precisely the same method that is used today in valuing all types of annuities.

3. How Fixed Is A Fixed-Dollar Annuity?

Many fixed-dollar annuities are much less fixed than the name implies. To demonstrate this the following should be noted:

(a) A fixed-dollar life annuity is variable as to duration. The total amount of dollars payable under the contract is indeterminate, depending upon how long the annuitant lives. Thus, the aggregate number of dollars payable under the contract is variable-not fixed.

(b) A participating annuity is variable to the extent of the dividends. (c) Under some fixed-dollar group-annuity contracts, the annuities are also variable to the extent of the vesting provisions. Vesting refers to the extent that a participant has acquired an indefeasible interest in the contract. Under a nonvested annuity contract an annuitant cannot tell how much the annuity payments will be until he has reached the point where there is full vesting and his rights to the annuity will not be defeated by the termination of his employment. He may work for a company for twenty years and regularly receive reports indicating he is building up a large annuity, but if his benefits are not vested and he leaves that employer he may find there is no annuity whatsoever to his credit.

(d) Under many group-annuity contracts on a fixed-dollar basis, the company reserves the right to modify the amount of annuity a given premium will provide on each contract anniversary after the first five years. Similarly, some individual annuity contracts have been issued. under which the company reserves the right to change the annuity rate at any time on ninety-days notice for premiums received thereafter. Under these contracts it is not possible to predict accurately at the outset what the annuity will be even on the assumption that a certain amount of premiums will be paid during the lifetime of the contract.

(e) One form of settlement option often found under fixed-dollar annuity contracts is an option to pay a specified amount of money as long as the proceeds with the interest thereon last, with a provision for a minimum percentage of the proceeds to be paid in any year. This is an annuity for an uncertain period which under certain circumstances may be based on a percentage of the proceeds rather than a specified amount. (f) Recently, a highly flexible form of group-annuity contract on a fixed-dollar basis known as the deposit-administration plan has come into vogue. With this plan there is often no allocation of benefits to an employee until he has actually retired. Thus, an employee forty years of age may be a participant under a group-annuity contract but the

amount he receives will depend upon many variables including the outcome of negotiations between the employer and the union during the next twenty-five years. This flexibility is considered to be one of the advantages of this type of fixed-dollar group-annuity contract.

These illustrations show that the life insurance industry has departed a long way from the old fashioned idea that an annuity necessarily involves buying a certain number of dollars for future delivery for a premium of a certain number of dollars. Even the so-called fixed-dollar life annuity is subject to many variables. In addition, the purchasing power of the fixed-dollar annuity will always vary with changes in the cost of living. Thus, the question arises: How fixed is a fixed-dollar annuity?

4. Combining Annuities

When the term "life annuity" is used, the ordinary person thinks of an annuity payable throughout the life of one person. By custom a number of modifications have been developed. Life-annuity payments can be arranged in a variety of ways such as payment ceasing at the death of one person with provision for a minimum number of guaranteed payments to a surviving beneficiary or guaranteeing that payments will be made throughout the life of a second payee after the death of the first payee, to name only two of the more popular. Life annuities with a guaranteed minimum period are, in effect, a combination of life annuities with an annuity certain. If the annuitant dies within the period certain, the annuity certain is payable to the beneficiary for the balance of the guaranteed period.

5. Variable Annuities

The term "variable annuity" came into use shortly after the organization of the College Retirement Equities Fund in 1952.52 Since that time the "variable annuity" has been accepted as a generic term for the various types of life annuities with varying payments. The term "variable annuity" is now used in the Internal Revenue Code,53 in statutes enacted in New Jersey54 and Kentucky55 to authorize life insurance companies 52 Probably the first use of the term "variable annuity" was made by this author in a paper entitled, The Variable Annuity, 7 J. Am. Soc'y C.L.U. 67 (1952).

53 Int. Rev. Code of 1954, § 801 (g) (Supp. 1959). This is a new section added by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112.

54 N.J. Stat. Ann. tit. 17, § 35a-1 (Supp. 1959).

55 This is a new statute passed by the Kentucky legislature on March 25, 1960. The new law has not yet been numbered. It was reported to the Kentucky Senate as House Bill No. 251 on February 26, 1960.

to write variable annuities, in several court decisions,56 and in the literature."7

Some confusion might be avoided in the developing discussion of variable annuities if the different types are separately classified. Such a classification might be as follows:

(a) Unit Annuities. The College Retirement Equities Fund issues unit-annuity certificates.58 The pro rata interest of the participants during the pay-in stage, i.e., before annuity payments begin, is determined by "accumulation units." When annuity payments begin there is a promise to pay the dollar amount on each annuity payment date that is equivalent to a specified constant number of annuity units. For example, one annuitant may be entitled to receive the dollar value of 100 annuity units each month as long as he lives. The accumulation units and annuity units serve two primary purposes. The participant can more easily understand what he receives if the undertaking is expressed in terms of units. If he were to be informed that he had a reserve fund of $5,000, and a year later after putting in an additional $1,000 he had a reserve fund of $4,000, he would probably be confused as to what had happened. If, on the other hand, he was informed that he had 500 units each worth $10 at the beginning of the year, that he had acquired an additional 100 units during the year which were worth only $6.67 each at the end of the year because of a decline in the market, he can more easily understand what has transpired. Moreover, the units serve as an index to the performance of the company. By looking at the different values of the accumulation unit and the annuity unit over a period of time, a participant follows the investment experience of the fund. Many variable-annuity plans have, therefore, stated benefits in terms of units. However, it is feasible to write variable annuities without using units; a variable annuity is not necessarily a unit annuity.

