A Brief History of Annuities

Annuity

Today we’re going to teach you a brief history of annuities. Because of the connection with retirement, one might assume that annuities are a more recent phenomenon. In reality, the origins of annuities can be traced all the way back to the Roman Empire.

A Brief History of Annuities

In the Beginning

Annuities themselves are not new. There has been archeological evidence suggesting that the Ancient Egyptians had an annuity for one of their princes. However, annuities, as we know them, can be traced back to Ancient Rome. 

It was during the Roman Empire that buyers and sellers entered into contracts that were called “annua” in Latin — which was the predecessor of the English word annual. Similar to what annuities today are like, “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,” writes Steve Jurich, aka My Annuity Guy.

But, there was another beneficiary of annua. And, this was the “Roman soldier who received military service compensation in the form of annual stipends,” says Jurich. “Governments and militaries would repeat this practice many times throughout the coming centuries.”

“As is often the case, necessity was the mother of this invention,” adds Jurich. “Sellers were unable to predict the lifespan of the buyers, which is necessary knowledge to create the terms of the annua contracts.” As such, the endgame “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.”

Eventually, these early annuities were modified so that payments would last for a specific period of years. And, just like today, this was called a “term.” 

It was also in Ancient Rome where the first version of today’s actuarial table originated. It was the creation of  Domitius Ulpianus, who’s believed to be the first annuity dealer, to calculate the probability of human life expectancy at the time. 

The Middle Ages

Fast forward to the Middle Ages. During this period, there was a new use for annuities for Europeans. And, just like today, it was funding expensive war coffers.

“Kings and feudal lords sought investors as financial backers for their conflicts,” explains Jurich. As such, they placed “these contributions into a tontine.” That means that “investors received payments from the pool.” However, after investors passed away “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” that resemble something more closely to what annuities are like today. The reason? It served “as a kind of savings account offering a guaranteed income.”

Here’s where things got interesting. “Those issuers offering annuities to royalty soon realized their titled patrons lived much longer lives than the public did,” clarifies Jurich. “Pricing adjustments quickly followed.”

In short, it was through annuities that enabled England,  as well as other powerful nations, to defend their borders. More consequently, this allowed these nations to expand and colonize the world.

The Age of Discovery 

Tontines gave way to more sophisticated annuity programs in England, France, and Holland throughout the 16th Century. In fact, many European nations opted to issue annuities instead of government bonds. This meant that annuity contracts would still offer a guaranteed lifetime income, the proceeds from the contracts would fund government programs and construction projects — some structures built at this time you can still see today.

Annuities continued to finance government projects and administrative operations until the 18th Century. Annuities even paid for the retirement income for certain government officials.

These early annuities were sold at the same fixed price — regardless of age or gender. Obviously, this procedure was problematic, so more payouts and pricing structures had to be refined. The early annuities even forced the English government to take action. 

In the 18th Century, Parliament put in place an intricate grid of annuity-related laws. These hundreds of laws defined the sale of annuities and clarified what they would fund. Mainly, at that time, annuities funded wars. And, interestingly, the annuities also provided the royal family’s annual allowance. 

In addition to the continued efforts of Parliament to define and regulate annuities during this time, the first charter for the Bank of England was funded through the sale of certain shares. In return,  the Bank of England promised a fixed rate of return each year. Many consider this an early example of an immediate annuity. 

Between 1780 and 1880, the English also created;

  • Consolidated Annuities where all securities were folded into one single issue that carried a fixed, 3% annual rate.
  • Navy Annuities were used to balance its ledger and up to a 5% interest rate.
  • Reduced Annuities let the government borrow money at lower interest rates in other markets.
  • New Annuities attempted to carry a lower rate of return paid on the former Navy Annuity. There was a public outcry when the government lowered the return from 5% to 4%.

By the 18th and 19th Centuries, annuities were de facto de rigueur for high society in Europe. In fact, wealthy investors and the royal gentry realized that having a guaranteed income could protect them from the potential humiliation of poverty. 

Annuities in the New World

Obviously, this concept was not reflected exclusively in Europe. In 1759, the concept of annuities finally reached the shores of the New World. Specifically, in Pennsylvania where the first fixed annuity was offered to Pennsylvanian Presbyterian ministers and their families.

Throughout the 18th Century, pastors were the first known Americans to receive annuities. These were “funded by donations from their congregants and church leaders,” states Jurich. In fact, any funds that widows or orphans receive have their origins in these types of annuities.

“Benjamin Franklin provides an excellent example of the potential longevity of an annuity,” notes Jurich. “In his will, Franklin left annuities to” both 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.”

Despite this, “Americans in the late 18th century mostly rejected the idea of annuities, preferring to rely on the generosity of family in their golden years.” Who were the main proponents of annuities at this time? It was typically “attorneys and estate planners, who saw the value of an annuity in fulfilling the final wishes of clients,” Jurich explains.

1812 was a landmark year when it came towards annuities — outside of a little war known appropriately as the War of 1812. As previously said before — it involved the state of Pennsylvania. In this case, a life insurance company offered annuity contracts. “Nearly half a century later, Union soldiers had the choice of receiving compensation in the form of an annuity,” says Jurich.

Despite annuities being sold and managed in the United States before it was a nation, life insurance policies became more favorable. In fact, these life insurance policies would outpace annuities through the remainder of the 19th century.

That doesn’t mean that it was smooth sailing for both instruments. Each of these retirement systems would be slow to gain acceptance. Primarily, the acceptance was due to the agrarian nature of American society at the time. Since family members took care of all their elders, their large and extended families living on farms, and ranches did not have much use for the annuity’s guaranteed income.

