Life annuity

The life annuity is a financial contract according to which a seller (issuer) - typically a financial institution such as a life insurance company - makes a series of payments in the future to the buyer (annuitant) in exchange for the immediate payment of a lumpsum (in the case of a single-payment annuity) or a series of payments prior to the return payments. The payment stream from the issuer to the annuitant has an unknown duration based principally upon the date of death of the annuitant: it generally stops then. Thus it is a form of longevity insurance.

It is possible to structure a life annuity so that the payments instead only stop upon the death of a second of two annuitants (i.e., a joint and survivor annuity); sometimes the instrument reduces the payments to the second annuitant.

With a "pure" life annuity an annuitant may die before recovering their investment in the annuity. If the possibility of this situation, called a "forfeiture", is not desired it can be ameliorated by the addition of an added clause under which the annuity issuer is required to make annuity payments for at least a certain number of years (the "period certain"); if the annuitant outlives the specified period certain, annuity payments then continue until the annuitant's death, and if the annuitant dies before the expiration of the period certain, the annuitant's estate or beneficiary is entitled to collect the remaining payments certain. The tradeoff between the pure life annuity and the life-with-period-certain annuity is in exchange for the reduced risk of loss, the annuity payments for the latter will be 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. Nevertheless, for 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. [http://wwwdocs.fce.unsw.edu.au/actuarial/research/papers/2006/Longevity%20Insurance%20-%20A%20Missing%20Market_28Aug_JP_Final.pdf Longevity Insurance: A Missing Market] Adam Creighton, et al. University of New South Wales AU] 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. [http://eastbay.bizjournals.com/eastbay/stories/2008/02/11/daily63.html Allianz Life Insurance agrees to $10M settlement over California annuities] East Bay Business Times] In the U.S., individual states provide assistance to the buyer and some regulation of the issuers.

Inflation detoriates the buying power of an annuity and can therefore be a concern.

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." 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. [" [http://www.insurancenewsnet.com/article.asp?a=top_news&id=30974 NCPA: Baby Boom Retirement Could Cause Annuity Market Explosion] " Insurance Newsnet, 12/9/2004]

Future

It is expected that the aging of the boomer generation [" [http://finance.yahoo.com/focus-retirement/article/105678/An-Income-Stream-to-Last-a-Lifetime?mod=retirement-post-spending An Income Stream to Last a Lifetime] " Anne Kates Smith, Kiplinger] in the US 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 Fund.

History

The instrument's evolution has been long and continues as part of actuarial science. [ [http://www.act.ku.dk/ Laboratory of Actuarial Mathematics] ]

The early practice for selling this instrument did not consider the age of the nominee, thereby raising interesting concerns. " [http://www.bus.sfu.ca/homes/poitras/FIN_HIS3.pdf From Commercial Arithmetic to Life Annuities: The Early History of Financial Economics, 1478-1776] " Goeffrey Poitras, Simon Fraser University] These concerns got the attention of several prominent mathematicians [ [http://www.fields.utoronto.ca/programs/cim/financial_math/finance_seminar/06-07/ Seminar Series on Quantitative Finance] The Fields Institute] over the years, such as Bernoulli, de Moivre, Huygens, Halley and others. Even Gauss and Laplace had an interest in matters pertaining to this instrument. [Stephen Hawking "God Created the Integers: The Mathematical Breakthroughs That Changed History", Running Press, 2005 ISBN 0762419229]

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.

ee also

*Annuity (European financial arrangements)#Life annuity
*Pension
*Actuarial present value
*Annuity (financial contracts)
*Defined benefit
*Retirement

External links

References