Insurance Continuing Education – Annuitization of Annuities

Annuitization is the even distribution of both principal and interest, or growth of the annuity, over a specified period of time. There is a distinct advantage to annuitization inasmuch as the disbursements are tax-favored. Those situations where funds are sporadic, the tax-favorable status does not apply.Annuitization is allowed under nearly all annuity contracts. When the annuity is annuitized, the owner of the contract makes the decision as to how to receive the funds, i.e. what will be the mode of payment (monthly, semi-annually, annually, quarterly, etc.). Variable contracts and fixed rate contracts may be annuitized.There is a disadvantage to annuitization. Once the annuitization procedure has been established, it cannot be changed (except for a very few exceptions). There can also be a disadvantage if a Variable Annuity is annuitized. In those cases, the amount of the check will vary, depending upon the results of the sub-accounts selected and the amount of money allocated to these sub-accounts. With a Variable Annuity, the investment “ups-or-downs” are risks of the person receiving the checks, which is usually the contract owner/annuitant, and is not that of the insurer.Obviously, and as discussed in more detail later, the more “aggressively” the money is invested, the less predictable is the payout stream. On the flip-side, if the annuity funds are invested in short-term bonds, utilities or money market sub-accounts, the more predictable the income will be from time to time.Another possible disadvantage for annuitizing a fixed rate annuity is that the amount of each check depends upon the competitiveness of the insurer, what the current rates happen to be at that time, the duration of the withdrawals, and of course, the principal amount annuitized.MORTALITY & ANNUITY TABLESThose in the life insurance industry are familiar with mortality tables, at least in concept. Basically a mortality table represents a record of the number of persons dying and those surviving at each age out of a composite of a large number of lives. In other words, a mortality table is a chart that shows the rate of death at each age in terms of number of deaths per thousand. It shows a hypothetical group of individuals beginning at a certain age and traces the history of the entire group year by year until all have died.The mortality tables based on life insurance experience are not suitable for use in the development of rates for annuities for several reasons:1. Generally, annuities are purchased by persons in poor health.
2. Especially with single premium immediate annuities, the rates of mortality among annuitants are generally lower than those insured covered by life insurance policies. Therefore, a life insurance table would overstate expected mortality rates.
3. While the continual improvement in mortality rates, even though offset occasionally by unanticipated developments (such as AIDs), creates a gradually increasing margin of safety for life insurance companies, it has just the reverse effect on annuities.Therefore, an annuity table must show the lower rates of mortality that can be expected in the future instead of a table showing rates that have been experienced in the past. Technically, these are called “Tables with Projection.” as opposed to “static” tables used for life insurance which did not provide for changes in rates depending upon the calendar year to which they were applied.While life insurance has reaped the benefit of improving mortality, in annuity policies the improving mortality has led to smaller margins as the “postponement” of death means more annuity payments and annuity tables in use today usually contain projection factors that make allowance for future reductions in mortality rates. The need for such calculations is particularly important in variable annuities because this portion of the annuity business is growing and there is no interest margin to help offset mortality losses that develop.To further complicate this discussion, there are annuity tables that are used for different purposes. For instance, the 1949 Annuity Table was developed to reflect steady improvement in mortality; the 1955 Annuity Table was developed to help determine the proper rates for annual-premium deferred annuities and live income settlement options. In 1971 the Group Annuity table was developed for the (at that time) time field of group annuities. Presently, the 2009 Annuity Basic Mortality Table has been endorsed by the Society of Actuaries to be used for individual annuities written in the U.S. but it is an extension of the 1983 Individual Annuity Mortality Table.