Charitabte Gift Annuities: Time for a Closer Look: Reinsurance Arrangements and How They Can Make Planned-Giving Programs Work

Article excerpt

THE ECONOMIC CRISIS HAS dominated the headlines since September 2008 and taken its toll on individuals and institutions alike. Few have been immune to the effects of a volatile stock market, low interest rates, rising unemployment, tight credit markets, and plunging real estate values.

Today, leaders at many colleges and universities are trying to manage the adverse effects of depressed endowments and a precipitous drop in private donations. Two of the most highly publicized examples have included a university in the Northeast that was forced to consider selling a 6,000-object art collection to raise funds and one Southern college's decision to put its president's home on the market in order to cut operating costs.

Further, all this is occurring at a time when the financial pressures facing universities, such as higher operational costs and a greater need for financial aid, continue to mount and intensify. Now more than ever, keen fiscal management is a critical discipline needed at institutions of higher education where every program and department has probably been or will likely be evaluated by its financial impact on the overall organization.

In light of the current economic environment, many institutions have begun to examine more closely charitable gift annuities as a planned-giving program. A review and evaluation of a charitable gift annuity program is important, because it can impact both financial risk management and development opportunities;

A charitable gift annuity arrangement is a contract between a donor and the university. The donor makes a contribution to the school and, in return, receives an income for life, as well as a charitable tax deduction. By entering into these arrangements, universities have, in effect, entered into the insurance business.

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Charitable gift annuities are increasingly appealing to people seeking additional income, typically in retirement, and who are also philanthropically minded. The bottom line is that they are a good way to attract new donors, especially in this economic climate.

MANAGING RISK THROUGH REINSURANCE

From a risk management perspective, one financial aspect of charitable gift annuities is that they can expose the university to a number of risks, such as market risk and longevity risk. Both of these risks can potentially impact the gift that the university ultimately receives.

With market risk, the volatility of returns inherent in the financial markets can negatively affect the investments that the university relies upon to produce the income needed to pay the donor.

Longevity risk poses a different kind of threat. The longer the donor lives, the more payments they are entitled to receive. Thus, a long life for the donor can mean less money--and in some cases, no money--left for the university and its programs. A charitable gift annuity program can in fact subject an institution to serious financial uncertainty.

An effective way to help eliminate the uncertainty created by these risks is through an arrangement commonly known as "reinsurance." In such an arrangement, the university uses a portion of the donor's gift to purchase a single-premium immediate annuity from an insurance company. The income generated by this immediate annuity is set up to match the university's obligation to its donor under the charitable gift annuity. The insurance company, as a result, assumes the investment risk underlying the gift annuity, thus eliminating the possibility that the university's investments cannot support the gift annuity payments. In addition, longevity risk is also transferred to the insurance company, thereby removing the risk that the donated assets will be diminished due to the donor living beyond his/her life expectancy.

PUTTING DONATIONS TO WORK

Another aspect of charitable gift annuities is that they are illiquid meaning the portion of the donation that's not needed to support the gift annuity payments may not be available to the university until some point in the future when the gift annuity terminates. …