Annuity Development
The word annuity
means "a payment of money."
The insurance industry designed them to do just that. The annuity is a periodic fixed payment for
life or for a specified period of time, made to the individual by the insurance
company. One of the most notable
industries to go into the insurance world is the banking and savings and loan
institutions.
In the early 1920's, the United States
government began using annuities to fund government retirement accounts, as did
the labor unions. Due to the
requirements the government mandated, the insurance industry came up with two
safety features:
1.
A guaranteed minimum interest rate built into the annuity contract,
and
2. The reinsurance network.
Backed by the insurance companies' reserves,
a reserve system for annuities was first introduced during the 1920s. The legal reserve system required then and
still requires now that insurance companies keep enough surplus cash on hand to
cover all cash values and annuity values that may come due at any given
time. It is the reserves that enable
the minimum interest rate guarantees to exist.
The reinsurance
network was designed so that if there was a large run on the money
in the insurance industry, no one company would be required to take the brunt
of the loss. The insurance companies
spread the risk out among all of the companies that are offering similar
products.
Annuities, as a financial vehicle, seem to
go in and out of favor, depending on what other financial products are
doing. Interest rates can especially
affect how annuities are viewed in current markets. Recent years have seen record low interest rates. While homebuyers are cheering, those who are
relying on interest rates to pay their daily bills (such as retired Americans)
are faced with tough choices. Should
they begin to dip into their principal, go back to work, or make other life
altering changes? Older Americans are
concerned with running out of money before they run out of life. Money placed in annuities are often
considered money that cannot be lost to riskier investments.
On October 19, 1987, the stock market
crashed and became known as "Black Monday." Annuities were primarily unaffected by this event. When the Great Depression hit the country in
the 1920's, over 9,000 banks failed.
Stocks and bonds were not worth anything. The exception to the utter economic disaster the country
experienced was insurance companies.
They had enough cash on hand to pay their policyholders. The government required this. The companies continued to pay their
guaranteed minimum interest rates that had been established years earlier. After the depression hit, new laws were
passed by congress requiring many of the other financial industries to provide
some of the same safety features on their products that insurance companies
were already required to have.
Variable annuities were first introduced in
the US in the early 1950s. One of the
best-known variable annuities is the College Retirement and Equities Fund
(CREF). At the end of 1991 it was
estimated that over $200 billion was invested in variable annuities and there
were well over eight billion contract owners.
These numbers have continued to climb, especially as interest rates
remained low.
From 1973 to 1978 the most popular annuity
products carried a permanent seven percent surrender
charge. The only way to
avoid this charge was to annuitize the contract. Then, as time went on, a few companies began to offer bailout options and limited
surrender penalties.
Bailouts allowed the client to withdraw their money without penalty
charges if the interest rate on their annuity fell below the initial rate. Once this bailout option hit the market, a
new generation of products developed.
In the 1980s The New York Stock Exchange
member firms began aggressively marketing bailout annuities. As interest rates hit all-time highs,
insurance companies quickly had to become superb asset managers as well as good
risk managers.
The early 1980s saw the introduction of indices and two-tiered
annuities. The index rate annuity is a fixed annuity whose
renewal rate fluctuates during the surrender charge period based upon some
independent market indicators. It might
be Treasury Bills or any variety of bond indices. This type of indexing is designed to protect the consumer in a
low interest rate environment. These
products do not tend to have bailout options since they are designed to
accurately reflect the changing financial climate.
Two-tiered
annuities were designed to reward the policyholder who decides not
to surrender their annuity by offering a higher first tier interest rate. If the policyholder surrendered or
transferred to another carrier, a lower interest rate was retroactively
applied; this was the second tier. The
two-tier has a second and permanent surrender charge in the form of the lower
interest rate. The annuity may have a
substantial charge for withdrawals, a charge that may never disappear. This may make it look as if the company is
paying competitive rates, but if the policyholder elects to withdraw, they may
be credited with an extremely low interest rate. The interest rate is only realized if annuitization is utilized
through the initial insurer. This,
then, locks the policyholder into the same company for life. When a person is comparing two-tier rates
with other annuities and/or companies one should keep in mind these limitations
between contracts.
