Life annuity

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The life annuity (also known as a single-payment annuity) is a financial instrument that allows for a seller (issuer) - typically a financial institution such as a life insurance company - to make a series of payments in the future to the buyer (annuitant) in exchange for an immediate payment of a known sum with a certain net present value. The payment stream from the issuer to the annuitant has an unknown duration based principally upon the life expectancy of the annuitant. Generally, such an instrument stops payment at the death of the annuitant. However, 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.

The "pure" life annuity can have harsh consequences for an annuitant who dies before recovering their investment in the annuity. The risks of such a situation, called a "forfeiture", 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.

1 Factors
2 Future
3 History
4 See also
5 External links
6 References

[edit] Factors

Many potential annuitants are already familiar with the concepts involved through knowledge of their own pension, whether from a business or government job, yet there can be a notion that annuities have limited value for the buyer or that the buyer cannot expect a fair payout from the investment. Some argue that this instrument has no advantage for the buyer. The other side of this notion is that the conditions for the instrument are stacked in favor of the issuer, though issuers have grappled with this instrument for years and do face risk. ^[1]

From 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. ^[2] 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.^{[citation needed]} In the U.S., individual states provide assistance to the buyer and some regulation of the issuers.^{[citation needed]} From the issuer's viewpoint, there are many technical factors that determine the amount of an annuity payment for the life expectancy of the annuitant and that influence yields on the investments annuity issuers invest premiums in. There are expenses (including distribution costs) related to managing the instrument and profit expectations that affect the decisions about the payment. Risk management costs for the issuer can become more problematic, if annuitant's returns are given more weight than has been the case.

Other factors are concerns, such as inflation and usury, which might be considered auxiliary by the issuers but not by the annuitants.

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." ^[2] 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. ^[3]

[edit] Future

It is expected that the aging of the boomer generation in the US^{[citation needed]} 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.

[edit] History

The instrument's evolution has been long and continues as part of actuarial science. ^[4]

The early practice for selling this instrument did not consider the age of the nominee, thereby raising interesting concerns. ^[1]^[5] These concerns got the attention of several prominent mathematicians ^[6] over the years, such as Bernoulli, de Moivre, Huygens, Halley and others. ^[1] Even Gauss and Laplace had an interest in matters pertaining to this instrument. ^[7]

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.