An annuity contract is a financial product, typically offered by a financial institution, that may accumulate value and take a current value and pay it out over a period of years. These contracts are regulated by various jurisdictions and this has led to the term being focused on different features in different parts of the world.
[edit] United States
Further information: Annuity (US financial products)
In the US, an "annuity" generally refers to a deferred investment contract that, upon "annuitization," will make regular payments (e.g., on a monthly or annual basis) to a person (called the "annuitant") for a period certain, over one or more specified individuals' lifetimes, or over a combination of life and a period certain. (See life annuity.)
Such contracts provide an income during retirement or a stream of payments as a settlement of a personal injury lawsuit (i.e., a structured settlement). Some annuities (called "joint life" or "joint and survivor" annuities) continue paying a second person (i.e., the "beneficiary") after the annuitant dies, until that person dies as well. (For example, an annuity may be structured to make payments to a married couple, such payments ceasing on the death the spouse second to die.)
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" in the parlance of the industry) from various money managers. This gives investors the ability to move between subaccounts without incurring additional fees or sales charges.
An annuity is an insurance product; annuities are typically issued by the same companies that issue life insurance policies, and the risks undertaken by the issuer are fundamentally the same for both products -- that is, the insurance company bets on the life expectancy of the customer. The result is to transfer the effects of the uncertainty of an individual's lifespan from the individual to the insurer, which reduces its own uncertainty by pooling many clients.
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 the retiree has saved in, for example, a 401(k) (i.e., tax-advantaged) savings vehicle during the retiree's working life and uses the money to buy an annuity whose payments will replace the retiree's wage payments for the rest of the retiree's 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, the retiree might run out of money before the retiree dies or not have as much to spend while the retiree is alive.
Another kind of annuity is a combination of retirement savings and retirement payment plan: the annuitant makes regular contributions to the annuity until a certain date and then receives regular payments from the annuity until the annuitant dies. 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.
United Kingdom
In the UK, the term "annuity" generally refers to the actual contract that makes payments. Commonly it is used to refer to a contract that is making payments (with the means of saving being referred to as a "pension"). In Britain the conversion of pension income into an annuity is essentially compulsory and this has led to a large market for annuities.
Showing posts with label Annuity. Show all posts
Showing posts with label Annuity. Show all posts
Monday, July 9, 2007
Life Annuity
The life annuity (also known as a single-payment annuity) is a financial instrument that allows for a seller (issuer), typically a financial institution such as a life insurance company, to provide a series of future payments to a buyer (annuitant) for a known sum with a net present value; the payment stream has an unknown duration based principally upon the life expectancy of the annuitant. Generally, such an instrument stops payment at the death of the annuitant. However, it is possible to structure such a contract so that the payments stop upon the death of the second of two annuitants (i.e., a joint and survivor annuity), sometimes with a reduction in the amount of the payment going forward.
The pure life annuity can have harsh consequences for the annuitant who dies before recovering his or her investment in the instrument. Such a situation, called a forfeiture, can be remedied by the addition of a period-certain feature under which the annuity issuer is required to make annuity payments for at least a certain number of years; if the annuitant outlives the specified period certain, annuity payments continue until the annnuitant's death, and if the annnuitant dies before the expiration of the period certain, the annuitant's estate or beneficiary is entitled to the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that the annuity payment for the latter is smaller.
Factors
Many potential annuitants are already familiar with the concepts involved through knowledge of their own pension, whether from a business or government job, yet there can be a notion that annuities have limited value for the buyer or that the buyer cannot expect a fair payout from the investment. Some argue that this instrument has no advantage for the buyer. [1] The other side of this notion is that the conditions for the instrument are stacked in favor of the issuer, though issuers have grappled with this instrument for years and do face risk. [2]
From the annuitant's viewpoint, factors related to the instrument can be fairly complicated. Some studies have stressed that rational decisions may be difficult for the buyer in this case. [3] As well, there are the ethical issues that can be of concern dealing with fair play. For example, witness reports of malfeasance on the part of some playing the role of issuer, such as selling unsuitable annuities.[citation needed] In the U.S., the individual states provide some assistance to the buyer and some regulation of the issuers. [4]
From the issuer's viewpoint, there are many technical factors that determine the amount of an annuity payment for the life expectancy of the annuitant and that influence yields on the investments annuity issuers invest premiums in. There are expenses (including distribution costs) related to managing the instrument and profit expectations that affect the decisions about the payment. Risk management costs for the issuer can become more problematic, if annuitant's returns are given more weight than has been the case.
