One of the primary activities of the American Council on Gift Annuities (“ACGA”) is publishing a table of suggested maximum charitable gift annuity rates for use by charities and their donors. The ACGA has published suggested annuity rates as a public service since 1927. Its suggested rates have long been recognized by charities, donors, state insurance departments, and the Internal Revenue Service as being actuarially sound and responsive to the best interests of all parties involved.
While the suggested rates are voluntary, 97% of the charities responding to the 2017 Gift Annuity Survey reported that they always or usually follow the suggested payment rates. By following the suggested ACGA gift annuity rates, charities are relieved of the expense of hiring an actuary and developing their own rate schedules.
The Rate Review Process
The ACGA Gift Annuity Rates and Regulations Committee (“Rates and Regulations Committee”) collects and analyzes information related to the suggested rates and the assumptions underlying those rates.
Rate reviews normally include the following steps:
- A general reassessment of the assumptions underlying the rates in light of available data regarding the experience of charities issuing gift annuities, current interest rates, the investment market environment, the mortality of annuitants, and expenses incurred in administering a gift annuity program.
- Consultation with professionals regarding expected investment returns and expenses for investment management and administration.
Assumptions underlying the ACGA’s suggested maximum payout rates
Following is a summary of the major assumptions on which the suggested rates are based.
- Target Residuum.Since 1955, the ACGA has targeted a residuum (the amount realized by the charity upon termination of an annuity) of 50% of the original contribution for the gift annuity.The latest rate schedules retain the 50% target residuum, and continues the requirement that the present value (PV) of the residuum be at least 20% of the original gift.
- Mortality Assumptions.The National Association of Insurance Commissioners (NAIC) has recommended the use of the 2012 Individual Annuity Reserving Table (2012 IAR). This table is designed to reflect annuitant mortality more accurately over time than previous mortality tables.
- Expense Assumption.Annual expenses for investment and administration are assumed to be 1.0% of the fair market value of gift annuity assets.
- Investment Return Assumption.The gross annual expected return on immediate payment and deferred payment gift annuity reserves is currently 4.25%. Both immediate and deferred payment annuity calculations use a net compounding rate of 3.25% (4.25% minus 1% assumed annual expenses).
- Payment Assumption.Annual payments are made in quarterly installments at the end of each period.
The suggested rates for the oldest ages are somewhat lower than the rates that would follow from the above assumptions. Single life rates are capped at 9.0% for annuitants aged 90 and above. Single life rates for annuitants between ages 81 and 89 are graduated downward from the rate cap. Two life rates are graduated downward in a similar way.
From its start in 1927, the ACGA has set a residuum target representing a percentage of the face value of the amount funding an annuity contract.
The first assumption is that the target residuum (the amount remaining for the charity at the termination of the annuity) will be 50% of the original contribution. The actual residuum at the termination of any particular annuity could be more or less than 50%, depending on the longevity of the annuitant(s), the investment returns on gift annuity reserves during the term of the contract, and other factors. Actual residuum over the years have generally averaged higher than the 50% target.
In the 2000s, the Rates Committee considered using a residuum expressed in present value terms because such an approach would mean that—given the investment return, expense, and mortality assumptions—charities would receive similar economic value from gift annuity contracts funded with like dollar amounts, regardless of the age of annuitants. However, the Committee felt then, and continues to believe today, that the 50% nominal residuum is an easily understood concept that has fundamental appeal in the fundraising context. In order to balance these two objectives, the Committee retains the 50% of nominal value assumption as a starting point, but also requires that each contract produce at least a 20% minimum present value. Today, the 20% minimum present value has the effect of lowering rates for annuities issued at ages 59 and below.
The ACGA endeavors to base suggested maximum annuity rates on mortality data for individuals as similar as possible to annuitants who will begin receiving payments under contracts to be established in the near future. Because new gifts might involve making payments for many years into the future, effective mortality assumptions for annuitants requires continual research and adjustments.
In the fall of 2010, the ACGA conducted what we believe to be the largest-ever mortality study of actual gift annuitants: 28 charities furnished mortality data on 47,075 gift annuity contracts. The results of the study were surprising: significantly more individuals from the sample population died during the five-year period of the study than was predicted by the mortality assumptions used over the past decade.
Another surprising finding was the proportion of annuities being established by men and by women. More men are establishing gift annuities than in the past and as such, the overall life expectancy for gift annuitants is not as long as previously assumed.
