If any of the periodic payments are life-contingent (i.e., the obligation to make a payment is contingent on someone continuing to be alive), then the claimant (or whoever is determined to be the measuring life) is named as the annuitant or measuring life under the annuity.

In an assigned case, the defendant or property/casualty company does not wish to retain the long-term periodic payment obligation on its books. Accordingly, the defendant or property/casualty insurer transfers the obligation, through a legal device called a qualified assignment, to a third party. The third party, called an assignment company, will require the defendant or property/casualty company to pay it an amount sufficient to enable it to buy an annuity that will fund its newly accepted periodic payment obligation. If the claimant consents to the transfer of the periodic payment obligation (either in the settlement agreement or, failing that, in a special form of qualified assignment known as a qualified assignment and release), the defendant and/or its property/casualty company has no further liability to make the periodic payments. This method of substituting the obligor is desirable for defendants or property/casualty companies that do not want to retain the periodic payment obligation on their books. A qualified assignment is also advantageous for the claimant as it will not have to rely on the continued credit of the defendant or property/casualty company as a general creditor. Typically, an assignment company is an affiliate of the life insurance company from which the annuity is purchased.

An assignment is said to be "qualified" if it satisfies the criteria set forth in Internal Revenue Code Section 130 . Qualification of the assignment is important to assignment companies because without it the amount they receive to induce them to accept periodic payment obligations would be considered income for federal income tax purposes. If an assignment qualifies under Section 130, however, the amount received is excluded from the income of the assignment company. This provision of the tax code was enacted to encourage assigned cases; without it, assignment companies would owe federal income taxes but would typically have no source from which to make the payments.,

Structured Settlements Appears In,

* JG Wentworth is the largest buyer of structured settlements in the US. The company is best known for the "Opera" commercial that appeared in early 2010 on most cable channels in the continental United States. J.G. Wentworth's commercials are often considered to be over the top and many parodies have been born from it ever since.,