What is an annuity?

In its most general sense, an annuity is an agreement for one person or organization to pay another a stream or series of payments. Usually the term “annuity” relates to a contract between you and a life insurance company, but a charity or a trust can take the place of the insurance company.

There are many categories of annuities. They can be classified by:

Nature of the underlying investment – fixed or variable

Primary purpose – accumulation or pay-out (deferred or immediate)

Nature of pay-out commitment – fixed period, fixed amount, or lifetime

Tax status – qualified or nonqualified

Premium payment arrangement – single premium or flexible premium
An annuity can be classified in several of these categories at once. For example, you might buy a nonqualified single premium deferred variable annuity. For brief definitions of these categories, click here.


In general, annuities have the following attractive features:

Tax deferral on investment earnings
Many investments are taxed year by year, but the investment earnings—capital gains and investment income—in annuities aren’t taxable until you withdraw money. This tax deferral is also true of 401(k)s and IRAs; however, unlike these products, there are no limits on the amount you can put into an annuity. Moreover, the minimum withdrawal requirements for annuities are much more liberal than they are for 401(k)s and IRAs.


Protection from creditors
If you own an immediate annuity (that is, you are receiving money from an insurance company), generally the most that creditors can access is the payments as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities. And your money in tax-favored retirement plans, such as IRAs and 401(k)s, are generally protected, whether invested in an annuity or not.


An array of investment options, including “floors”
Many annuity companies offer a variety of investment options. You can invest in a fixed annuity which would credit a specified interest rate, similar to a bank Certificate of Deposit (CD). If you buy a variable annuity, your money can be invested in stock or bond (or other) mutual funds. In recent years, annuity companies have created various types of “floors” that limit the extent of investment decline from an increasing reference point. For example, the annuity may offer a feature that guarantees your investment will never fall below its value on its most recent policy anniversary.


Tax-free transfers among investment options
In contrast to mutual funds and other investments made with “after-tax money,” with annuities there are no tax consequences if you change how your funds are invested. This can be particularly valuable if you are using a strategy called “rebalancing,” which is recommended by many financial advisors. Under rebalancing, you shift your investments periodically to return them to the proportions that you determine represent the risk/return combination most appropriate for your situation.


Lifetime income
A lifetime immediate annuity converts an investment into a stream of payments that last as long as you do. In concept, the payments come from three “pockets”: Your investment, investment earnings and money from a pool of people in your group who do not live as long as actuarial tables forecast. It’s the pooling that’s unique to annuities, and it’s what enables annuity companies to be able to guarantee you a lifetime income.


Benefits to your heirs
There is a common misconception about annuities that goes like this: if you start an immediate lifetime annuity and die soon after that, the insurance company keeps all of your investment in the annuity. That can happen, but it doesn’t have to. To prevent it, buy a “guaranteed period” with the immediate annuity. A guaranteed period commits the insurance company to continue payments after you die to one or more beneficiaries you designate; the payments continue to the end of the stated guaranteed period—usually 10 or 20 years (measured from when you started receiving the annuity payments). Moreover, annuity benefits that pass to beneficiaries don’t go through probate and aren’t governed by your will.

California & Allstate

California Insurance Commissioner Steve Poizner said Wednesday that Allstate Corp. could be required to issue refunds to its policyholders if the state determines its rates are excessive.

Poizner issued an order that requires Allstate, which said 13 days ago that it will stop selling new residential policies in the state beginning July 1, to demonstrate its rates are not excessive. In dropping new policies, Allstate said California is "catastrophe-prone.'' The insurer did say it will continue to serve existing policyholders.

The commissioner said he has reason to believe Allstate rates are excessive because other insurers have reduced their rates in the state while Allstate is seeking a 12 percent rate increase. He also said the company's loss ratio is relatively low.
Poizner said he believes the Department of Insurance could hold a hearing on Allstate's rates as early as July.

"I am drawing a line in the sand,'' Poizner said during a conference call with reporters. "If I find that Allstate's rates are excessive, refunds will occur.''

Allstate's current California homeowners insurance rates were reviewed and approved by the Department of Insurance in 2003, "and our policies are competitively priced,'' Rich Halberg, a spokesman for Allstate in California, said in a statement.

He said Allstate is seeking the 12 percent rate increase "so that the company will be in a strong position to help meet the needs of policyholders in California over the long term.''

"This rate increase would reflect the true costs of providing homeowners insurance in the state,'' said Halberg, "including the cost of potential assessments from the California Earthquake Authority and the costs of reinsurance contracts, which help to provided added protection by diversifying catastrophe risk.''

E-mail George Raine at graine@sfchronicle.com.

Forgotten Wealth

We've all done it at least once. Deep in thought you instinctively grab a calculator from your desk and hastily figure the value of your agency to see what you could get for it on the open market. Come on, be honest...you've done it. Hell I've done it weekly depending on how the month is going. There's nothing wrong with it either, eventually selling the business is a big part of why we all bought into this deal we call an EA Contract.

But I wonder how often we consider what happens to an agency over a long period of time. Too often we think with a "Here and Now" mentality. Let's face it, we're in America...the instant gratification country. However, if the agency were held for say a period of 19-years, and grew by an average of 5% per year, the numbers get pretty sizable toward the end of that period.

Now, if you never tried to grow your agency at all in that period, and merely factored in the rate increases over that time, you'd probably come close to growing by an average of 3%, assuming higher than average retention, but for illustration purposes and to keep the math simple, I'm sticking with a 5% average over a 19-year period.

For this example, let's assume we own a $500,000 book of business valued at $125,000 (0.25 x 500,000)in year one. That same busines will be worth $131,250 the next year, a difference of $6,250 or roughly $520 a month. Continue out to the 19th year, and your $125,000 investment will be worth $315,868. Not bad, not great, but not bad either. Add to it over 1.6M in 1099 income over that period and you've got nearly $2,000,000 gross, or a $105,000 annual average for 19-years on a $125,000 investment. Where else can you do that?

$500,000 Agency with 5% Growth Over 19-Years

Year Yearly
1 $525,000.00
2 $551,250.00
3 $578,812.50
4 $607,753.13
5 $638,140.78
6 $670,047.82
7 $703,550.21
8 $738,727.72
9 $775,664.11
10 $814,447.31
11 $855,169.68
12 $897,928.16
13 $942,824.57
14 $989,965.80
15 $1,039,464.09
16 $1,091,437.29
17 $1,146,009.16
18 $1,203,309.62
19 $1,263,475.10

The point here isn't how much it's worth, but that we tend to forget about the equity our agency builds on a monthly basis. This would come in really handy, say for determing a price when you do sell...(don't have a set price based on the date of the contract, consider the time it will take to get the deal closed. Three months later could be a few thousand in your pocket).

It's also reassuring to know that your agency is more than just a 1099 income stream, it's should be building revenue in the form of equity as long as you own it.