The Basics of Annuity Part II : The Annuity Contract

The following are the two important information required from Annuitant while :

1. Current Age:

a. Required to calculate the accumulation period for deferred annuity
b. Required to estimate length of payout period for some kind of annuities
c. Some annuities can be sold until certain age only. Max. Age is between 70 -85 years.

2. Sex: Life expectancy depends on sex.
The same information might be required for owner if the owner and annuitant are different persons.
Joint Owner: Someone who shares the ownership of contract.Contingent Owner: Someone who takes over as annuitant if primary annuitant dies.
Provisions of an Annuity Contract:
1. Assignment Provision: This grants power to contract owner to transfer ownership of a non-qualified annuity temporarily or permanently. e.g., Owner might decide to transfer ownership to bank to be able to use the cash value of policy as collateral.
2. Entire Contract Provision: This states that only documents appearing as attached to contract or part of the contract are valid parts of contract. Something not in writing is not part of the contract.
3. Incontestability Provision: Usually annuities do not require proof of insurability and do not have this provision. If there is an age or sex misstatement then insurer just pays benefits based on correct age and sex.However sometime riders like waiver of premium for disability rider might be attached to it and which requires proof of insurability and thus a incontestability period of 2 years might be attached.
4. Non forfeiture Provision: If the contract owner stops making payments, he will still receive benefits based on premiums he has paid. It also states that the annuity contract provides for settlement in lump some amount. Thus if the contract is surrendered in accumulation period then insurer will provide a lump some in lieu of benefit.
5. Free Look Provision: It states that for a period of time contract owner can examine the contract with the option of returning it and get full refund of payment. Sometimes if owner returns a variable annuity contract, he might get the current market value of the money.
6. Automatic Rebalancing Provision: It states that values automatically will be transferred between specified accounts to maintain the allocation percentages designated by the contract owner.
7. Free Withdrawal Provision: This provision states that an owner can withdraw all or portion of annuity’s accumulated value during the accumulation period. Many annuities allow a provision of 10-15% withdrawal without surrender charges. Sometimes the number of withdrawals can be accumulated and can be used later. If owner withdraws more than allowed under provision then surrender charges apply. Withdrawal below a minimum is also not allowed and off course owner pays taxes.
8. Surrender Provision: A type of withdrawal, which involves withdrawing total accumulated value and is known as surrender.
Surrender Cash Value = Accumulated value – Surrender Charges
Usually surrender charges apply if surrender is done within a stated period of time and keeps on decreasing with time. Some policies have waiver of surrender charge provision to waive off surrender charge in special condition like disability.
9. Bailout Provision: This provision states that owner can surrender without any charges if the interest rate falls by a certain margin usually 1%. Also, know as escape clause or cash-out provision.
10. Death Benefit Provisions: This provision states that if the owner dies before the benefits have started to pay then the beneficiary named by the contract owner will receive the larger of the total premium amount paid and the accumulated value amount. Based on how investment performance is, this hugely helps to retrieve at least the premium amount for a variable annuity. If the owner dies in the payout period then insurer may continue remaining payments based on how the payout option was specified.
11. Payout Provisions: Also known as settlement provisions and states the terms of how the payments will be made. The provision is chosen by Immediate Annuities at the time of purchase of annuity whereas for deferred annuities it is done just before the payments starts. Some options are:

a. Lump sum: Single payment of lump some amount. Bad since higher tax bracket.
b. Fixed Period or Fixed Amount: Insurer pays for a fixed period of time or pays a particular amount as long the accumulated value lasts. Both these options are independent of whether annuitant lives or not. If he does not contingent payee gets the entire balance of the account. An annuity that is paid out for a certain period of time irrespective whether annuitant lives or dies is called annuity certain. The period is known as period certain. Payment ceases at the end of the period certain.
c. Annuitization: A payout option that involves payments tied to a life expectancy.

1. Straight Life: Payment made until annuitant is living. So high premium.
2. Life Income with Period Certain: Guarantees that payments will be made throughout the lifetime of annuitant’s or a minimum stated period whichever is larger. If annuitant dies before the period certain then the contingent payee receives the payment for the remainder of the period.
3. Life Income with Refund Annuity: This guarantees that payment will be made throughout the lifetime of the annuitant and guarantees that at least the purchase price of the annuity will be paid out. If annuitant dies before that then a refund is issued which can be lump some or installments.
4. Joint and Survivor Annuity: Series of payments to one or more person and those payments continue until the death of last surviving annuitant. It might be stated that the premium will be same after one of the insured dies or might be that it may be reduced by say 50%.
5. Fixed and Variable Payout: The owner of a fixed annuity will receive a fixed payout, which means fixed annuity payments throughout the payout period. Owner of a variable annuity may choose variable payout, which means payments are not fixed but dependent on performance of underlying sub accounts.

Four Factors that influence size of annuity payments are:

1. Interest Rate
2. Accumulation Period
3. Premium amount
4. No. of payments.