Regardless of questions of equity and technical soundness, most persons seem to oppose placing a substantial sum of money into a contract that promises little or no return if they should die shortly after income payments commence. Therefore, companies permit annuitants various so-called refund options if death occurs shortly after annuity payments have begun. In contrast to the situation with the pure life annuity, not the entire purchase price of refund annuities is used to provide income payments. Part of the purchase price is applied to meet the cost of guaranteeing a minimum amount of benefits, irrespective of whether the annuitant lives to receive them. Thus, for a given
premium outlay, a smaller periodic income payment will be available under a refund life annuity than would be available under an otherwise identical pure life annuity. The minimum benefit guarantee or refund feature may be stated in terms of a guaranteed minimum number of payments or as a refund of the purchase price (or some portion thereof) in the event of the annuitant’s early death.
With all life annuities that contain a refund feature, any amounts that are payable at the time of the annuitant’s death can be viewed as a death benefit, the amount of which equals the refund guarantee. Technically, therefore, there is no “refund” but rather a death benefit equal to a set amount payable either as a single sum or periodically. One class of life annuities with refund features, often named life annuity certain and continuous or life annuity with installments certain, calls for a guaranteed number of monthly (or annual) payments to be made whether the annuitant lives or dies, with payments to continue for the whole of the annuitants life if he or she should live beyond the guarantee period. Contracts are usually written with payments guaranteed for 5, 10, 15, or 20 years. Of course, the longer the guarantee period the smaller the income payments, all else are equal.
Two important forms of annuity income promise to “return” all or a portion of the purchase price. The first form, the installment refund annuity, promises that, if the annuitant dies before receiving income installments equal to the purchase price, the payments will be continued to a beneficiary until this amount has been paid. The second form, the cash refund annuity, promises to pay in a lump-sum amount to the beneficiary the difference, if any, between the purchase price of the annuity and the simple sum of the installment payments made prior to the annuitants death. For a given purchase price, the cash refund annuity provides a somewhat smaller income than the installment refund annuity, as the insurance company loses the interest it would have earned had the balance been liquidated in installments. In both cases, payments to the annuitant continue for as long as he or she lives, even after recovery of the guaranteed minimum benefits.
All refund life annuities can be thought of in two ways. First, we can consider them as a combination of (1) an annuity certain for the length of the guarantee or installment refund period plus (2) a pure life annuity thereafter. Second, we can consider them as being a combination of (1) a pure life annuity for the entire period plus (2) term life insurance whose decreasing face amount is always just enough to provide income payments for the balance of the guarantee period or to provide the amount of the “cash refund.”
Of course, at the time the annuity owner is about to enter onto the annuity, he or she could elect to surrender the annuity, withdrawing its full value as a lump sum. These funds could be invested elsewhere, including into another insurer’s single-premium immediate annuity (SPIA)The first insurer naturally prefers to retain the funds. Some insurers provide an incentive for the owner to annuitize with them. They may offer a one-time bonus or interest rate bonus, thereby increasing the annuitized amount; some offer an annuitization rate greater than that offered under their SPIAs, and most waive surrender charges. In an effort to encourage agents to recommend annuitization, a few insurers pay commissions at annuitization.
For many customers, the preceding choices—although in some ways extensive—seem limiting. Flexibility is lost upon entering onto the annuity. A fixed, guaranteed income stream that is appropriate today may be inappropriate in the future. Of course, sound financial planning argues that one should take these facts fully into consideration in deciding upon the liquidation option. A few insurers, however, are now experimenting with some non-conventional means of allowing annuitant flexibility during the liquidation period. For example, a few insurers will allow surrender of a life annuity during the liquidation period provided the annuitant is in good health; in other words, they are protecting themselves against adverse selection. Their annuity rates include a loading for this option.