Charities Tweak Their Handling of Gift Annuities in Bad Economy

Nonprofit groups around the country are making changes in the way they handle a popular type of donation — the charitable gift annuity — as the economy calls into question the basic assumptions that made the annuities a good deal for both charities and donors.

The topic is a sensitive one: Nonprofit groups are so worried donors will think the annuities are threatened, or that problems with annuities are a sign of deeper problems, that almost no nonprofit group is talking publicly about their annuities.

Gift annuities allow donors to give cash or other assets to a charity in exchange for fixed payments. The percentage of the gift that a charity pays varies with the donor’s age.

Younger donors receive smaller payments because they presumably will live longer than older ones. The charity receives what remains of the initial gift when the donor dies.

Payout rates to donors, based on actuarial estimates and other factors, are generally designed to give charities 50 percent of the original sum donated.

But last fall’s investment crash — and the continued low rates available to investors — has made it trickier for charities to ensure that they will have enough money to cover lifetime payments to all donors and leave money for charity at the end.

Charities that were accustomed to receiving 60, 70, even 80 percent of donors’ initial gifts during the long bull market are expecting that they may now end up with well below 50 percent in many cases, depending on when annuities were issued and at what payout rate.

In addition, some planned-giving experts predict that many annuities — particularly those issued in the late 1990s and early 2000s and thus subject to two big recessionary hits soon after they started — will have nothing left well before the donors die. That means not only that charities will not get any of the contribution donors intended to make, but that the organizations will have to use assets from other gifts, or other sources altogether, to cover annuity payments.

Keeping Promises

Charity officials emphasize that while they may be loathe to dip into other assets to cover payments, they are both contractually obligated and willing to do so to make sure donors get paid — a point many fund raisers are quick to make after a stir created by a Wall Street Journal article in May.

The article said that the economic downturn has sapped the ability of many organizations to pay donors their promised yields.

While some groups may be struggling to keep their gift-annuity pools afloat, charity officials say, payments to annuitants, which are by law backed up by the total assets of an organization, are not in jeopardy except if an organization goes bankrupt.

Still, many groups, whatever their overall financial health, are taking steps to strengthen their gift-annuity pools, by such measures as adding new annuities and investing more carefully, and thus minimizing the risks of exhausting gifts in the future.

“We are trying to encourage organizations to take the long view because these are long-term contracts, long-term obligations, and long-term relationships,” says Lindsay L. Lapole III, chair of the American Council on Gift Annuities, a group that recommends the payout rates largely followed by the roughly 4,000 charities around the country that issue annuities.

Organizations are taking a number of steps to recover from the plummeting value of their annuities, but few would allow their names to be attached to their approaches.

One large national nonprofit organization with nearly $100-million in its gift-annuity pool is no longer automatically withdrawing money when a donor dies, instead letting what remains of the initial gift stay invested to help shore up the rest of the pool.

A small college with only a handful of gift annuities, including one big one that accounts for most of the few hundred thousand dollars the institution pays annuitants each year, has asked the one major donor to forgo half of his annual payout to help the college keep up with all its annuity payments.

And a New York health organization is considering for the first time reinsuring some of its more than 125 gift annuities, selling them to an insurance company that would then take on the obligation to pay the donors.

Reviewing Investments

Mr. Lapole, a planned-giving official at the Salvation Army, says perhaps the most beneficial step charities can take is to review investment strategies. Underlying the gift-annuity council’s recommended payout rates, he says, is the assumption that organizations invest their annuity assets 40 percent in equities, 55 percent in fixed-income vehicles such as bonds, and 5 percent in cash.

The New York health organization, which has had 60 percent of its portfolio in the stock market, is considering a more conservative investment approach.

But not all groups think they need to move their money around. Another large charity, which also would not be named, has had as much as 70 percent of its gift-annuity assets in equities, and says that after close examination it has decided to stick with its allocations.

That same group is instead taking other measures to make sure it can sustain its gift-annuity investments, including limiting the top amount paid out to donors at 8.5 percent, a full percentage point lower than the upper limit recommended by the gift-annuity council for the oldest donors.

Reinsuring Risks

Like the New York group, the other large organization is also looking into reinsurance, specifically for a small number of especially large annuities where the donors are older but healthy, and are thus getting a relatively high payout but are likely to live longer than predicted by actuarial estimates.

