Gift Annuity Risk

Gift Annuity Risk

I was wondering if I am crazy or not. Was I the only one in the planned giving world ringing the alarm, calling out to whoever would listen, that many gift annuity programs might be in big trouble? When you are an alone alarmist, you have to start wondering.

At Planned Giving Day in New York a few weeks ago, I presented on a panel various “doomsday” projections about exhausting CGAs but the response was quiet – too quiet, like maybe people didn’t want to hear the message or maybe I was wrong. There was of course the misleading article in the Wall Street Journal, hardly backup for my theory that CGA programs in general could be in trouble.

Finally, Frank Minton on PGCalc’s latest webinar on Advanced Gift Annuities dedicated the first 20 minutes of his presentation, billed as a discussion on advanced and new gift annuity techniques, to “risk control.” And, listening to Frank’s presentation and seeing that he used similar projection models to what I use, mostly “what ifs” using assumed constant rates of return, I know I am not crazy.

Here is the bottom line in what I found with the NEW (February 2009) ACGA rate tables. If your program returns 4% a year constant returns, I feel comfortable saying that your program will never experience (or very rarely) exhausting CGAs. Great news if you think 4% is attainable on a consistent basis.

The problem is what are we to do with older annuities? Under the same analysis on ACGA rates a few years ago, I figured out that you need to return 5% a year consistent returns, to be generally safe from gift exhaustion. Less than that, not always safe.

But the problem gets even stickier. I know from experience that even the biggest and best gift annuity investment/administration providers have seen the CGAs pools on their watch drop over 25% in principal value since January 1, 2008. That is on the conservative side – I am sure many have lost more. And, as CGA payments don’t change, the rate of diminishing principal speeds up even if you return to “normal” investment returns. What I mean is that your program may seem ok but really it’s not – one big annuity that runs out of money could bring the rest of your pool underwater with it. You don’t want to be hoping that your donors don’t live into their 90s because their annuity principals will be gone and perhaps eating up the rest of your pool.

In the midst of working through sticky situations for clients, I finally started feeling a ray of hope. Not that all will be well with every annuity out there – certainly not – as many are paying the price now for offering rates over the ACGA tables, or for the ACGA rates being too high, or for sloppy oversight, or for uncontrolled gift acceptance policies, or for small organizations taking on CGAs when they shouldn’t have, or taking on CGAs much too large for certain organizations.

The point is that proceeding carefully from this point forward can rescue your CGA program from “doom” that might be coming. Wake up now. Ask your provider for an updated “market value” report showing the current value of every annuity. Create an excel spreadsheet calculating what happens to the principal of each annuity under different flat rate assumptions over the next 10 to 20 years. Here is my super-secret excel formula for doing this: =(C1*$A1)+C1-$B1, column A is the assumed rate of return, column B is the fixed annuity payment, column C is current principal, put the formula in column D and then drag it over the next 10 to 20 columns. The $ sign keeps rate of return and payment amount fixed – the rest changes column by column – year by year. If you have trouble doing this, get someone from the finance department to help you.

You will start to see when CGAs are approaching negative. Maybe you will see an exceptionally large CGA that not only might run out of funds in 4 or 5 years, but will literally eat up the rest of the pool should it exhaust. It might be time to meet with that donor to see if he or she will take a lower income stream or would even give up all of the income.

New annuities are great for struggling pools as long as the pool isn’t so far depleted that news funds will only just push off the inevitable exhaustion of the whole pool – that really is more like a Ponzi scheme.

Perhaps it’s time to ask new CGA donors if they will take less than the ACGA rate – preserves a bigger remainder gift and bolsters the whole CGA program.

The biggest change though has to be your “remainder” policy. Dig deep enough into the CGA concept and you will find that the CGA program rests on the theory that “you win some and you lose some.” In other words, “profits” from annuitants dying before life expectancy should cover “losses” from those outliving their life expectancies. But most organizations pull 100% of an annuity’s funds when an annuitant passes away leaving a pool that is filled only with the “losers,” those outliving their life expectancies. Coupled with unexpected 25% investment losses in principal this past year and this is why we’ll soon start seeing CGA programs fail.

You should consider developing a policy to leave something from every annuity in your CGA reserve account – look at it as a rainy day fund. One large charity I know actually leaves all of the “liability” portions of each matured annuity in its reserve – creating an unrestricted endowment within their CGA reserve account. Even after years of offering even higher than ACGA rates, this past year’s market losses didn’t have a material impact on their program.

And, in dealing with a fund currently in danger of exhaustion – or at least a few years away, one solution after adding the proper reserves that the New York State Department of Insurance requires (and not a bad idea for non-New York licensed issuers either) is to leave 100% of new matured annuities in the fund until the pool has recovered. I know that your donor’s wishes may be delayed a bit, but you also have to make sure your program and organization is solvent.

Eventually, with careful supervision and understanding that CGA programs don’t run on autopilot, your program can be back on track for providing long-term financial resources for your institution.

Jonathan Gudema, Esq.
Changing Our World, Inc.