California Insurance Continuing Education – How Are Annuities Purchased

Prior to the 1970s, annuities were marketed by traditional insurance agents, most of whom were career agents. During the 19970s and early 1980s, stockbrokers increased their distribution of annuities, followed by growth in brokerage general agency distribution, followed by growth by banks marketing annuities. In today’s market, all marketing and distribution systems are doing well.

A TYPICAL ANNUITY OWNER

The Gallup Organization surveyed over 1,000 nonqualified annuity owners in 2004 for the Committee of Annuity Insurers – an organization of life insurance companies that issue annuities. Gallup identified the nonqualified annuity-owners by several characteristics3:

1. Interestingly, the average of these annuity owners was 65.
2. 52% of these annuity owners were male, 48% female.
3. 63% of annuity owners of these contracts were married, 20% were widowed.
4. Of owners of nonqualified annuities, 56% were retired, 38% were employed (either full-time of part-time).
5. 55% of owners had “moderate” household income, described as between $20,000 and $74,999. 62% had total annual household incomes under $75,000.
6. 85% of the owners purchased that first annuity when they were less than 65 years old. Average age at which owners purchased their first annuity was 50.

PREMIUM PAYMENTS

The specific premium amount depends on several factors, primarily the length of the guaranteed benefit payment period. The “Straight life” (discussed later) annuity offers maximum income per dollar of outlay. Obviously, the reason for this is that some annuitants will die prematurely, or in the early part of the annuitization, thereby restricting the total amount of payout. Period certain and refund options provide less income per dollar of outlay, as the element of mortality does not enter the equation.

The interest the company earns on investments is an important factor in determining annuity premiums. The higher the interest, the more income per dollar of outlay. During the discussion of Equity Indexed Annuities, the effect of the company’s investment portfolio is extremely important. Obviously, the higher the investment returns the lower the premiums to the annuitants.

The third factor is the expenses of the insurer. If the insurer has high expenses (such as high commissions and overrides), the higher the premium to the policyholder. In other words, the lower the expenses, the lower the premiums paid to the insurer which is required by the insurer to pay all claims and satisfy their stockholders.

CONSUMER APPLICATION

Bertrand, age 66, and his wife, Louise, also age 66, talk to their insurance agent about the purchase of an annuity that will pay $1,000 to each of them for his/her lifetime. Since Bertrand is a CPA, he has an interest on how the premiums are calculated. Their agent refers to his company’s actuarial department, who offers the following explanation:

The Insurance company assumes an earned interest rate of 8% on the investments that they purchase using the premiums paid by the insured.

Bertrand’s single premium cost would be $9088. Louise’s premium would be $8890.

Difference in premium would be $198. Therefore $198 would be liquidated the first year (one-year difference in ages).

8% of $9088 = $727.04.

Added to the one year cost difference ($198) would be $925.04.

Since the company promises to pay $1,000, the company would be $74.96 short.

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