The Great Fall of Gift Annuities

Say it ain't so!

The sky might be falling (on gift annuities), or it might not be.

I think it is reasonable to say that planned giving and fundraising professionals see gift annuities as the primary planned gift we are "selling" these days and its been that way for over 10 years (regardless of the never changing fact that bequest dollars generally overwhelm all other planned gift dollars by far).

But it wasn't always the case and it probably will not be the case in the future. The question is only when will the shift take place? A change in the field away from gift annuities may be sooner than you think.

Background

Pooled income funds were the planned giving chic of the 1980s. Why? Interest rates were sky high - over 10% much of the time. A good friend of mine even wrote a manual about setting up and running pool income fund programs (I found multiple copies of it lying around the UJC offices, written on a typewriter, pages melded together after a decade or more of sitting unused on the shelves or in boxes, gathering dust).

Their downfall: interest rates eventually dropped and other vehicles offered donors higher fixed rate or annuity returns.

Charitable remainder trusts (CRTs) were chic of the 1990s. Why? In addition to offering donors fixed rate/annuity payments, capital gains avoidance coupled with financial adviser self interest in retaining investment management control over their clients' assets caused CRTs to rule the planned giving world.

Their downfall: big slowdown in capital gains avoidance (i.e. stock market crashes) coupled with the discovery of easier, cheaper, fixed income, better tax-treatment CGAs.

So CGAs rule the roost, for now. But, where are the cracks in their lead position in the planned giving world? This blog has already touched on some of the potential for underwater gift annuity programs (http://plannedgift.blogspot.com/2009/06/gift-annuity-risk.html) and other serious issues with gift annuity pools and the challenge of finding good administrative services (http://plannedgift.blogspot.com/2009/07/gift-administration-revolving-door.html). And, as a consultant working with a few national charities, I can say that CGA licensing across the country is a bear! These facts alone should probably scare off most medium and smaller charities from getting in or staying in the CGA business.

And, how can we forget the recent Warfield case (Robert Dillie ponzi scheme) from the U.S. Court of appeals, with a new specter of investment/SEC regulation hanging over the head of CGAs again. (see http://plannedgift.blogspot.com/2009/08/important-legal-ruling-impacting.html)

Why this post and why I am announcing that the heyday of CGA programs may really be over?

In a conversation with one of the most prominent planned giving attorneys in the field this morning, my eyes were further opened to additional colossal problems that CGAs are facing as a result of the Warfield case.

I personally had sent a copy of the Warfield case to this attorney early in the summer, when I was claiming that the sky was falling on CGAs. He didn't read it carefully until a few weeks ago and his reaction was what I feared.

Here is the colossal problem. The Philanthropy Protection Act (PPA) of 1995 provides exemptions from various securities regulations for all types of charitable funds/investment pools (including CGAs, of course). One caveat was that CGA funds/pools in particular would not be exempt if they were sold with commissions.

What I couldn't figure out about the Warfield case was why didn't the court just cite the PPA, note that the parties in that case were selling CGAs with commissions, and just conclude that they no longer had the exemptions of the PPA. Why the analysis of CGA marketing and other practices to determine that CGA agreements were investment contracts? And, as one critic to my posts on the topic noted - since charities sell CGAs WITHOUT commissions, wouldn't the Warfield case have no impact on the good guys anyway?

I heard the answer to my question this morning from one of the best attorney in this area. It is a very subtle point, easy to miss. The PPA exempts charitable FUNDS, pools of investments, from various SEC regulations if you follow the disclosure rules found in the PPA itself. The PPA did not address, or exempt, CGAs from being considered investment contracts. That actual decision is one that generally falls under state law jurisdiction over contracts (even though the real scary investment laws are the federal ones).

This needs repeating so that readers won't miss it: CGA contracts are not exempt by the PPA from being considered investment contracts by any court, the IRS or Congress. And, the U.S. Court of Appeals (second only to the U.S. Supreme Court) very easily determined that CGAs were investment contracts (regardless of whether they are sold with commissions or not).

The ramifications: In theory, CGA contracts need to follow all of the disclosure requirement of investments. In theory, there could be investment licensing issues for charities and/or planned giving/fundraising professionals who sell these investment products. In theory, CGAs could really be sitting ducks for disgruntled families once your CGA donors pass away - assuming they pick a sharp attorney.

And, to top it all off, the word out there in the planned giving legal universe is that the IRS is sitting on a letter ruling request addressing whether CGA programs can offer CGAs in which the contract specifies another charity (related or not) as the ultimate remainder beneficiary (common among community foundations, Jewish federations and large university/hospital systems).

Not that this narrow question of issuing CGAs for other organizations is that big - but it opens the door for some serious thought by the IRS, and maybe others in the government, as to this whole CGA business.

Honestly, CGAs have been under the radar of regulators for a long time. Except for a short time in the mid-90s with a class action price fixing suit against the ACGA that partially resulted in the PPA's enactment, gift planners have been somewhat free from serious regulations (besides annoying departments of insurance in NY, NJ, California and a few other states).

Yet, running a CGA program is harder than ever before (based on investment, administration and licensing issues). How about after the IRS finally puts some thought into this area and issues a letter ruling that may not be so favorable to current practices?

Put all of these factors together: tougher state licensing issues, concerns over investments and administration, faltering investment performance, and throw in the new investment contract issues. It is a recipe for the end of the CGA generation and on to the next chic planned gift vehicle.

I think it is just a matter of time before we start seeing another planned giving options as the favored child of the planned giving world. Maybe it will be the good old bequest - not like it ever really went out of style.