(b) Equity Annuities. Life annuities based primarily on equity investments may be called "equity annuities." One of the first variableannuity pension trusts was so designated.59 A variable annuity, however,

56 E.g., SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959); Spellacy v. American Life Ins. Ass'n, 144 Conn. 346, 131 A.2d 834 (1957).

57 E.g., Day, A Variable Annuity Is An Annuity, 1955 Ins. L.J. 775; Note, 44 Minn. L. Rev. 289 (1959).

58 The CREF program is fully discussed in a paper entitled, "An Experiment with the Variable Annuity," which was read by this author before the Association of Life Insurance Counsel on May 12, 1953.

59 This was the retirement program for the employees of Long Island Lighting Company of Mineola, New York.

need not be based on equity investments. It may be based on investments in debt obligations, or equities, or a combination of both. If the reserves supporting the annuities are invested completely in equities or largely in equities rather than in debt obligations, the income is likely to be larger during the period when equity earnings and prices are high and less when the reverse economic conditions prevail. Thus a variable annuity based largely on equities will be likely to fluctuate more widely than a variable annuity based on debt obligations. A company selling unit annuities with most of the investments in equities might therefore refer to its annuities as variable annuities, unit annuities, or equity annuities, but the broader, more comprehensive, words are "variable annuities."

(c) Cost-of-Living Annuities. The variable-annuities pension trust of National Airlines is referred to as a cost-of-living annuity plan. The formula for paying the annuity is keyed to the movements of the U. S. Labor Department Cost of Living Index. The plan is complicated by several adjusting factors, but it is designed to provide an annuity with a tendency to follow changes in the cost of living. The annuity is chargeable only against the funds of the trust. The liability of the trustee does not go beyond the exhaustion of the funds which have been established under the trust.

6. Minimum Guaranteed Fixed-Dollar Annuities

Some life annuities provide for a minimum guaranteed fixed-dollar annuity but contemplate little variation in the actual amount paid. This is true under the so-called participating annuities where a dividend is paid depending upon the experience of the company. Most contracts which have been sold to date have been invested largely in debt-type securities so that the variations have been relatively minor. There is no reason, however, why a contract cannot be devised which will combine a substantial variable feature with a minimum fixed-dollar guaranteed annuity. Even under some outstanding contracts, the variations in interest income have been substantial on a percentage basis. Some companies with guaranteed rates of 24 percent interest per annum have credited interest at the rate of 31⁄2 percent. In the one case involving variable annuities which has come before the Supreme Court,60 the problem of these participating annuities was discussed. The contracts in question had no minimum guarantee. Mr. Justice Douglas, in writing the majority opinion of the Court, said: "The difficulty is that, absent some 60 SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959).

guarantee of fixed income, the variable annuity places all the investment risks on the annuitant, none on the company." "61 This raises the question as to the legal status of a variable-annuity contract with a fixed-dollar floor. For example, the Security Annuity Life Insurance Company of Louisville, Kentucky, now has an annuity contract with varying payments but with a guarantee, first, that if the annuitant dies before the annuity payments begin, his beneficiary will be paid a sum at least equal to the sum of the premiums paid; or secondly, after fifteen years a guaranteed cash value of at least the amount of the net premiums paid. Will such an annuity be classified as an insurance contract, an investment contract, or both?

III

PRESENT STATE OF ANNUITY REGULATION

In People ex rel. Metropolitan Life Ins. Co. v. Knapp, the court points out the following distinction between insurance and the annuity:

The typical case of life insurance is found when a person insured pays annually during his life a stipulated sum to an insurer in consideration of which the insurer engages to pay on the death of the insured a lump sum to a beneficiary. The typical case of an annuity is found where a purchaser pays down a lump sum to a grantor who engages himself to pay a beneficiary during life a stipulated sum annually. In the one case the insurer receives an annual sum during the life of another and pays out a lump sum upon a stipulated death. In the other the grantor presently receives a lump sum and begins to disburse annual payments during life. In the former case the insured “insures” a dependent or other person against the contingency of his death, and thereby seeks to make indemnity for a possible loss. In the latter case payments are immediately made without regard to the death of the purchaser, and there is no indemnity feature whatever. The one is a provision for death, and the other is a provision for life.

62

In view of these distinctions an annuity is ordinarily regarded as an investment. 63 However, the courts have generally treated the sale of annuities as part of the "insurance business."64 The sale of fixed-dollar

61 Id. at 71.

62 193 App. Div. 413, 415, 184 N.Y. Supp. 345, 346 (1920).

63 Carroll v. Equitable Life Assur. Soc'y of United States, F. Supp. 223 (W.D. Mo. 1934); Corporation Comm'n v. Equitable Life Assur. Soc'y of United States, 73 Ariz. 171, 239 P.2d 360 (1951); Prudential Ins. Co. of America v. Howell, 29 N.J. 116, 148 A.2d 145 (1959); 1 Appleman, Insurance Law and Practice § 83 (1941).

64 E.g., Equitable Life Assur. Soc'y of United States v. Johnson, 53 Cal. App. 2d 49, 127 P.2d 95 (Dist. Ct. App. 1942); Bates v. Equitable Life Assur. Soc'y of United States, 206 Minn. 482, 288 N.W. 834 (1939); Bankers Life Ins. Co. v. Laughlin, 160 Neb. 480, 70 N.W.2d 474 (1955).