Reinsurance, which has been shunned in some quarters as an improper way to handle a charitable contribution, is getting more attention these days as some charities grow more skittish about the risks associated with taking on gift annuities.

Instead of investing the gifts themselves, paying donors from the proceeds, and ending up with some portion of the assets when the donor dies, reinsuring a gift means turning over to an insurance company usually 65 to 75 percent of the initial gift and letting the insurer assume the risk of investing the money and covering the cost of paying the donor.

Critics of the arrangement say that donors may be offended that the majority of their gift goes up front to an insurance company. But some charities think it is smart to get a guaranteed portion of the contribution — versus uncertain leftovers after some number of years — and are happy to be freed of the obligation of annuity payments.

An international relief organization that also did not want its name used has reinsured all its gift annuities since it began issuing them about 12 years ago.

The organization began the practice, says its director of planned giving, both because it did not initially feel like it had the management capacity to invest the money on its own and because it wanted to use cash from the gifts for immediate needs, such as hunger relief.

Now, the official says, he is especially glad the organization went the reinsurance route because it has made the group immune from the vagaries of the investment markets and has even allowed it to step up its promotion of gift annuities.

One selling point to potential donors: The organization did not lower its payout rates when the gift-annuity council recommended lower rates starting in February, so it offers a better deal than many other charities do.

“My line in the sand is what percentage I can keep,” the planned-giving official says. “If I can keep 30 percent and the insurance companies aren’t changing their rates, we might as well keep ours where they are, too.”

Increased Marketing

Other organizations have also stepped up their marketing of gift annuities.

The UJA-Federation of New York says that its gift-annuity pool is in good shape largely because it has long had a strict policy that limits spending from the pool to 7.5 percent a year, regardless of which annuitants die and when. Many groups withdraw from the investment pool most or all of the money left at the death of a donor.

“We don’t spend too much money from the pool in good times and so we have enough money in the bad times,” says William D. Samers, vice president of planned gifts and endowments.

He says that while the drop in interest rates on certificates of deposit and other types of investments may make gift annuities, with their often higher payout rates, more attractive to many donors, his organization’s marketing efforts have focused recently on the impact of the charitable gift itself.

“People care about our mission and when people have less discretionary money to make gifts, they want to make sure their gifts can make a difference,” Mr. Samers says. “You can’t take the returns out of the equation, but we are talking more about what we do as an organization.”

The American Bible Society, which notes that in 1843 it received the first annuity ever donated to charity, says its marketing efforts emphasize the stability of its program and the longevity of its organization, hoping to put people at ease about the security of a gift annuity.

“We tell people, ‘We haven’t missed a payment, and we’ve been doing this since 1843,’” says Lewis H. von Herrmann, director of major and planned-gift programs.

Even so, the Bible group did have to make some adjustments to meet the heightened reserve requirements being phased in by New York insurance regulators, covering New York charities and charities elsewhere that may have gift-annuity donors in the state. The rules oblige organizations to maintain a certain amount of money in a special reserve fund to ensure that it has more than enough to cover its annuity payments.

Many groups, like the American Bible Society, had to transfer money at the end of last year from other funds — like endowments or operating budgets — to meet the requirement, and, depending on investment returns, may have to do so again this year.

At some organizations, while transferring the money did not present a financial hardship, it did raise concerns about the gift-annuity programs.

“I’ve lost a bit of enthusiasm about our gift-annuity program getting a glimpse of what it would be like if we needed to dip into other assets,” says a fund raiser, who declined to be identified, at an organization that transferred $200,000 into its gift-annuity reserves to meet the New York requirements. “What seemed to me before the stock-market fallout to be a can’t-miss prospect for charities and donors looks a little less certain now.”

At least one organization weighing whether to start offering gift annuities may have drawn just that conclusion from watching other groups flounder in this economy.

Lorri M. Greif, a planned-giving adviser in New York, says a hospital fund-raising arm she works with has decided to start seeking planned gifts, but with bequests only, putting plans to start issuing gift annuities on hold.

“I’m a huge fan,” she says of gift annuities. “They build loyalty, and, if managed right, work for everybody. But I understand the nervousness out there. It’s a hard time to strongly support the idea of starting a program.”