20th Century Annuity

It wasn’t until the early 20th Century when the American public could finally get a crack at annuities. It took place “when the Pennsylvania Company for Insurance on Lives began offering them in 1912,” writes Jurich. “Growth remained slow but steady until the Great Depression.”

However, following the Great Depression, “investors placed more trust in insurance companies than in banks.” Thanks to FDR’s New Deal there was a greater emphasis on savings, which the public overwhelmingly responded to. It was so popular that corporations threw their hat in the ring and developed group annuities for pension plans.

“These early public annuity offerings offered fixed rates, tax-deferred status, and a guaranteed return,” Jurich writes. “Clients had two options for payment: fixed income for life or payments throughout a given number of years.”

Suffice to say, the annuities that were offered in the late 1930s and early 1940s were comparatively simple. An annuity provided a fixed return during accumulation periods. It also guaranteed safety and return on principle. 

Tax-deferral, however, would become a major feature of the annuity. As a result, this made compounded accumulation more appealing to customers. 

While these annuities may not have had all the bells and whistles of today, they did allow annuitants to make withdrawals, And, even the option to receive payments over a (few) set number of years became popular.

Then, in 1952, variable annuities arrived. As a result, this allowed annuity owners to choose their account type. What’s more, it created interest-type earnings that were based on more speculative financial vehicles in separate accounts. This posed a greater level of risk, but variable annuities did offer certain guarantees of principal.

Variable annuities were essentially an early version of the contemporary mutual fund. It was during the 1960s that assets of stock mutual funds doubled. So, it’s easy to see why purchasers would gravitate towards variable annuities. 

Variable annuities offered even more diversity. In fact, Congress was all about annuities with the passage of the 1982 Periodic Payment Settlement Act. As a consequence, this “exempted structured settlement payments from taxes,” explains Jurich. “Through the remaining years of the 20th century, annuities have kept growing in complexity.”

Additionally, there was the Tax Reform Act of 1986. This Tax Reform reduced the ability of IRAs to defer tax liabilities for investors. In turn, this made IRAs less attractive and bolstered the tax-deferred status of annuities. 

The Birth of Indexed Annuities 

Unlike other investments, the history of fixed index annuities began with a bang, rather than a long pondered or meandering progression of product changes,” writes Cathy DeWitt Dunn for Annuity Watch USA. “The big bond market massacre of 1994, where federal interest rates ratcheted up 1.5% in one year caused massive flux with cautious investors.”

“Nothing was safe,” says Dunn. “It was tempting to just hide money in your mattress again, which is never a good idea to support your retirement.”

As a result, a new annuity variant came into existence. Known as an indexed annuity, this type sought to take advantage of the economic climate of the early ’90s. 

“In its effort to keep up with mutual funds,” wrote best-selling author and financial wizard Suze Orman, “the insurance industry introduced yet another kind of annuity in the mid-1990s – the index annuity. It was created to compete with the very popular index funds and mutual funds that track a stock market index. I have to admit,” concluded Orman, “I like the concept (of the index annuity) – for the right investors.”

“The first fixed indexed annuity was developed in 1995 by a Canadian company, Keyport Life, to provide their clients with interest credited above their standard minimum guarantee by buying call options on an equity index,” states Dunn. “In this way, the annuity was hedging its guaranteed interest rates paid to subscribers with a product that had the potential for paying out even higher interest rates.”

“At a time when the bond market was producing negative gains, banking institutions were providing lackluster interest guarantees, and the markets were experiencing wild swings, the FIA with its guaranteed principal and guaranteed interest plus the potential for further growth potential made sense to many investors.”

At the same time, variable annuities became less desirable. The reason being that the value of variable annuities is based on how mutual funds perform. As such, with a rocky stock market, variable annuities would suffer. 

“Keyport Life and Genesis Financial of Canada introduced the first equity-linked indexed annuity named the KeyIndex in February of 1995,” Dunn adds. “The first purchaser paid $21,000 for the first premium, which at the end of the five-year term was worth $51,779––an amazing return by any standard.” 

“By the end of 1995 other insurance companies saw the opportunity and started offering their own products,” she says. “By the end of that first year, there was over $130 million in sales of FIAs.”

Fixed indexed annuities experienced tremendous growth from 1994 to 1999. For example, there were only two carriers in 1995. That rose to 50 by 1999.  

Even more impressive? By 2005, index annuity sales rose to 13.8 billion. Despite this, they still only represented only roughly 8% of total annuity sales.

Annuities in the 21st Century

After entering a new century, a wide variety of available products and new features became available. Most notably were principal guarantees and long-term care benefits. Mainly this was to appease critics and address the popularity of annuities.

The result? Well, in 2000 if you were 65 years old and had $100,000 in savings then you could purchase an annuity that guaranteed an income of $744 per month.

Even sweeter? Annuity sales reached a record by 2019. The reason? The economic condition was favorable following the Great Recession.

Unfortunately, rates plummeted in 2020 and 2021.

To put that in perspective, that $744 you may have received in 2000 is now just $469. It was actually less than half that amount in 1990.

“They’re a function of interest rates,” says Rob DeHollander, a financial adviser with DeHollander & Janse Financial Group told MarketWatch. “I remember when you could go to the bank and get a CD [certificate of deposit] that was paying 5% or 6%, but those rates are long gone.” If you buy a single premium annuity here, he says, “you’re locking in rates that are as low as they’ve ever been.”

“For people who want steady income, and want safety, annuities have usually been pretty good,” added Chris Chen, a planner with Insight Financial Strategists in Newton, Mass. “But with interest rates pushing to zero, there isn’t that much advantage anymore. You’re locking away your money and you’re not getting any return.”

In other words, collapsing inflation and low interest rates can be to blame for lower returns. But, traditionally — annuities will always bounce back.