It is not surprising that the number of female annuitants continues to be larger than the number of male annuitants: there are many more women than men in the age range likely to create gift annuities. For example, the 2010 Census counted 11,122,000 males age 70 or older and 15,471,000 females age 70 or older. It is important to note that mortality rates vary by gender, but gift annuity payment rates do not.
The ACGA continues to feel that a unisex rate table offers important benefits in terms of simplicity.
The ACGA plans to conduct another gift annuity mortality study in 2020.
The annual expenses for administering gift annuities are assumed to be 1% per year. These expenses include investment and custodial fees, the costs of making payments and filing federal tax forms, and the costs of submitting reports in regulated states. They do not include the costs of marketing or stewardship, which are presumed to be covered in a charity’s general budget for the development office. For large charities with economies of scale, and for charities that do not issue gift annuities in heavily regulated states, the 1% expense assumption might be high. However, charities with smaller and mid-sized programs, and those that operate in regulated states that require annual filings, actuarial reports, and sometimes a fee for each annuity written, 1% appears reasonable.
Perhaps the most challenging assumption to make is the average annual investment return assumption. The first challenge is to determine the appropriate asset allocation to use in the return calculation. Next is the task of what return assumptions to use for each asset class in the assumed allocation.
ACGA surveys provide information about the asset allocations charities use. In the 2017 Survey, charities reported the investment allocation for their gift annuity assets within six categories. On average, charities invested 51% in stocks, 14% in government bonds, 16% in corporate bonds, 2% in real estate, 7% in other investments and 10% in cash.
From time to time, the Rates Committee receives guidance from highly-regarded investment advisors, as well as from members’ own business offices, regarding the use of current and past performance of various asset classes to estimate future returns. Finally, the Committee notes current state restrictions on the investment of gift annuity reserves.
Asset Allocation and Benchmarks
Taking into consideration the above factors, the Rates Committee selected the following asset allocation for calculating the weighted average return assumption on which gift annuity rates are based.
- 40% equities
- 55% 10-year Treasury bond yields, and
- 5% cash and equivalents.
The following benchmarks are used to determine the average annual total return for each component of the portfolio:
- For equities, the approximate average annual total returnfor the period 1926 – 2019 less 2.0% for purposes of conservatism. The average annual compound return of the Standard and Poor’s 500 Index return for that period was approximately 10% per year.This number is then reduced by 2.0%, resulting in 8.0% as the assumed total return on the equity portion of the portfolio.
- For bonds, the average current yield(using a 13-week rolling average) on the 10-year U.S. Treasury bond.
- For cash, the average current yield(using a 13-week rolling average) on the 3-month U.S. Treasury Bill.
The Committee exercises judgment in rounding the expected return, taking into account current economic conditions, forward-looking projections, recent rate change history, and other practical issues. The current return assumption is 4.25% gross of fees.
History has shown that asset allocation (and not investment manager selection or individual security selection) is the primary driver of investment return. Because returns from equities have historically outpaced returns from fixed income and cash, most investment professionals believe that allocations emphasizing higher percentages of equity asset classes are likely to have a higher expected return than those emphasizing fixed income allocations.
However, risk is also a very important element of the portfolio management decision. Equities have significantly greater variability in returns and much greater downside risk than fixed income asset classes. A large investment market decline (such as we experienced in 2008) can quickly turn a gift annuity contract paying the annuitant 7% of its initial gift value into one that is paying 10% (or more) of its current value. Sustained poor investment markets could lead to a gift annuity contract running out of money, requiring the charity to make payments on the contract from other sources.
The ACGA believes the 40% equity/55% fixed income/5% cash allocation used in the derivation of its rate schedule is a reasonable allocation that is achievable by virtually all charities, although not all charities will or should choose this particular asset allocation. (In the past, investment restrictions in states such as California made a 40% equity allocation difficult or impossible, depending upon the mix of contracts in a particular charity’s program.)
However, it is very important that charities and their investment advisors select an asset allocation that is appropriate for the unique circumstances and preferences of the institution and its gift annuity program. For some institutions, it might be appropriate to invest the gift annuity assets more aggressively than the 40%/55%/5% allocation; for other institutions, it can be equally appropriate to invest in a more conservative allocation.
 The 2017 Gift Annuity Survey was conducted in October and November of 2017 and published in April of 2018.
 The first table of suggested rates in 1927 was based on a residuum target of 70%.