Annuities

General Characteristics 

While many insurance contracts have the purpose of creating a sum of money or an estate, annuities have the opposite purpose of liquidating an estate in order to prevent its exhaustion before the death of the annuitant. Both the annuity and life insurance policy provide economic or income security to the individual; each, however, provides a solution to a different problem. Life insurance protects an insured’s family against loss of income resulting from his death, whereas annuities assure the individual that he will not outlive his income. Both contracts are based on the law of large numbers and utilize mortality tables. Under the life insurance contract, however, the insured pays periodic premiums to the insurance company until his death, whereupon the insurance company pays the face value of the contract either in a lump sum or under a settlement option. Under an annuity, the annuitant pays the lump sum to the insurance company which then makes periodic payments to the annuitant until his death. The objective of the annuity is not only to assure a person an income until his death but also to provide an income larger than that which could be derived from interest on the principal amount. Basically, the annuity payment is a distribution of the interest earned on the principal, a portion of the principal, and a survivorship benefit. It could be thought of as the scientific liquidation of principal and interest over the annuitant’s expected lifetime. Because some annuitants will live less than their expected lifetime, the payments that would have been made to them are available to continue payments to those who live longer than their expected lifetime. It should be mentioned at this point that the expected lifetime of annuitants is longer than that for insureds because there is a tendency for individuals with good health who expect a long life to seek annuities. 

Because of the varying needs of the insurance consumer many types of annuities have developed. The available annuity forms may be distinguished by the method of building up principal, the method of distributing proceeds, the number of lives covered, and whether a fixed or variable base is used to govern payments.