Other factors are concerns, such as inflation and usury, which might be considered auxiliary by the issuers but not by the annuitants.
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." [3] 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. [5]
[edit] Future
It is expected that the aging of the boomer generation in the US[citation needed] 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.
Recently, New York Life introduced a variable annuity that allows both tax-deferred growth and longevity protection.[6] Earlier, MetLife had introduced 'longevity insurance' via a fixed deferred income annuity. [7]
[edit] History
The instrument's evolution has been long and continues as part of actuarial science. [8]
The early practice for selling this instrument did not consider the age of the nominee, thereby raising interesting concerns. [2][9] These concerns got the attention of several prominent mathematicians [10] over the years, such as Bernoulli, de Moivre, Huygens, Halley and others. [2] Even Gauss and Laplace had an interest in matters pertaining to this instrument. [11]
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.
The pure life annuity can have harsh consequences for the annuitant who dies before recovering his or her investment in the instrument. Such a situation, called a forfeiture, can be remedied by the addition of a period-certain feature under which the annuity issuer is required to make annuity payments for at least a certain number of years; if the annuitant outlives the specified period certain, annuity payments continue until the annnuitant's death, and if the annnuitant dies before the expiration of the period certain, the annuitant's estate or beneficiary is entitled to the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that the annuity payment for the latter is smaller.
Factors
Many potential annuitants are already familiar with the concepts involved through knowledge of their own pension, whether from a business or government job, yet there can be a notion that annuities have limited value for the buyer or that the buyer cannot expect a fair payout from the investment. Some argue that this instrument has no advantage for the buyer. [1] The other side of this notion is that the conditions for the instrument are stacked in favor of the issuer, though issuers have grappled with this instrument for years and do face risk. [2]
From the annuitant's viewpoint, factors related to the instrument can be fairly complicated. Some studies have stressed that rational decisions may be difficult for the buyer in this case. [3] As well, there are the ethical issues that can be of concern dealing with fair play. For example, witness reports of malfeasance on the part of some playing the role of issuer, such as selling unsuitable annuities.[citation needed] In the U.S., the individual states provide some assistance to the buyer and some regulation of the issuers. [4]
From the issuer's viewpoint, there are many technical factors that determine the amount of an annuity payment for the life expectancy of the annuitant and that influence yields on the investments annuity issuers invest premiums in. There are expenses (including distribution costs) related to managing the instrument and profit expectations that affect the decisions about the payment. Risk management costs for the issuer can become more problematic, if annuitant's returns are given more weight than has been the case.
Other factors are concerns, such as inflation and usury, which might be considered auxiliary by the issuers but not by the annuitants.
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." [3] 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. [5]
[edit] Future
It is expected that the aging of the boomer generation in the US[citation needed] 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.
Recently, New York Life introduced a variable annuity that allows both tax-deferred growth and longevity protection.[6] Earlier, MetLife had introduced 'longevity insurance' via a fixed deferred income annuity. [7]
[edit] History
The instrument's evolution has been long and continues as part of actuarial science. [8]
The early practice for selling this instrument did not consider the age of the nominee, thereby raising interesting concerns. [2][9] These concerns got the attention of several prominent mathematicians [10] over the years, such as Bernoulli, de Moivre, Huygens, Halley and others. [2] Even Gauss and Laplace had an interest in matters pertaining to this instrument. [11]
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.
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