Principles of Annuities

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1 While a great deal of care has been taken to provide accurate and current information, the ideas, suggestions, general principles and conclusions presented in this text are subject to local, state and federal laws and regulations, court cases and any revisions of the same. The student is thus urged to consult legal counsel regarding any points of law. This text should not be used as a substitute for competent legal advice. This book is the property of Insurance Schools, Inc. Any unauthorized use or duplication of this study manual is strictly prohibited. Stephen Fineman, CLU, ChFC, LUTCF Insurance Schools, Inc. Continuing Education Systems 5512 Big Tyler Road PO Box 7280 Charleston, WV (304) (800) /14

2 Table of Contents I. Introduction to Annuities 1 II. Annuities in the Financial Marketplace 3 III. The Structure of Annuity Contracts 7 IV. Phases of Annuity Contracts 11 V. Risks Assumed by the Insurer 17 VI. Primary Types of Annuity Contracts 19 VII. Riders on Annuity Contracts 55 VIII. Taxation of Annuity Products 63 XI. Retirement Accounts 69 X. Specialized uses of Annuity Contracts 79 XI. Considerations when Purchasing Annuity Products 82 XII. Conclusion 85 TOC - i

3 I. Introduction to Annuities Annuities are fast becoming one of the most popular and versatile investment products to help individuals and businesses meet their financial objectives. Annuities have distinct features that enable an investor to help in funding a retirement, provide an income stream that can never be outlived as well as conserve and create an individual s estate. Annuities offer the investor guarantees that no other investment product can offer. In 2012, approximately $219 billion dollars were invested in annuities and the number is expected to increase in the coming years. This influx of money is mainly due to the large number of baby boomers who will be retiring or receiving inheritances. Annuities are diverse contracts which can meet almost any financial goal. Annuities are complex investment products and this course will explain in detail how they operate, the different types of contracts that can be purchased and when their use is indicated. Historical Background The use of annuities, although not in their present form, dates back to the Roman Empire. In return for giving the emperors a lump sum of money, an individual would receive an annua or annual stipend for a stated number of years or for the investor s lifetime. In addition, the Roman soldiers were compensated in the form of an annua. Roman speculator and jurist Gnaeus Domitius Annius Ulpianis was the originator of the annua and is said to have created the first actuarial life table. In the middle ages, annuities were used by the feudal lords and kings to help finance the heavy cost of warfare. Individuals would contribute a sum of money to the government and receive a tontine which provided an income until the individual s death. There were only a set number of tontine holders, and whatever money remained was paid to the last surviving holder in a lump sum. This was appealing to the holders since there was a potential to receive a large amount of money as well as a lifetime income. In 1759, annuities were introduced in the United States by a group of church leaders and congregants in Pennsylvania who pooled their money together to provide ministers and their families an income during retirement. This was considered the forerunner of current day Social Security retirement benefits

4 Benjamin Franklin was a believer in annuities and left the cities of Boston and Philadelphia a yearly income for an indefinite period of time. In Boston, the annuity payments continued until 1990 when the payments were finally commuted to a lump sum. During the civil war, Abraham Lincoln compensated injured and disabled soldiers by offering them annuities or land. The first commercial annuities were sold by a Pennsylvania company in1812 but were not well accepted since the elderly population was supported by their extended families. Executors of estates purchased annuities, to pay the beneficiaries of the deceased a reliable source of income. After the stock market crash of 1929, annuities gained in popularity by the investing public due to their inherent guarantees and safety. To counteract the impact of inflation and subsequent purchasing power risk, variable annuities were established in 1952 by the Teachers Insurance and Annuities Association, TIAA-Cref. Today annuities are highly regulated financial instruments that are sold by a multitude of insurance companies nationwide

5 II. Annuities in the Financial Marketplace Retirement Planning Annuities may be purchased to meet a variety of financial needs but are predominately used in retirement planning. Retirement is by far one of the most important life stages for which one needs to plan. There is a substantial cost to support a comfortable retirement and the following statistics show why the need for funding a retirement is so important. The average savings of a 50 year old is $43,797. There are 6,000 people turning age 65 each day. 30% of older adults are now being supported by their children. Life expectancy has increased by 10 years which means an additional 120 monthly income payments are needed. The average retiree will need approximately $255,000 to pay for health care costs. 35% of Americans over the age of 65 rely almost entirely on Social Security benefits. 80% of people between the ages of 30 and 54 will not have enough money saved for retirement. A large percentage of baby boomers do not have a traditional pension plan. 36% of Americans do not contribute to a retirement plan. The average retirement age is now 62 with a length of 18 years. As shown in the above statistics, the vast majority of Americans are unprepared for retirement and have a significant income shortage. Annuities can help in increasing a retiree s income. Annuities have several characteristics that make it a preferred financial product in retirement planning. Tax Deferred Growth In addition to the income guarantees, annuities have unique properties which make them a preferred investment to accumulate funds for future needs. One of the most important attributes of an annuity is that it accumulates money on a tax deferred basis, until that money is withdrawn. The money invested in an annuity will increase in value more substantially than a taxable investment, because the money that would need to be used to pay taxes is still accumulating and earning compound interest. For example, if an investor - 3 -

