Ms. Ella Kelly was a fortunate and very healthy annuitant. When she was age 92, she purchased a gift annuity paying 14% from a private university in Florida (14% was the rate at that time for annuitants over age 90). Ms. Kelly was so encouraged by her 14% gift annuity payouts that she lived to be 111!

Another donor purchased a $100,000 gift annuity for cash from a west coast charity. She also received a high percentage rate of return and was paid one quarterly payment before passing away.

Some gift annuitants live a very long time – some pass away fairly quickly. It is quite difficult to know what the probable life expectancy will be of an individual. The concept of gift annuities and insurance is that the two extremes will balance in the middle.

IRS Mortality Tables

Every ten years the federal government completes a census. Based on the census tables and an initial group of 100,000 persons, the IRS projects from age zero to 110 the probable number of people who will survive to any year. By considering the estimated number of survivors in one year and the number in a future year, it is easy to calculate the probability of survival. For example, if 60,000 people are living at one age and 30,000 people are surviving 15 years later, then there is a 50% probability of surviving for the 15 years.

With a gift annuity, the decision to self-insure or use reinsurance is greatly affected by the estimated life expectancy of the annuitant. The IRS tables for IRA expectancies are not always accurate because they are not gender specific, do not consider the health of the donor and do not reflect family heritage.

Insurance Underwriting Factors

Most gift planners do not have the full underwriting information that an insurance company has before issuing a large insurance policy. The life underwriter for the insurance company may have a quite complete medical background. A gift planner is not likely to be privileged with that information.

It is possible for a donor to use a website such as www.realage.com to determine his or her probable expectancy. The Real Age website considers approximately 50 to 80 health, history, medical and conduct factors in projecting expectancy.

However, the charity typically must make an estimate of life expectancy in determining whether to self-insure or reinsure. If the charity reinsures and the person lives a very short time, then the cost to the charity is very large. If the charity reinsures and the person lives a very long time, the charity can receive substantial benefit.

Life Expectancy - Increase or Decrease?

It is helpful for the charity to make approximate estimates of probable adjustments to expectancy in making this determination to reinsure or not reinsure. There are three or four factors that can be considered.

First, self selection is typically considered with annuity contracts. Individuals who purchase annuities normally expect to live to receive the annuity payments.

Second, the typical annuitant is likely to be in average to good health. People who are in very poor health are less likely to purchase annuities.

Third, there may be factors such as smoking, diabetes, heart conditions or cancer that affect longevity. Any of these would reduce the probable longevity.

Fourth, the Treasury tables are not gender specific. If a gift annuity includes a female person or a two-life annuity with two female persons, then it can be projected that there will be a longer expectancy.

Gift Annuity Reserve Return

A CFO of a charity is responsible for making certain that the funds of the charity are used in a prudent and appropriate manner. CFOs are appropriately asking whether issuing gift annuities is beneficial for the charity.

American Council on Gift Annuities

The American Council on Gift Annuities is a voluntary organization that periodically sets recommended rates for charitable gift annuities. The board of the ACGA recommended a change in the rate schedule effective February 1, 2009. The schedule is available on www.acga-web.org.

Gift annuity rates are established based upon projected investment returns, the age of the person and selected mortality tables. The American Council on Gift Annuities Rates Committee uses a reference portfolio with 40% equities, 55% bonds and 5% cash. The equities portfolio assumes the 100-year total equities market return less 1%. The bond portfolio assumes a yield based upon the last three months rate for a 10 year Treasury note. The 5% cash portion tracks the Treasury bill return.

Based upon these factors, the ACGA Rate Committee determines the composite return rate. A 1% further allocation is set aside for administrative and investment costs and the net return typically ranges from 4% to 5.5%.

Based on this assumed net return and adjusted mortality tables, the actuary for ACGA calculates recommended rates for one-life and two-life charitable gift annuities. While there are some modifications at the lower and upper end of the age spectrum, the actuary generally attempts to produce a 50% residuum for a gift annuity. That is, if a 75 year old person purchases a gift annuity with $20,000, a charity earning the projected net return should receive $10,000 if the individual lives to normal life expectancy.

