A History of Annuities
Despite my own passion for annuities, I recognize that this vital financial planning tool offers little excitement for the average person. It comes as no surprise that history courses rarely (ever?) include units on the history of annuities. This is a shame, because this history dates all the way back to the Roman Empire, when buyers and sellers entered into contracts called “annua.”
Like many Latin words, annua is the obvious predecessor of an English word: annual. As with today’s annuities, annua involved a buyer paying a lump sum to a seller who would later make annual payments to the buyer each year until the buyer passed. Financial tools such as the actuarial life table also came into existence during this time, around 222 A.D.
As is often the case, necessity was the mother of this invention. Sellers were unable to predict the lifespan of buyers, which is necessary knowledge to create the terms of the annua contracts. The goal was to make enough of a profit on the annua whose buyers passed before the full payout and therefore cover the losses experienced on those whose lives surpassed the original contract.
Another beneficiary of annua was the typical Roman soldier who received military service compensation in the form of annual stipends. Governments and militaries would repeat this practice many times throughout the coming centuries.
Europe in the Middle Ages
In the Middle Ages, Europeans found a new use for annuities: funding war coffers. Just as today, war isn’t cheap. Kings and feudal lords sought investors as financial backers for their conflicts, placing these contributions into a tontine. Investors received payments from the pool. As investors died, the remaining investors split their shares, continuing until only one investor remained and received all remaining monies in the tontine.
Europeans continued using annuities in later years, expanding the concept to something that more closely resembled the annuities of today, as a kind of savings account offering a guaranteed income.
One interesting note here: Those issuers offering annuities to royalty soon realized their titled patrons lived much longer lives than the public did. Pricing adjustments quickly followed.
Across the Pond
In 1759, Pennsylvania pastors became the first known Americans to receive annuities, funded by donations from their congregants and church leaders. Today’s widows’ and orphans’ funds have an origin in these types of annuities.
Benjamin Franklin provides an excellent example of the potential longevity of an annuity. In his will, Franklin left annuities to two cities: Boston and Philadelphia. For over 200 years, all the way through to the early 1990s, Franklin’s annuity to Boston continued paying and only stopped when the city opted to receive the remaining balance in a lump-sum distribution. Even so, Americans in the late 18th century mostly rejected the idea of annuities, preferring to rely on the generosity of family in their golden years. The main proponents of annuities at this time became attorneys and estate planners, who saw the value of an annuity in fulfilling the final wishes of clients.
The next big step America made toward annuities came in 1812. It once again featured Pennsylvania; specifically, a life insurance company began offering annuity contracts. Nearly half a century later, Union soldiers had the choice of receiving compensation in the form of an annuity.
The 20th Century
The early 1900s gave the American public its first shot at annuities, when the Pennsylvania Company for Insurance on Lives began offering them in 1912. Growth remained slow but steady until the Great Depression. In the late 1930s, investors placed more trust in insurance companies than in banks. FDR’s New Deal also placed great emphasis on savings, and the public responded. Even corporations got involved, developing group annuities for pension plans.
These early public annuity offerings offered fixed rates, tax-deferred status and a guaranteed return. Clients had two options for payment: fixed income for life or payments throughout a given number of years.
Variable annuities arrived in 1952, allowing owners to choose their account type. In the late 1980s, indexed annuities offered even more diversity. Congress even encouraged annuities with 1982’s Periodic Payment Settlement Act, which exempted structured settlement payments from taxes. Through the remaining years of the 20th century, annuities kept growing in complexity.
Annuities continue evolving today, with a wide variety of available products and new features such as principal guarantees and long-term care benefits. Some of these innovations came about in response to annuity critics. Investors responded, too, with annuity sales doubling over the amount recorded in 1995.
Part of the reason behind this increased popularity belongs to the expansion of entities offering annuities. In addition to the original insurance agents, banks and brokerage houses joined the field. Even with all of the changes, though, today’s annuities are easy to recognize as the descendants of those from 1,800 years ago.