6 had to withdraw $100 to pay taxes on investment income received, the $100 will no longer be available in the account to earn interest. If on the other hand, the $100 stayed in the account earning compound interest of 7.2%, the $100 would grow to $200 in 10 years. If the interest stayed the same, the $200 would grow to $400 in an additional 10 years. The greater amount of money invested will increase the compounding effect proportionately. The following is a table comparing taxable and tax deferred investments over a period of years

7 Growth of a Tax Deferred Investment of $5,000 vs. After Tax Investment of $3,750 (25% Tax Rate) (Compounded at 6% Annually) Growth of Tax Deferred Growth of After Tax Investment Investment of $5,000/Yr Investment of $3,750/Yr Years of (Balance at year end with (Balance at year end with Investing Age Purchase made yearly on Jan. 1 st ) Purchase made yearly on Jan 1 st ) Difference 1 30 $ 5,300 $3,975 $1, ,918 8,189 2, ,873 12,655 4, ,185 17,389 5, ,877 22,407 7, ,969 27,727 9, ,487 33,366 11, ,457 39,342 13, ,904 45,678 15, ,858 52,394 17, ,350 59,512 19, ,411 67,058 22, ,075 75,056 25, ,380 83,535 27, ,363 92,522 30, , ,048 34, , ,146 37, , ,850 40, , ,196 44, , ,223 48, , ,971 52, , ,484 57, , ,808 62, , ,992 67, , ,086 72, , ,147 78, , ,230 84, , ,399 90, , ,718 97, , , ,752 This is for illustrative purposes only and is not indicative of any investment. The data assumes reinvestment of all income and does not account for taxes or transaction costs. Investment products are not FDIC insured, may lose value and have no bank guarantee

8 Annuities in Estate Planning Not only can annuities create wealth, but they can also play an important role in conserving an individual s estate from taxes and administrative costs upon death. One of the major advantages of annuities over other investments is the owner s right to name a beneficiary upon the annuitant s death. By having a named beneficiary, the proceeds will not be subject to probate administration which can be costly and time consuming for the heirs. Probate is the process of proving a person s will under the jurisdiction of the probate court. Upon the annuitant s death, the cash value of the annuity or death benefit, if greater, is paid to the beneficiary after a claim is filed. If the death claim value of the account would have been subject to probate administration, there would have been probate fees ranging from 1% to 3% of the account s value and the cost for the services of an attorney, if needed. In addition, no money can be released to the beneficiaries without a court order until the estate is closed, which potentially can be a lengthy period of time. Annuities are also utilized as an advanced estate planning tool to help minimize the federal estate tax due at a person s death. The government will impose a federal estate tax on a descendant s estate that is currently valued over $5,250,000, if the estate property is transferred to a non-spousal beneficiary. The use of specialized annuity products will minimize the value of a person s estate and provide the annuitant with an income that cannot be outlived

9 III. The Structure of Annuity Contracts Parties to an Annuity Contract An annuity is a financial product designed to accumulate funds on a tax deferred basis as well as provide a systematic liquidation of the principle. Upon payout, it provides the owner/annuitant a guaranteed lifetime income that cannot be outlived. The following are the four parties that comprise the annuity contract. The Insurer - The insurer is the party that issues the annuity contract. Due to their inherent guarantees, annuity contracts can only be issued by insurance companies. There are a multitude of insurance companies issuing annuities with a variety of types, benefits, structures and costs. The contract is between the insurance company and the owner of the annuity and is referred to as a unilateral and adhesive contract. Since the insurance company is the only party of the contract that makes specific promises, it is considered a unilateral contract. The contract is written solely by the insurance company and is non negotiable which makes it a contract of adhesion. If there is any ambiguous language, the courts will always favor the annuity contract owner. The provisions, promises and conditions between the owner and issuer are contained in the contract. The insurance company must be properly registered and have a certificate of authority (license) to operate in the state in which the contract will be written. All representatives of the company who are responsible for sales of the product must be properly licensed for the type of annuity being marketed. The Contract Owner - The contract owner is the party that has all ownership interests, signs the application, names the annuitant as well as the beneficiary and decides on the type, structure and benefits of the annuity to be purchased. The contract owner can be an individual, business entity or trust and is the entity that funds the contract as well as receives the benefits

