The benefits of reinsuring charitable gift annuities.
CGAs enable donors to support causes they care about, while gaining the security of lifetime income. A donor can typically begin to receive income right away, or at a predetermined date in the future, the latter of which can be attractive for younger donors. CGAs, which are tax-advantaged, are particularly well-suited for "philanthropic, often high-net-worth retirees to meet their need for lifetime income and their desire to donate money to charity in a single contract." (i) The American Council on Gift Annuities (ACGA), which provides standardized CGA payout rates, suggests a payout rate of 4.7% for a single 65-year old, although payout rates do vary from charity to charity. In comparison, a commercial annuity would likely offer a 7% rate. ACGA rates are calculated so that with average life expectancy, a significant portion of the original gift will be available to the nonprofit at donor's death. The donor also is entitled to a tax deduction for a portion of their gift annuity purchase.
CHARITABLE GIFT ANNUITIES: THE RISK OF SELF-INSURING
Historically, most philanthropic organizations have been willing to act like an insurance company by self-insuring the longevity, investment and other risks associated with their gift annuities--risks that are backed only by the assets of the charity. Self-insuring the risks associated with a CGA can have a significant negative impact on the financial viability of the charity if a significant market event was to occur and the charity was unable to meet donor obligations. This can be a very risky proposition for the charity since a CGA's guarantee is based on the claims-paying ability of the charity. In fact, according to a Retirement Income Journal article, "During the [2008-9] financial crisis, many small or shallow-pocketed charitable funds were said to be "underwater," and a few actually went bankrupt." (ii) With the unpredictability of volatile markets, self-insuring can result in mismatches with the charity's risk tolerance and unexpected contributions may be needed to shore up the charity's obligations.
In addition to the risks associated with self-insuring CGAs, charities need to be aware of the requirements that govern CGAs, which differ by state. Most states require that a separate annuity reserve fund be created by the CGA, but the specific requirements, including the amount required to be kept in reserve and the annual reporting requirements, vary. According to John Hook, Esq., an attorney with the law firm of Stradley Ronon Stevens & Young, LLP, "Some states provide minimal regulation and oversight (e.g., Pennsylvania, where the charity self-regulates) and other states provide a much higher level of regulations (e.g., New Jersey, which requires the charity to file an extensive application, obtain a permit to issue gift annuities and file annual reports)." (iii) These complexities can be a distraction to the mission of the non-profit.
WHAT IS CGA "REINSURANCE"?
How can charities minimize or transfer the risks associated with their CGAs? One way is to "reinsure" their CGA with a commercial insurance carrier. The term itself is actually a bit of a misnomer because reinsurance usually describes an arrangement where one insurance company cedes excess risk to another insurance company for a premium. In contrast, CGA reinsurance is "simply a financing technique whereby a charity chooses to purchase a commercial single premium immediate annuity as an asset to back its contractual life-income liability owed to the donor." (iv) This eliminates investment, longevity, mortality and concentration risks for the charity, and relieves the administrative burdens and costs associated with managing a CGA program.
An article in Planned Giving Today provides a practical example of how CGA reinsurance works: "Some charities, acting at their own discretion, use a portion of the amount contributed for a gift annuity to purchase a commercial annuity from a life insurance company that will make payments equal to the amount stipulated in the gift annuity agreement. For example, a woman age 70 contributes $100,000 for a gift annuity, and the charity agrees to pay her $5,100 per year for life. The charity then covers its obligation by purchasing from an insurance company at a cost of $73,368 a single-premium immediate annuity that will pay $5,100 per year. Assuming the reinsurance relieves the charity of reserve requirements, which will be true in most states, the charity can either spend the remaining $26,632 or invest the money in its endowment until the death of the annuitant." (v)
KEY BENEFITS OF CGA REINSURANCE INCLUDE:
Immediate use of CGA donations: When a non-profit organization reinsures a gift, funds are immediately released after the purchase of CGA reinsurance. They obtain the immediate use of the difference between the remaining value of the gift and the cost of the annuity, without having to worry about providing a payment stream to the donor. Faced with declining residuums, the ability to use donors' funds immediately rather than later may be attractive, particularly for those charities that have time-sensitive objectives.
In the ACGA's 2013 Gift Annuity Survey Report, (vi) the fifth edition of the survey, for annuities that terminated in the last five years, the average residuum--the net amount remaining for the charity after the donor's passing--was 65%. This is the lowest average residuum reported in the last fifteen years since the high of 98% in 1999. It is unclear from the survey findings but some possible reasons for the decline in average residuums among survey respondents may include:
* a decline in the average donor age (a younger donor means more years of income the charity has to pay to them);
* donors living longer than assumed (meaning more years of income to be paid out than assumed) or both; and,
* actual interest rates earned on the reserves the charity is supposed to establish are lower than assumed, meaning that more of the principal is used in making the annuity income payments.