Many charities have been issuing gift annuities for 50 to 100 years and can track the residua over longer periods of time. Most charities who report residua during those longer periods of time have achieved an average of 65% to 85% residuum at gift annuity maturity.

Because some gift annuities for senior donors pay a rate higher than the actual earnings, there are some annuities that will return little or no residuum. However, there also will be annuities in which the annuitant passes away after receiving one or two payments. In determining the benefits of gift annuities, it is essential to consider the probable averages for a portfolio of annuities.

Potential Gift Annuity Benefits to Charities

One reference method is from a 200 year analysis by Prof. Jeremy Siegel of the University of Pennsylvania's Wharton School. Mr. Siegel studied two centuries of stock returns and determined that the real rate of return for the past 200 years on stocks has been 7%. When plotted on a logarithmic scale, the 7% growth line is a straight line and permits a comparison of total market value with the predicted 7% real return trend line.

Stocks in 2000 were approximately 80% above the trend line, but stocks at bear market bottoms were far below the trend line. The 1981 market was 40% below trend, the 1974 market was 41% below trend and the 1932 market was 42% below Professor Siegel's trend line.

While it is not possible to make any short-term predictions about equities, the pattern of the past 100 years for all three of the prior market bottoms is that there is a general return to the trend line over a period of five to 15 years. Therefore, for our typical duration of a gift annuity, the reasonably strong probability is a return to the equities trend line over the expectancy of a portfolio of annuitants.

Bonds are the second part of the portfolio. If interest rates do increase substantially during the next five to seven years, there could be some reduction in total bond return due to the increased rates leading to lower values on existing bonds. However, there are reasonable prospects for five to 15 year yields reasonably close to the historic 5% average.

Market Returns in 1935, 1948 and 1977

One helpful perspective is to consider the potential benefits or residua with gift annuities if the stock and bond markets were to parallel the five to 15 year returns for three different years in which there were also recessions. The selected years are 1935, 1948 and 1977.

The assumptions are that the gift annuity value is invested in a portfolio that is part equities and part corporate bonds. The returns reflect the actual historic returns starting in 1935, 1948 and 1977 for each portfolio of four gift annuities.

The annuitants will be paid for the respective life expectancies as determined under the Uniform Table applicable under Sec. 408 for individual retirement accounts (IRAs). This table reflects 2002 life expectancy data.

Using the equities and bond returns for the years following 1935, 1948 and 1977, the residua are calculated. Based on those assumptions, it is possible to calculate a range of possible residua.

Why CFOs Should Promote CGAs

Therefore, there are three reasons why CFOs should be very interested in promoting gift annuities.

First, the residuum for a portfolio of annuities funded in 2010 is likely to be 60% to 80% of initial funding. With a five to fifteen year typical maturity for gift annuities and the likely recovery of the equities markets during that time period, it is probable that the residua will be at or above historic averages. Therefore, it is very likely that a charity over that time period will earn at least the ACGA assumed net total return and benefit from a 50% or greater residuum.

Second, there is an additional benefit for the charity because some gift annuitants will live to senior ages and use their annuity funds to acquire new charitable gift annuities. Your author surveys seminar classes regularly to discover whether or not they have annuitants with multiple annuities. Some seminar attendees have noted that their organizations have annuitants with over 10 charitable gift annuities.

As a person moves into his or her 80s and 90s and continues to receive ever larger tax-free distributions from each new annuity, excess cash accumulates. A frequent response is to use this cash to acquire additional gift annuities. Because the multiple annuities are essentially repeat business, they could be considered to augment the original residuum.

Third, charitable gift annuities may lead to bequests. Seniors are attracted to gift annuities because of the fixed payment for one or two lives. The beneficial result of a senior receiving quarterly or monthly payments for a lifetime is that he or she tends to acquire a more positive feeling toward the charity.

Positive feelings do indeed lead to bequests. With consideration given to bequests and multiple annuities, the residuum on average is likely to exceed 60% of the initial gift value.