10 The Annuitant - The annuitant is the individual on whose life expectancy the guaranteed lifetime income and other benefits will be calculated. It is the responsibility of the owner to select the annuitant. The insurance company refers to this person as the measuring life in regards to the calculation of benefits. The annuitant must be a natural person and not any other entity since benefits are based on life expectancy. For example, a corporation could not be the annuitant since it has an unlimited life. The annuity will remain in force until the contract owner surrenders the contract or the annuitant dies. The annuitant is similar to the insured in a life insurance policy. Unless the annuitant is the contract owner, he or she has no control of the annuity contract but must sign the annuity application. Currently, most insurance companies will not issue the contract for an annuitant age 85 or older; however, there is a trend to begin accepting annuitants over this age due to the rising life expectancy. With the vast majority of annuities being issued, the annuitants are also the owners of the contract. This form of ownership is preferable due to the ease of administration and gift tax implications. The Beneficiary - The beneficiary is the person who will receive the annuity proceeds upon the owner s death. The beneficiary can be an individual, trust or other business entity. There can be any number of beneficiaries listed in different classes. The primary beneficiaries are the class which receives the proceeds first. If no primary beneficiaries are living, the proceeds will be payable to the second class or contingent beneficiaries, if designated in the contract. If no contingent beneficiaries have been designated, the proceeds will be payable to the owner s estate and will be subjected to probate administration. For multiple beneficiaries in a class, an owner can stipulate the amount of proceeds they are entitled to receive. For example, an owner can name his or her two sons, Joe and John as the primary beneficiaries with Joe receiving 75% of the proceeds and John 25%. The beneficiary designation can be either revocable or irrevocable. With a revocable beneficiary designation, the owner has the right to change the beneficiary at any time. Conversely, if the designation is irrevocable, the owner cannot change the beneficiary designation or make other contractual changes without the consent of the beneficiary

11 Unlike life insurance, the owner will very rarely name an irrevocable beneficiary in an annuity contract. The irrevocable beneficiary is mainly used when ordered by the court such as in a divorce decree on retirement accounts for a married participant. If the owner and annuitant are different persons, the owner is usually named as the beneficiary. There are some contracts written to allow the beneficiary to continue the contract as the new annuitant and defer any taxes which might be owed upon the annuitant s death. Owner and Annuitant Driven To further explain the role of the annuitant and owner, it is important to note that annuities can either be owner driven or annuitant driven. If the annuity is owner driven, the death benefit is payable only on the death of the owner. When the annuitant dies, the owner simply designates a new annuitant on whose life benefits will be measured. Upon the death of the owner, the account value is distributed to the named beneficiaries. With an annuitant driven contract, benefits are payable to the beneficiaries upon the death of the annuitant. It is common, and usually advisable, with this type of arrangement for the annuitant to also be the owner of the contract. If the annuitant, owner and beneficiary are three different entities, there is a possibility that the owner will incur gift taxes upon the death of the annuitant. Prior to establishing this type of arrangement, it is highly advisable to consult with one s tax advisor and attorney. For purposes of simplicity, the information contained in this course will assume the annuitant is the same as the owner and the contracts are annuitant driven. Free Look Provision When purchasing an annuity, the owner has the right to return the contract within a specified number of days and receive back the amount contributed or current account value without the imposition of surrender charges. The following are the free look provisions for two of the most common annuity contracts. Fixed Annuities - The majority of states have a 10 day free look period and all money contributed is returned without surrender charges. Variable Annuities - The majority of states have a 10 day free look period and either the account value is returned or the amount contributed without surrender charges