No industry is immune from failures, and
insurance companies are no exception.
Two companies that suffered setbacks were Baldwin United and Charter
Oil. In the 1980s interest rates
fueled uncontrolled growth. This growth
affected Baldwin United. The interest
rates of the eighties affected much of the insurance industry. Baldwin United's internal investments and
questionable accounting procedures eventually resulted in their block of
annuity business being sold to Metropolitan Life. Charter Oil suffered from the 1981-1982 over supply of oil and
gas that crippled the entire industry.
This resulted in Charter Oil selling their annuity block to Metropolitan
Life also.
One very important point to make note of: in
both cases, the contract owners did not lose any of their investment. Policyholders continued to earn tax-deferred
interest in the seven to eight percent range.
Not all industries can say the same thing.
The public reacted adversely to the
insurers failures. In addition TEFRA
(The Tax Equity and Fiscal Responsibility Act of 1982) affected the publics
perception of annuities as an investment and caused annuity sales to drop. During this time, new annuity products
emerged. Surrender periods reduced,
bailout provisions improved and a move towards multiple year guarantees
developed. Many of these new annuities
were designed to compete with Certificates of Deposit (CDs).
Tax Reform Act 1986
The general rule has been that annuity
earnings accumulate tax-deferred.
TRA-86 modified the general rule, so that only an annuity that is owned
by a natural person will enjoy this tax-deferred income. Code Sections 72(u) and 71(q) provide that
an annuity contract issued or added to after February 28th, 1986,
owned by a corporation, partnership or other non-natural person may not enjoy
the tax deferral on the inside build-ups.
Taxes will have to be paid each year on contract earnings. Contracts contributed to by February 28th,
1986, have been grandfathered in and will not be taxed on prior or continued
earnings on such contributions.
What is withdrawn first from an annuity
interest or principal? To determine how
funds will be taxed when distributed from tax-deferred annuities, one must
consider the date that the funds were deposited. If the funds were deposited by August 14th, 1982,
withdrawals will be received by the annuitant as principal first and income
second (called first-in-first-out or FIFO). If a contract received deposits after August 14th,
1982, withdrawals are taxed as income first and principal last, to the extent
of earnings in the contract (called last-in-first-out or LIFO). The annuitant is exposed to ordinary income
tax immediately on withdrawals from such contracts. The ordinary income tax liability is created when a partial
withdrawal or lump sum distribution is made.
If the annuity contract is pledged or assigned as collateral for a loan,
ordinary income taxes are due on the amount collateralized up to the amount of
the accumulated earnings in the pledged contract, and the 10-percent penalty
applies if prior to the annuitants age 59 .
TRA 1986 also increased the penalty tax from
the previous five percent up to ten percent on withdrawals prior to age 59
from both non-qualified and qualified deferred annuities. The penalty tax is waived if the owner of
the annuity is age 59 or older, dies, or becomes disabled; or if the annuity
contract is being used relative to the periodic payments required under a
personal injury suit. The penalty also
will be waived if benefits are annuitized, paid out in a series of
substantially equal payments over the life of the annuitant or over the joint
life of the annuitant and the primary beneficiary. This ten-percent penalty tax is also applicable to withdrawals
from pre-August 14th, 1982 annuities. These contracts were grandfathered from the standpoint that you
may still consider withdrawals to be principal first and thus not subject to
tax up to ones pre-August 14th, 1982 cost basis. However, you will now have to pay the
ten-percent penalty tax to take taxable funds out prior to age 59 . Once your
pre-August 14th, 1982 basis has been recovered without taxation,
your next withdrawals will be entirely taxable annuity earnings and therefore
also subject to the ten-percent pre-59 penalty.[1]
As financial products go, annuities are a simple instrument. A designated insurer pays the designated
annuitant a specified amount of money for a length of time determined by the
annuitant. The amount paid out will, of
course, depend upon the amount deposited.
