Cashing Out to Avoid Annuity Risk

Some charities transfer assets to insurers, but others dislike idea

Economic strains and financial-market uncertainties have prompted a growing number of charities to engage in a controversial, but potentially money-saving, practice: giving insurance companies the millions of dollars donated through charitable gift annuities and letting them assume the risk of investing the money. In exchange, charities keep about 25 percent of the annuity’s value.

Organizations such as the Christian Community Foundation, in Colorado Springs, Colo., the Community Foundation for Greater Atlanta, and Oral Roberts University, in Tulsa, Okla., have made deals with at least 20 large insurance companies, including American International Group, Allstate Insurance Company, Hartford Life Insurance, and Mutual of Omaha, to transfer, or “reinsure,” $58-million of gift annuities in the past year. The volatile stock market could lead charities to reinsure more than $300-million in gift annuities in 2004, insurers say.

Gift annuities allow donors to contribute cash, real estate, or other assets to a charity in exchange for fixed annual payments. Older donors receive higher annual payments from annuities, since they are likely to die sooner than young donors. Instead of investing the gifts themselves, paying donors from the proceeds, and ending up with about 50 percent of the assets when the donor dies, as is the customary practice, however, some charities reinsure their gift annuities by turning over to an insurance company about 75 percent of the amount a donor contributed and letting the insurer pay the donors.

By reinsuring, the charities reason, they do not have to risk defaulting on their payments to donors if the market falls. What’s more, the charities are freed of any obligations to make annuity payments and can invest the money aggressively before waiting for donors to die to do so.

Other nonprofit organizations, however, shun the practice of reinsuring. They worry that donors will be upset to learn that their annuities were transferred. Some organizations also do not worry about the investment risk because they have plenty of reserves to cover market downturns.

“If you do the math, it’s very hard to lose money on gift annuities,” says G. Thomas Waite, chief financial officer for the Humane Society of the United States, in Washington, which holds $12-million of gift-annuity assets. “If your organization can make 6-to-10-percent annual returns on investments and you’re paying 6 to 8 percent to annuitants, you can easily cover the spread of the gift annuity and keep the whole donation.”

Donor Reaction

Despite the increasing practice of reinsuring, few organizations are willing to discuss whether their organizations transfer annuities to insurance companies. For instance, one large youth organization acknowledged that it reinsures gift annuities, but its director of planned giving refused to talk about that on the record — saying that there is “nothing wrong” with reinsuring, but that the group doesn’t want to be the “poster child” for the approach.

Another reason some charities don’t want to talk about their involvement, say some charity and insurance-company officials, is that they don’t want to appear so financially vulnerable that they cannot honor their commitments to make payments to donors. Others say that charities fear losing donors who might be offended if they found out that a large part of their donation is going to an insurance company.

Donors have become more interested than in past years in establishing gift annuities, charities say. Donors are attracted to the guaranteed annual payments, which are often higher than the amount they would receive if they put the same sum in a fixed investment, such as a certificate of deposit.

For example, based on current market rates, a 70-year-old who establishes a $100,000 gift annuity could earn 6.5 percent interest every year, or $6,500, for the rest of his or her life. If the same person invested in a five-year certificate of deposit, he or she would fail to earn a charitable tax deduction and would earn less than 4 percent interest a year — not quite $4,000 annually — on the investment.

But as charities’ investments of gift-annuity assets have suffered diminished returns in the markets in recent years, insurance companies have aggressively entered the reinsurance field. They have found many charities receptive to the idea, because the charities are worried that they would have to withdraw funds from their endowments to cover annuity payments.

Bryan Clontz, president of Charitable Solutions, an Atlanta company that counsels charities about risk management, says that such a concern prompted him to propose reinsuring a $1-million gift annuity three years ago, when he was the vice president of development at the Community Foundation for Greater Atlanta.

“If we hadn’t reinsured that gift, within six to seven years from now it would have exhausted,” he says, meaning that the foundation would have no money left from the annuity. “After that, we would have had to come up with $74,000 — fire two staff members or whatever it took — every year until the donor died.”

Mr. Clontz’s calculations suggested that the charity would get about $967,000 from the gift if it reinsured it, $65,000 more than it would have gotten if it had kept the annuity and been required to make payments to the donor until she died.

But reinsuring could have backfired on the organization if the donor had died soon after the group reinsured the gift, as the insurer — rather than the charity — would have gotten to keep a large portion of the donation without having to make many payments to the donor. The community fund also could have lost out if it had invested its portion of the annuity in high-risk stocks and those investments did not perform well. Charities that keep the full value of gift annuities themselves generally put gift-annuity assets in low-risk investments to guarantee that they will have enough money to pay donors.

Small Charities

Organizations with $10-million or less in annual revenue have expressed the most interest in reinsuring, says Lewis M. Schwartz, president of LMS Financial Services, in Yardley, Pa., a company that offers planned-giving advice to charities. Mr. Schwartz says he has received calls from planned-giving directors at 10 charities this year who were interested in reinsuring gift annuities — though none has done so yet.