12 Funding and Classification of Annuity Contracts Depending on the funding and phase of the annuity, there are three different classifications: Single Premium Deferred Annuity (SPDA) A type of annuity that is established with a single payment that is invested for growth on a tax deferred basis. The annuitant s main consideration is the accumulation of funds for the future that can be withdrawn, annuitized or payable to beneficiaries upon the annuitant s death. Single Premium Immediate Annuity (SPIA) A type of annuity that is established with a single payment and provides the annuitant with an immediate guaranteed lifetime income. The annuitant s main consideration is the systematic distribution of a lump sum of money which provides him or her with a dependable source of income. Many insurance companies require that the first payment to the annuitant be made no later than 60 days after the insurance company receives the invested funds. Periodic Payment Deferred Annuity (PPDA) A type of annuity that is established with periodic payments that are invested for growth on a tax-deferred basis. The annuitant s main consideration is the accumulation of funds for the future that can be withdrawn, annuitized or payable to beneficiaries at a later date. Depending on the frequency or size of the payments, this type of annuity is also designed to help annuitants manage market volatility through dollar cost averaging

13 IV. Phases of an Annuity Contract There are two distinct phases in an annuity contract, the accumulation phase and the annuitization or payout phase. The phases are independent of one another and the annuity may be in either phase depending on the investor s needs, but not both phases at the same time. Accumulation Phase During the accumulation phase, the funds being invested in the contract are accumulating on a tax deferred basis. The type of annuity in this phase can be classified as a SPDA or PPDA. No income tax is payable on the growth of the funds until they are withdrawn from the account. If the money being invested is not part of a qualified retirement plan, referred to as non-qualified money, there is no IRS requirement that the funds be withdrawn at any particular time or age. For ease of administration, some insurance companies will require the annuitant to begin withdrawing funds at age 90 even though it is not an IRS requirement. In essence, an investor can purchase an annuity which will only be in the accumulation phase. This is permitted by the IRS, since the beneficiary of the contract will be responsible for paying ordinary income tax on any gain received upon the annuitant s death. Allowable Withdrawals and Surrender Charges If the annuitant desires, money may be withdrawn while the invested funds are still in the accumulation phase. Many companies allow an annuitant to withdraw upward of 10% of the amount contributed per year without incurring any surrender charges from the insurance company. For example, an annuitant who has contributed $50,000 would be permitted to withdraw $5,000 a year, ($50,000 X.10 = $5,000). Even though the insurance company has not imposed any charges, the money being withdrawn is still subject to income taxation and potential penalties from the IRS. There are some annuities that have a cumulative withdrawal rights permitting the annuitant to withdraw a higher percentage each year the contract is in force. Cumulative withdrawal rights are rarely included in newly issued contracts. For example, an annuity with a cumulative 10% withdrawal right will allow the annuitant the right to withdraw 30% of the amount invested after three years. Any withdrawal made above the allowable limit will be

14 subject to surrender charges within the surrender charge period. The insurance company determines if the surrender charge period is from the date the contract was issued or the date the contribution or investment was made. This provision should be taken into consideration, especially if money will be contributed to the annuity at different times such as in a PPDA. The surrender charges are based only on the amount the annuitant has contributed and the applicable surrender charge schedule. There are some versions of annuity contracts where there are no surrender charges but the internal contract expenses are likely to be higher. Annuities are long term investment contracts and for the insurance company to continue to pay the credited interest rate and maintain the contract, money needs to be invested for the long term. By charging a surrender charge, the insurance company is discouraging early withdrawals and compensating itself for the loss of investment income and administrative costs. Surrender fees are expressed in percentages which decrease the longer the annuity is in force. The following illustrates a typical surrender charge schedule. Year 1: 7% Year 2: 6% Year 3: 5% Year 4: 4% Year 5: 3% Year 6: 2% Year 7: 1% For example, an annuitant contributed $80,000 three years ago needs to withdraw the entire account balance of $90,000 due to unforeseen circumstances. If the company has a 10% withdrawal right and used the above schedule, the surrender charge would be calculated as follows. Charge free withdrawal: $80,000 X.10 = $8,000 Amount withdrawn subject to charges: $80,000 - $8,000 = $72,000 Surrender fee: $72,000 X.05 (from the schedule) = $3,600 Amount of the surrender value: $90,000 - $3,600 = $86,400 If the contract would have been in force for seven years, there would be no surrender fees and the annuitant would have received the entire account balance of $90,