There are many clauses in the policy that will affect how payouts are
made and how interest is earned, but basically it is a payout of money for life
or a specified time period.
Annuities have primarily been used as a way to save money on a
tax-deferred basis for retirement or education. The principal use of a life annuity is to arrange for income
during retirement. When an individual
reaches that state in life when he or she can no longer earn his or her living,
he or she must live off earnings that have been accumulated during the
individuals working years. It is
preferable to live off the interest earnings since depleting the principal may
mean running out of money to live on before one runs out of years left to
live. It is the function of the annuity
to provide this protection (prevent running out of money prior to running out
of life). To put it more exactly, the
function of the annuity is to provide a vehicle for the scientific liquidation
of capital, during which the individual will be provided with income that
cannot be outlived. It should be noted
that there is no guarantee that there will be enough money to
live on; simply that there will be some amount coming in each month.
Annuities are a very old form of retirement investing. They date back some four thousand
years. Originally, someone who wanted
to assure financial security for his family in his old age or after his death
would deposit grain in the local grainary.
Many years later, when the worker was too old to work, the granary would
ensure that everyone in the household was supplied with enough grain for the
rest of his or her life.[2]
Of course, today annuities are not issued by granaries, but
rather by insurance companies. Even so,
the main purpose is to provide the same service: a guaranteed income to live
on.
Attachment
I
(Provided
by California)
Understanding of the following annuity legislation is significant. It provides the evolutionary changes for
each law throughout the years. It is
important to know what impact the following pieces of legislation have had on
annuity insurance. To review or obtain
copies of the following pieces of legislation, you may log onto the California
Legislatures Website at: http://www.leginfo.ca.gov or you may call the
Legislative Bill Room at (916) 445-2645 to order copies of this legislation.
Year: 2003
SB 620, 2003, (Scott, Chapter 547),
Annuities: life insurance: required disclosures and prohibited sales practices.
An act to
amend Sections 787, 1725.5, 10127.10, and 10509.8 of, and to add Sections
789.9, 789.10, 1724, and 1749.8 to the Insurance Code relating to insurance.
Enacts additional
restrictions on advertising practices that target senior citizens and would
expand the scope of existing restrictions, currently applicable to disability
insurance, to life insurance, and annuities.
Prohibits the sale of
annuities to seniors in certain circumstances.
Prohibits insurance agents,
brokers, and solicitors who are not attorneys from sharing commissions or other
compensation with attorneys.
Requires, effective
January 1st, 2005, specific training for life agents in order for
these producers to sell annuities, unless the agents are nonresidents agents
who represent a direct response provider, as defined.
Limits the investment
of premiums during the 30-day cancellation period, except as specified, and
revises the disclosure requirements applicable to the sale of life insurance
and annuity products to seniors.
Imposes restrictions
on the sale of life insurance policies and annuities in the home of a senior
citizen.
Prohibits an agent or
insurer from recommending the unnecessary replacement, as defined, of an
annuity by a senior citizen.
Imposes certain
duties on the Insurance Commissioner in this regard, and enacts other related
provisions.
SB 618, (Scott, Chapter 546),
Insurance: unfair acts: licenses.
An act to
amend Sections 782, 786, 789.3, and 10509.9 of, and to add Sections 1668.1 and
1738.5 to the Insurance Code relating to unfair acts.
Raises the fine for a
violation of these provisions to $1,500.
Extends to
individuals age 65 or older who purchase life insurance the protections
described above that apply to those individuals who purchase disability
policies.
Declares that it
applies to the purchase of life insurance only to the extent that it does not
conflict with the provisions of law regarding cancellation of life insurance
policies and annuities.
Increases the amounts
of these monetary penalties, as specified.