Security and certainty: CGA reinsurance reduces investment, longevity and concentration risk, eliminating the need to draw on other revenues or unrestricted dollars in order to meet donor obligations. CGA reinsurance can be used to back reserve funds, and may also be considered an alternative fixed income asset. It helps ensure that the charity will not default on annuity payments by reducing or eliminating the possibility of depleting CGA reserves if (a) the donor lives past estimated life expectancy or (b) assets underperform.
Reassurance about the security of lifetime payments: If desired, the insurance company providing the CGA reinsurance can make annuity payments directly to the donor. Employing an insurance company funding mechanism can make donors more comfortable with the amount of their donation or increase the possibility of additional donations.
"Risk capacity" for accepting more CGA gifts: The transfer of risks may free up capital and enable the organization to issue additional CGAs.
Renewed focus on the charity's primary mission: According to the ACGA, gift annuity administration requires the "structure and resources to invest reserve funds, manage accounts, make annuitant payments and meet state and federal reporting requirements." (vii) The transfer of risk to the insurance company requires fewer of an organization's resources to maintain the program, which allows an organization to focus more time on its primary mission.
SELECTING A SUITABLE ANNUITY PROVIDER
When selecting an insurer to reinsure CGAs, there are several criteria that a charity should consider. First, it is important for a charity to select an insurer with CGA reinsurance as a core competency to ensure that the charity is working with a provider who truly understands the need to balance the charity's ability to promote its mission by freeing up its capital, and protecting the income stream that has been promised to valued donors in exchange for their generosity. It is also extremely important to select an insurance carrier with strong financial strength ratings to be certain the insurer is able to meet all of its payment obligations.
INTEREST IN CGA REINSURANCE PROJECTED TO GROW
The 303 charities responding to the ACGA's 2013 Gift Annuity Survey Report who reported issuing one or more gift annuities in 2013 were asked whether they purchased commercial annuities to "reinsure" the gift annuities they issue. Nine in ten charities (91%) reported they do not purchase commercial annuities at all, while 7% purchase some commercial annuities, and 2% reported that all gift annuities they issue involve the purchase of commercial annuities, compared to 6% and 1%, respectively, in the 2009 survey. This means that the percentage of charities reinsuring their annuities is up slightly since the wake of the 2008-2009 U.S. financial crisis, which, as noted above, saw several charities go bankrupt and be left unable not only to re-pay their donors, but also to promote their missions.
The increase in the percentage of charities reinsuring their CGAs indicates that awareness of the extensive benefits that CGA reinsurance can offer to charitable organizations is expanding. The percentage is likely to grow even further as more charitable organizations realize that working with an insurance company whose expertise lies in mortality and longevity risk management and asset-liability matching can mitigate the risks associated with managing CGAs, relieving some of the burdens that come with administering a CGA program and allowing the organization to focus on its core philanthropic purpose.
For more information, please visit www.metlife.com/cga.
(i) Pechter, Kerry, "The Weird Math of Charitable Gift Annuities," Retirement Income Journal, March 22, 2012.
(ii) Pechter, Kerry, "The Weird Math of Charitable Gift Annuities," Retirement Income Journal, March 22, 2012.
(iii) Hook, John, Stradley Ronon Stevens & Young, LLP, "Ten Things You Need to Know About Planned Charitable Giving," Metropolitan Corporate Counsel, October 21, 2013.
(iv) Clontz, Bryan K., "Charitable Gift Annuity Reinsurance: The Top Ten Frequently Asked Questions," Planned Giving Design Center website, March 29, 2006.
(v) Minton, Frank, Frank Minton Consulting LLC, "Unbundling Gift Annuities," Planned Giving Today, July 2013.
(vi) The ACGA's 2013 Gift Annuity Survey was conducted online among 378 charities with gift annuity programs in October and November 2013- The survey was sponsored by Bank of New York (BNY) Mellon. The survey has been conducted in five year intervals since 1994.
(vii) The Fundamentals of a Successful Charitable Gift Annuity Program, American Council on Gift Annuities," June, 29, 2011.
Metropolitan Life Insurance Company 200 Park Avenue, New York, NY 10166 www.metlife.com
THE EXAMPLE BELOW SHOWS HOW FUNDS ARE RELEASED AFTER THE PURCHASE OF CGA REINSURANCE. FUNDS RELEASED BY REINSURANCE * Male Age at Purchase 65 70 75 Age at Expected 86 87 88 Death Term of Annuity 21 years 17 years 13 years Funds Released 54% 57% 56% at Death Present Value of 27% 33% 37% Released Funds Funds Released 33% 36% 38% by Reinsurance Female Age at Purchase 65 70 75 Age at Expected 88 89 90 Death Term of Annuity 23 years 19 years 15 years Funds Released 49% 51% 51% at Death Present Value of 23% 28% 32% Released Funds Funds Released 30% 32% 33% by Reinsurance * Key Assumptions (a) Mortality:Annuity 2000 Basic Mortality Table with Projection Scale AA; (b) Annual Fund Return: 3.25%, net of expenses; and, (c) Reinsurance cost based on MetLife purchase rates in effect on October 1, 2013.
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|Publication:||The Non-profit Times|
|Date:||Oct 1, 2014|
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