15 Depending on the type of annuity and benefits being offered, insurance companies can alter the surrender charge schedule by increasing or decreasing the number of years the charge is applicable and can also change the surrender charge percentage. There are no surrender fees charged upon the annuitant s death. As an added benefit, many insurance companies will waive surrender charges in the event of the annuitant s confinement to a nursing facility or having a terminal illness. It is also important to note, most contracts will allow the annuitant to transfer the funds from the accumulation phase to the annuitization phase with no charges, provided the funds have been invested for at least one year. The insurance company is prohibited from arbitrarily changing the surrender charges on contracts that have already been issued. Systematic Withdrawal Program Annuity contracts offer annuitants the right to systematically withdraw a fixed amount of money at regular intervals. The money can be withdrawn monthly, quarterly, semiannually and annually until there is no remaining balance in the account. This is subject to certain limitations which include the minimum amount that can be withdrawn and the account value. Any withdrawals made within the surrender charge period and over the allowable amount would be subject to surrender charges. For example, an annuitant with an account balance of $50,000 could request a systematic withdrawal of $500 per month. If the surrender charge was 3% and there was a 10% allowable withdrawal right, the first $5,000 could be withdrawn without charges. The remaining $1,000 would incur a charge of $300 ($500 X 12 = $6,000 - $5,000 = $1,000 X.03 = $300). Withdrawals can be made until the account balance is depleted. The Annuitization or Payout Phase During the annuitization or payout phase the annuitant begins receiving systematic payments for his or her lifetime. The insurance company guarantees the payment will be made regardless of how long the annuitant lives. The type of annuity in this phase can be classified as a SPIA or a SPDA and PPDA in which the accumulated value is transferred to the annuitization phase

16 Most annuitants will receive a monthly payment but the payment mode can also be on a quarterly, semi-annually or annual basis. For the purposes of this course, the mode of payment will be considered monthly as that is the payment mode utilized by most annuitants. The amount of income received is based on several factors which include the value of the account, the annuitant s gender, age and the payout option selected. Without provisions indicating otherwise, the decision to annuitize is irrevocable and cannot be changed after income payments begin. The account value which is also referred to as the principle, belongs solely to the insurance company and can no longer be accessed by the annuitant. In return for agreeing to relinquish the accumulated value of the contract, the insurance company promises to pay the annuitant a monthly income that cannot be outlived. The question is raised as to why an investor would be willing to relinquish ownership of his or her money and be locked into receiving a set payment. Investors selecting this option desire security, simplicity and a guaranteed lifetime income. There are a few annuity products that are currently marketed which allow the owner the right to revert back to the accumulation phase or surrender the contract for whatever balance is remaining. This is referred to as commuting to a lump sum. Payout Options The annuitant can choose several different options on how the monthly payout is structured. As a general rule, the payout options that have the most guarantees will result in a lower monthly payment. Conversely, the payout options that are not as guaranteed will result in a higher monthly payment. The following are the payout options that can be chosen and when their use is indicated. Straight Life Payout This option pays the annuitant a guaranteed lifetime income until his or her death. The annuitant has no guarantee as to how long payments will be made. Upon the annuitant s death, payments cease and the insurance company retains any remaining principle in the account. For example, an annuitant contributes $100,000 to a SPIA and is receiving a monthly check of $1,000. If the annuitant lives for only one year, $12,000 has been paid and the remaining balance is forfeited to the insurance company. This option is usually chosen by annuitants who are in excellent health, have no heirs and who are in need of the highest amount of income

17 Life with Period Certain or Guaranteed Term - This option is designed to pay the annuitant a lifetime income with the guarantee that the payment cannot be made for less than a certain period of time. The annuitant chooses the period of time the payment is guaranteed which is normally 10, 15 or 20 years. With this option, if the annuitant should die prior to the expiration of the term period, the beneficiary will receive payments for the remainder of the term. For example, if an annuitant chooses a life with a 10 year certain option and dies after five years of receiving payments, his beneficiary would receive payments for an additional five years. If the annuitant lives past the 10 year period certain, the beneficiaries would no longer be eligible for continuing payments upon the annuitant s death. Even though the period certain may expire, annuitants are still guaranteed to receive the payment for their lifetime. Life with period certain is the most utilized of all the options and annuitants will usually choose the period certain which guarantees the payments will never be less than what the account value was upon annuitization. This option is chosen by annuitants who are willing to accept a smaller payment to provide their beneficiaries an income, if death occurs prior to the expiration of the period certain Joint and Survivor Life - This option provides the annuitant with a lifetime income and upon the annuitant s death, the payment will continue to be paid to the survivor for his or her lifetime. There is flexibility when electing this option. The annuitant has the right to choose the percentage of the income being received will be payable to the survivor. When the survivor receives the same amount as the annuitant, the option is referred to as 100% Joint and Survivor. If the survivor will only receive 50% of the annuitant s payment, the option is referred as 50% Joint and Survivor. For example, an annuitant with an account balance of $100,000 elects the 50% Joint and Survivor option. If the annuitant was receiving $2,000 per month, the survivor would receive a lifetime payment of $1,000 per month upon the annuitant s death. The higher the percentage elected, the lower the payment will be. Due to paying over two lifetimes instead of one, the 100% Joint and Survivor option pays the lowest amount of income of all the options. It is primarily used in retirement planning and is a popular option for married couples where one spouse is participating in a defined benefit pension plan. This option is chosen by annuitants who are willing to accept a much lower payment in order to guarantee their survivors a lifetime income. Life with Cash Refund - This option provides the annuitant with a guaranteed lifetime income and upon his or her death and pays any remaining balance in the account to the beneficiary in a lump sum. For example, an annuitant with an initial account balance of $100,000 elects this option and is receiving $1,000 per month. If after five years, the

