Comments on Gift Annuity Rates

These comments apply to the new gift annuity rates, which were approved by the ACGA board at its April meeting, and which will become effective on July 1, 2001. (Note: You may start using these new, lower rates at any time before 7-1-2001, since they are LOWER than current rates. But, be sure to start using them no later than 7-1-01, or any of the permit issuing states will require you to hire an actuary to *prove* that your rates (which will then, no longer be the *Current ACGA Suggested Gift Annuity Rates* will not run afoul of their state law).

Except for a reduction in rates for the youngest ages (ages 20-60) in 1999 to ensure that all rates at all ages passed the 10% requirement, even when the CMFR is quite low, there has been no rate change in three years. During that three-year period, interest rates on Treasury bonds and other fixed-income investments have declined significantly.

ASSUMPTIONS USED FOR 7/1/2001 RATES

The ACGA suggested rates are based on the following assumptions:

1. A 50% residuum (amount of contribution remaining at the death of the annuitant(s)).

2. Life expectancies based on the Annuity 2000 tables, using female life expectancies and setting ages back one year.

3. A yearly cost of 75 basis points for administering gift annuities.

4. Total return on gift annuity reserves for immediate gift annuities, and for deferred annuities with deferral periods of up to 20 years, of 6.50% (5.75% net of expenses).

The return assumption is based on an assumed portfolio consisting of 30% equities, 60% 10-year Treasury bonds, and 10% cash equivalents, using historical averages on large-cap equities and current yields on the bonds and cash. Although many charities invest reserves more aggressively, this portfolio is attainable by nearly all charities, even by those that issue gift annuities in states that restrict the types of investments.

In 1998, the year that the current schedule (with the exception of an interim adjustment for the youngest ages - see 1999 rates) was adopted, a portfolio of 20% equities, 70% Treasury bonds, and 10% cash was assumed. Such a portfolio would have produced a return of 6.75%, which was the return assumption for the 1998 rates.

As noted above, the new (2001) rates are based on a portfolio of 30% equities, 60% 10-year Treasury bonds, and 10% cash equivalents. The equity portion of the portfolio was increased because the 1999 ACGA survey revealed that even charities operating in restricted states were investing more than 20% in equities. Although the equity portion of the portfolio has been increased from 20% to 30%, the current return on such a portfolio is only 6.50%, which is the return assumption underlying the new rates. In 1998, the return assumption on a portfolio of 30% equities, 60% Treasury bonds, and 10% cash equivalents would have been 7.10%.

Following a consistent methodology for computing the rates, it is necessary to reduce the return assumption, and this, in turn, leads to a reduction in the rates. In calculating the rates, the ACGA actuary also factors in projections for increased life expectancies since the Annuity 2000 tables were determined. While the gift annuity rate reduction results mostly from the reduction in the return assumption, the projected increases in life expectancies do have a slight effect as well.

It should be noted that the gift annuity rates for the oldest and youngest ages are somewhat lower than would follow from the above assumptions. The rates for the youngest ages are based on lower assumed returns, and the rates for the oldest ages are based on more conservative mortality assumptions.

SIZE OF RATE REDUCTION

For people aged 60 through their mid-80s, the rate reduction in most instances is about .3%. The reduction for the youngest ages is smaller, (as little as .1%), partly because those rates had already been adjusted downward two years ago. For the oldest single-life ages, there is NO reduction. The cap on gift annuity rates remains at 12%, the same as it has been for several years.

(Note: The increase in charitable deduction will tend to cancel out the loss of annuity, due to the slightly lower annuity rates.)

COMPARISON WITH COMMERCIAL ANNUITY RATES

Part of the process of reviewing rates entails comparing gift annuity rates with commercial rates, using a representative, highly-rated company. These commercial rates fluctuate daily, and they vary somewhat from company to company. Yet, we are able, when doing the comparison, to observe that the gap between commercial and gift annuity rates is much greater at the oldest ages.

That was one consideration in the decision to reduce rates for the oldest ages to a lesser degree, if at all. The other consideration is that rates for the oldest ages are already more conservative.

CONSIDERATION FOR CHARITIES

No one likes to see frequent rate changes -- neither charities nor vendors. Likewise, the board of the ACGA does not want to suggest changes more often than necessary. At the same time, the board feels a responsibility to adjust rates when there is a significant change in financial markets to protect charities and ensure that there will be a significant residuum for their charitable work. This has always been the board's practice and will continue to be so.

Even though gift annuity rates will be a little lower, they should continue to appeal to donors because the rates they are receiving on CD's, bonds, and commercial annuities are correspondingly lower. Charities might also note that a lower rate increases the deduction, which somewhat mitigates the effect. (Note: Of course, a larger deduction, creates a slightly smaller tax-free portion per year for the annuitant's life expectancy, which is the *actuarial value* (FMV value of gift less the charitable deduction) divided by the years and tenths of a year of life expectancy).

Over the years the ACGA rates have achieved credibility with certain state insurance departments, and so long as a charity does not exceed them, it does not have to provide an actuarial justification for its rate schedule. (Note: Exceed them by only one tenth of a percent at even just one age, ... or continue to use older but higher ACGA rates ... 1997, 1998 or 1999 rates, for example) and you are NO longer using the *Current ACGA Uniform Gift Annuity Rates*, and the regulating states will require you to hire an actuary to prove that your rates meet the requirements of their state law, that at every age, at least 50% of the original gift will accrue to the charity if each annuitant lives to their life expectancy. IF you are required to hire an actuary, you also will be required to prove that the earnings assumption you use is the actual one for your Annuity Fund. If you use ACGA rates, you can use the ACGA earnings rate assumptions. Also, note that New Hampshire requires charities to use rates no higher than ACGA rates for gift annuities.

(Note: You will need to notify any permit issuing state of your new annuity rates, if you have a permit/certificate of authority from that state. Send each state a copy of the rates you will be using and advise them of your starting date for those new rates.)

COMMENTS ON NEW METHODOLOGY FOR CALCULATING DEFERRED GIFT ANNUITY PAYMENTS

In addition to approving a new schedule of suggested gift annuity rates, the ACGA approved a new methodology for calculating payments from deferred gift annuities. The new methodology is based on two changes:

Annuity Starting Date

Currently, the annuity starting date for the purpose of determining the amount of the payments is six months before the first payment. However, the annuity starting date for the purpose of calculating the charitable deduction (assuming end-of-period payments) is one month, three months, six months, or one year before the first payment, depending on payment frequency. The new methodology will make the annuity starting date for determining the size of the payments the same as the annuity starting date for calculating the charitable deduction.

Period for which Interest is Credited

Currently, interest is credited for the number of whole years from the date of contribution to the annuity starting date.

Consider this example: On February 13, 2001, X made a contribution for a deferred gift annuity and will receive quarterly payments beginning on June 30, 2011. The annuity starting date is January 1, 2011 (six months prior to the first payment). The number of whole years from February 13, 2001 to January 1, 2011 is nine, so interest will be credited for nine years.

Following the new methodology, the annuity starting date would be April 1, 2011, and interest would be credited for the total period from the date of the contribution to the annuity starting date, which is 10.1273 years.

The new methodology is more fair to donors because it credits interest for the ENTIRE deferral period.

Note: Different software programs may use different methodologies for calculating the number of whole and fractional years, but in most cases the difference will be too slight to affect the size of the payment.