The reason small charities tend to be more interested in reinsurance, says Frank Minton, president of Planned Giving Services, a Seattle company that advises charities, is that nonprofit groups with only a few annuities are in a riskier position than those that have a lot of them.

“A group that has one donor assumes a far greater risk than an organization with 1,000 donors that its annuitant will live longer than he or she is expected to live,” he says. “The smaller the number of gift annuities, the greater the possibility of having significant variance from life expectancy.”

That logic helps explain why insurance companies want to garner as many annuities as they can. The more annuities they have, the more the risk is spread out, and the better the odds that they will make money.

Insurance companies sometimes have restrictions against accepting gift annuities for donors older than 85. Insurers don’t have as many older annuitants, and they’re not comfortable when they have a limited number of people from any group, says Nick Gregory, president of the Financial Engineering Alliance, in Clearwater, Fla., which helps insurers establish reinsurance programs.

Big charities often have the same goal of having as many gift annuities as they can. Robert D. Mitchell, chief development officer at the American Cancer Society, in Atlanta, says that his organization might have reinsured some gift annuities before 1990 — when it began to heavily promote them — but that the $45-million of gift annuities it has established since then generates enough income to make payments to donors. “For those organizations that issue a limited number of gift annuities or that don’t have a lot of cash reserves on which the organization can draw in bad times, reinsuring could be a really good thing for them,” he says. “We’re not in that category.”

But some larger organizations also look positively at reinsuring. Oral Roberts University reinsures all of its gift annuities to give donors an added assurance that an insurance company is backing their gift.

In the 1960s, Oral Roberts established its own insurance company, Abundant Life Insurance, for the sole purpose of reinsuring gift annuities, says George T. Paul, the university’s associate vice president for alumni and development.

But last year Oral Roberts switched $3.5-million of its reinsuring business to Mutual of Omaha because Mutual’s costs were more attractive than those of Abundant Life, Mr. Paul says.

“Hiring Mutual to manage our gift-annuity assets relieves us of the investment uncertainty and gives the program to someone else to manage,” says Mr. Paul. “In general, this is a math issue. Our university has a lot of assets, and I’m not saying we couldn’t assume the risk of our gift annuities or that we won’t someday. But our philosophy now is to give donors some assurances beyond the health of the charitable organization that we will stand behind their gift.”

Immediate Use

By reinsuring almost half of their $10-million in gift-annuity assets, the Christian Community Foundation and National Foundation Inc. — Colorado Springs, Colo., donor-advised funds that together hold $80-million in assets — “put donations to work immediately” rather than potentially waiting years for donors to die to collect money from gifts, says John C. Mulder, president of the groups.

Although the organizations have achieved a 15-percent increase in donations in the past year and do not need reinsured dollars for operations, Mr. Mulder says, reinsuring allows the groups to “produce a lot of charitable activity right away as opposed to waiting through the life expectancies of donors to use the money.”

And while his organization thinks some donors might prefer to have a large insurance company agree to make their annuity payments because the insurers have more assets than the charity, Mr. Mulder says that both of his groups often choose not to tell donors that they plan to reinsure their gifts.

“We are not required to tell donors that we reinsure,” Mr. Mulder says. “I can see why charities might be reluctant to tell donors that ‘we took this $100,000 from your gift annuity and exchanged it for reinsurance, which may have only allowed us to use $25,000 for the charitable activity.’”

Effects of Inflation

When insurance companies make their pitches to charities, they like to suggest that inflation could deplete the value of a gift annuity over time, and that a charity’s investments probably won’t make up for the amount lost to inflation. What’s more, they say charities will be better off if they aggressively invest the money they retain after giving the bulk of the annuity to the insurance companies than they would be if they held on to the annuities and pursued low-risk investments.

Philip G. Karno, charitable gift-annuity sales manager at Mutual of Omaha, contends that because the charity doesn’t have to worry about making payments to donors, it has more freedom to put its money into high-risk investments that, over the long term, could be more lucrative than conservative investments. “A charity could invest their 25 percent aggressively and actually make more money on that 25 percent by the time the donor dies than if they had invested the full gift conservatively,” Mr. Karno says.

But many charities think they can do better than the insurance companies suggest. Instead of reinsuring, the majority of charities often view the market risk as a bet they are willing to take — thinking that they can “beat the insurance companies” and avoid the cost of reinsurance, says Mr. Clontz, of Charitable Solutions.

Kevin Hogan, a director at Hartford Life Insurance, in Simsbury, Conn., worries that that attitude has put charities at risk. He says some charities fail to invest their annuity assets conservatively enough to guarantee they can cover payments to donors.

“Charities are rushing into this field and dumping gift-annuity assets into mutual funds that are invested mostly in equities, and it’s very dangerous,” he says. “I can’t imagine planned-giving directors, when they really understand the risks, not considering offloading some of that risk to insurance companies.”

But charities should remain cautious about reinsuring, especially if the amount they must give the insurance company to reinsure a gift is 75 percent or more of the value of a gift, says Rocky Menge, a senior vice president of Wachovia Securities, in Richmond, Va.

Says Mr. Menge, who invests gift-annuity assets for seven charities: “If charities are that worried about the money running out, don’t take the gift in the first place.”