18 annuitant dies, the beneficiary would receive $40,000. ($1,000 X 12 X 5 = $60,000; $100,000 - $60,000 = $40,000). This example does not include any interest assumptions and is mainly chosen by annuitants that can afford a lower lifetime income with beneficiaries who have the financial acumen to manage money effectively. Life with Installment Refund - This option provides the annuitant with a guaranteed lifetime income and upon his or her death pays any remaining balance in the account to the beneficiary in installments. For example, an annuitant with an initial account balance of $100,000 elects this option and is receiving $1,000 per month. If after five years, the annuitant dies, the beneficiary would receive $40,000. If the installment period was 10 years, the beneficiary would receive $333 per month. ($1,000 X 12 X 5 = $60,000; $100,000 - $60,000 = $40,000; $40,000/10 years/12 months = $333) This example does not include any interest assumptions. The spendthrift clause in a life insurance policy works very similarly to this option. This option is chosen by annuitants who can afford a lower lifetime income and prefer that their beneficiaries receive the remaining balance in installments, instead of a lump sum. Fixed Amount Option - This option allows the annuitant to choose the desired amount of monthly income to be received. This amount will be payable to the annuitant until the account value is depleted. For example, an annuitant that current has an account balance of $100,000 wants to receive $2,000 per month. The annuitant would receive $24,000 per year until there is no remaining money in the account. Fixed Period Option - This option allows the annuitant to choose the period of time the income is to be paid and not the amount to be received. At the end of the time period, the account value will be depleted. For example, an annuitant with an account balance of $50,000 desires to receive income for 10 years. Without an interest assumption, the amount of the monthly check would be $416. ($50,000/10 years/12 months = $416) This option works very similarly to the spendthrift clause. The following options are listed in the order that provide for the highest amount of lifetime income to the lowest. Fixed amount and fixed period are not included since the income is not guaranteed to be paid for the annuitant s lifetime. Straight Life Life with10 year Period certain Life with15 year Period certain Life with Installment refund Life with cash refund 50% Joint and Survivor 100% Joint and Survivor

19 V. Risks Assumed by the Insurer Expense Risk When a guaranteed lifetime income is payable, the insurance company assumes the risk of continuing to pay the annuitants an income if they should live beyond their life expectancy. For example, according the table of mortality below, a male annuitant age 64 is anticipated to live for an additional 17 years until he is 81. If the annuitant was receiving a check for $1,000 per month and lived until his life expectancy of age 81, he would have received a total of $204,000 ($1,000 X 12 X 17 = $204,000). If he were fortunate enough to live until age 90, the insurance company would have paid $312,000 which is a difference of $108,888, ($1,000 X 12 X 26 = $312,000 - $204,000 = $108,000). This is a significant risk that the insurance company incurs. Since females have a longer life expectancy and will be receiving income for a longer period of time, the payout is less than a male of the same age. In addition, the insurance company also assumes the possible risk of having to pay more than anticipated for the general administration of the contract. These increased expenses are due to the increased costs of technology and adherence to regulatory requirements. Since the expense risk is also a mortality risk, the terms can be used interchangeably. The following is an excerpt from the Commissioners 2001Standard Ordinary Mortality Table. Commissioners 2001 Standard Ordinary Mortality Table Age Male Mortality Rate per 1,000 Female Mortality Rate Per 1,

20 Mortality Risk The mortality risk is the insurance company s guarantee that upon the death of the annuitant, the beneficiaries can never receive less than the amount contributed to the contract minus any withdrawals. This becomes very important when the annuitant s account value has reduced considerably in value, as in a variable annuity. The insurance companies are compensated for this risk by charging a fee or adjusting the amount of interest payable on existing and new contracts