Provides that, if the
commissioner brings an action against a licensee under these provisions and
determines that the licensee may reasonably be expected to cause significant
harm to seniors, the commissioner may suspend the license pending the outcome
of the action. It allows the
commissioner to require the rescission of any contract marketed, offered, or
issued in violation of these provisions.
Authorizes the
commissioner to suspend or revoke any permanent license issued if the licensee
induces the client to make a loan or gift to or investment with the licensee,
or to otherwise act in other specified ways that benefit the licensee or other
people acquainted with or related to the licensee.
Requires that, if a
disciplinary hearing of this type involves allegations of misconduct directed
against a person age 65 or over, the hearing be held within 90 days after the
Department of Insurance receives the notice of defense, unless a continuance is
granted.
Sets forth the
grounds for granting a continuance, and provides that the burden of proof in a
hearing shall be by a preponderance of the evidence.
Increases the amounts
of these monetary penalties, as specified, and allows the commissioner to
suspend or revoke the license of any person who violates these provisions.
AB 284 (Chavez, Chapter 381),
Deferred annuities: nonforfeiture
An act to
amend Sections 10168.1 and 10168.2 of, and to add Sections 10168.25 and
10168.92 to the Insurance Code, relating to annuities.
Requires that these
annuity contracts also provide that the company shall grant the paid-up annuity
benefit upon the written request of the contract owner.
Eliminates the
requirement applicable to certain contracts that a company reserve the right to
defer the payment of the cash surrender benefit for a period of 6 months and
instead allows the company to reserve that right after making written request
and receiving written approval of the commissioner, as specified.
Allows payment of the
cash surrender benefit to be deferred for a period not to exceed 6 months.
Provides for a
uniform method of calculating minimum nonforfeiture amounts under these
contracts. It modifies the interest
rate applicable to accumulations under these contracts, the amounts by which
those accumulations may be decreased, and the minimum amount of considerations
used to determine the minimum nonforfeiture amount, as specified.
Provides that these
provisions shall apply to contracts issued on and after January 1st,
2006, but that a company may elect to apply them, on a
contract-form-by-contract-form basis, to any contract issued on or after
January 1st, 2004, and before January 1st, 2006.
Allows the Insurance
Commissioner to adopt regulations to implement these provisions and to adjust
the calculation of minimum nonforfeiture amounts for certain other contracts.
Year: 2002
AB 2984 (Committee on Insurance,
Chapter 203), Insurance: depository institutions: production agencies: surplus
line brokers: reinsurance intermediaries.
An act to
amend Sections 1628, 1637, 1639, 1656, 1662, 1679, 1704, 1750.5, 1765.2, 1767,
1768, 1781.3, and 10234.93 of, to add Sections 1638.5 and 1639.1 to add Article
5.2 (commencing with Section 759) to Chapter 1 of Part 2 of Division 1 of, and
to repeal Sections 1647, 1648, 1649, 1659, and 1714 of the Insurance Code,
relating to insurance.
Establishes
provisions regulating retail sales practices, solicitations, advertising, and
offers of any insurance product or annuity to a consumer by a depository
institution, or any person engaged in those activities at the office of a
depository institution or on behalf of a depository institution.
Revises licensing provisions
with regard to production agencies, surplus line brokers, and reinsurance
intermediaries, and also revises requirements for certain licensees within
those categories. Because this bill
expands the duties of a surplus line broker and thereby expands the definitions
of crimes associated with a violation of these duties, the bill imposes a
state-mandated local program.
Provides that no
reimbursement is required by this act for a specified reason.
Year: 2000
SB 423 (Johnston, Chapter 694), Life
insurance: guaranteed living benefits
An act to
add Section 10506.5 to the Insurance Code, relating to insurance, and declaring
the urgency thereof, to take effect immediately.
Authorizes a life
insurer to deliver or issue for delivery variable contracts or riders to
variable contracts containing guaranteed living benefits, as defined, under
certain conditions.
AB 2107 (Scott, Chapter 442) Elder
Abuse
An act to
add Section 6177 to the Business and Professions Code, and to amend and
renumber Section 10193 of, to amend Section 10234.8 of, and to add Section
789.8 to the Insurance Code, and to amend Section 15610.30 of the Welfare and
Institutions Code, relating to elder abuse.
Imposes the duty of
honesty, good faith, and fair dealing on insurers, brokers, agents, and others
engaged in the business of Medicare supplemental insurance and long-term care
insurance with respect to prospective policyholders.
Only permits life
agents, on or after July 1st, 2001, to sell or offer for sale to an
elder or his or her agent any financial product on the basis of the products
treatment under Medi-Cal after providing the elder or his or her agent with a
specified disclosure, in writing, explaining the resource and income
requirements of the Medi-Cal program, including, but not limited to, certain
exempt resources, certain protections against spousal impoverishment, and
certain circumstances under which an interest in a home may be transferred
without affecting Medi-Cal eligibility.
The bill excludes from the application of these disclosure provisions
credit life insurance, as defined.
Requires the State
Bar to make a report, by December 31st of each year, to the
Legislature on the provision of financial services by lawyers to elders, as
specified. The report would include the
number of complaints filed and investigations initiated, the type of charges
made, and the number and nature of disciplinary actions taken by the State Bar.
Revises the
definition of existing law that defines financial abuse for the purpose of
reporting and investigating elder and dependent adult abuse.
Year: 1998
SB 1718 (Calderon, Chapter 386), Life
insurance.
An act to
amend Sections 10509.6 and 10541 of the Insurance Code relating to life
insurance.
Existing law provides
that every life insurer that uses an agent shall, among other things, when a
replacement of insurance is involved, provide a notice delivered with the
policy that the applicant has a right to an unconditional refund of all
premiums, which right may be exercised within 20 days of the date of delivery
of the policy. Existing law contains
other provisions applicable to variable annuity contracts, variable life
insurance contracts, and modified guaranteed contracts that authorize the
return of the contract during the cancellation period. This bill adds the latter provision to the
previous provisions requiring the applicant to be given notice of a right to an
unconditional refund, and changes the 20-day period for the exercise of the
right to obtain a refund to a 30-day period.
Existing law permits
certain insurers to issue funding agreements and provides that this
authorization does not affect the priority of claims against insolvent
insurers. This bill corrects a
cross-reference relating to this priority of claims.
Year: 1997
SB 203 (Lewis, Chapter 28), Insurers:
mortality tables.
An act to
amend Sections 10163.2, 10489.2, and 10489.3 of the Insurance Code, relating to
insurance.
Existing law
regulates the types of benefits to be paid under a policy of life insurance in
the event of a default in premium payments or upon surrender of the policy, and
also regulates the manner in which reserves are to be maintained by insurers
issuing life insurance policies and annuity and pure endowment contracts.
Existing law provides
for insurers to use certain mortality tables for these purposes that have been
approved by the Insurance Commissioner through promulgation of a
regulation. This bill alternatively
allows the commissioner to approve mortality tables through issuance of a
bulletin.
Year: 1994
SB 1505 (Calderon, Chapter 984), Life
insurance and annuity contracts: senior citizen policies and annuities.
An act to
amend Sections 10127.10, 10127.11, 10127.12, 10127.13, and 10506.3 of the
Insurance Code relating to life insurance, and declaring the urgency thereof,
to take effect immediately.
Makes specified
changes in the cancellation procedures and notice requirements and, in
addition, applies those procedures and requirements to individual annuity
contracts. In addition, for variable
annuity contracts, variable life insurance contracts, and modified guaranteed
contracts, a canceling purchaser would be entitled to a refund of any policy
fee paid as well as payment for the value of the account. These provisions do not apply to specified
types of group life insurance or group annuity contracts. Under specified circumstances, senior
citizens are entitled to refunds if they cancel policies of group term life
insurance during the first 30 days of the policy period. The bill also makes conforming changes.
Also adds the options
of stating only the location in the policy text of the required information in
12-point bold type on the cover page of the policy, or by disclosing that
information on a sticker that is affixed to the cover page of the policy or to
the policy jacket.
Provides that
modified guaranteed annuities are subject to the forfeiture provisions for
individual deferred annuities computed under the terms of the annuity, but
excluding market adjustment factors, as specified. In addition, group annuities exempted from the provisions
governing individual deferred annuities are also exempted from any modified
guaranteed annuity regulations.
This exemption is
retroactive to January 1st, 1987 to the extent that the assets
underlying the group contract have not been maintained in a separate
account. The bill provides that it is
to take effect immediately as an urgency statute.
AB 1667 (Hoge, Chapter 6), California
Insurance Guarantee Association.
An act to
amend Sections 1063, 1063.1, 1063.2, 1063.4, 1063.5, 1063.7, 1067.04, 1067.05,
and 10112.5 of, to add Section 1067.055 to, and to repeal and add Section
1063.3 of the Insurance Code, relating to insurance, and declaring the urgency
thereof, to take effect immediately.
Existing law
establishes a California Insurance Guarantee Association and specifies those
insurers that are required to be members of the association. It exempts certain classes of insurance from
assessments and other requirements of the association. This bill specifically enumerates those
exempt classes of insurance, and provides that any insurer admitted to transact
only those classes or kinds of insurance excluded from specified provisions
shall not be a member of the association.
Existing law provides
that the association shall be managed by a board of governors serving 3-year
terms. Those terms expire each
year. [Three of the nine terms expire
yearly.] This bill provides that those terms expire each year on December 31st.
This bill also, among
other things, does all of the following with respect to the California
Insurance Guarantee Association: (a) Revises the definition of insolvent
insurer, and covered claims, and defines ocean marine insurance, as
specified. (b) Revises certain policy
construction and cancellation provisions with respect to insurer insolvency.
(c) Revises the authorization of the association to submit reports and make
recommendations to the Insurance Commissioner regarding the financial condition
of member insurers, and certain examination and other report requirements, as
specified. (d) Revises insolvency
premium provisions, as specified. (e)
Specifies certain notice provisions with respect to an ancillary liquidator.
Existing law provides
for the California Life and Health Insurance Guarantee Association. The statute
that established that association abolished the California Life Insurance
Guaranty Association. This bill
provides that the California Life and Health Insurance Guarantee Association is
created by the merger of the Robbins-Seastrand Health Insurance Guaranty
Association with and into the California Life Insurance Guaranty Association
and that the association succeeds to the rights, property, and obligations of
the predecessors, as specified.
Revises provisions
dealing with the applicability of the specified disability insurance policies
issued outside of California to an employee whose principle place of business
and majority of employees are located outside of California.
Year: 1993
SB 1065 (Mello, Chapter 516), Life
insurance.
An act to
add Sections 10127.10, 10127.11, 10127.12, and 10127.13 to the Insurance Code,
relating to insurance.
Adds additional
provisions which permit a senior citizen, as defined, to cancel any policy of
life insurance within 30 days following delivery, as specified. It requires those policies to contain a
notice of that provision. Those
provisions are inapplicable to individual life insurance policies issued in
connection with a credit transaction or issued under a contractual policy
change or conversion privilege provisions contained in a policy.
Additionally makes
those provisions inapplicable to noncontributory employer group life insurance
contracts.
Requires offerings of
life insurance policies to senior citizens that contain illustrations of
nonguaranteed values to contain certain disclosures. It requires annual statements to senior citizen policyowners to
disclose the current accumulation value and current cash surrender value and
requires life insurance policies for senior citizens, which contain a surrender
charge period to disclose the surrender period and penalties associated
therewith.
End of Chapter One
United Insurance Educators, Inc.