Readers may find part I of the annuity in a financial plan discussion by going to www.theroyalgazette.com and typing in Martha Myron under the 'Search' feature. Most columns for the last year are archived for your reference.

Last week we discussed a reader's question regarding the use of annuities as part of a long-term financial plan.

This week we discuss the implications of the payout choices, and most interestingly, why it is important to review the strength of the life insurance company (and its reinsurer) providing the annuitised stream of revenue to you and your beneficiary over the next 20,30,40, or who knows how many years of your natural life.

As employees reach retirement age, they will be faced with some very complex decisions regarding their accumulated pensions, such as whether to take a lump sum or an annuity, indexed, non-indexed, or a combination of both.

They will also be contemplating - in some cases - radical changes in their lifestyle, changes in allocations of their investments, increased cost for continuation of health benefits in some form or another, transfer for continuation of life insurance as an individual rather than in a group, and many other issues, not the least of which may be just exactly what will I do with all my free time?

Under The Bermuda National Pension Scheme law, and depending very much on your Employer pension plan structure, retiring employees are asked to choose how they would like to receive the results of the money they have worked so many years for.

Individuals may also purchase an annuity as part of their retirement investment plan. It is extremely important to note that some of the payout options are not treated the same way; for instance, there is vast difference in a ten year pension annuity versus a ten-year certain non-pension annuity.

Most of the pensions provided today provide several choices of payments, partial Lumpsum, a life income portion and an annuity portion.

Let's exclude the lump sum and life income choices for now, since several articles could be written on them alone.

Definition Of An Annuity: a series of income payments over a specified time frame at some specified interest rate. Most of the annuities sold in the domestic market are fixed annuities, where insurance companies carry the responsibility for investing and payment of the guaranteed revenue stream.

Variable annuities resemble mutual funds within a life insurance wrapper, where there may be a guaranteed death benefit by the insurer, but the responsibility for investing the premiums falls to the client and the revenue stream may be significantly more or less, depending upon the performance of the underlying mutual funds.

Why would anyone want a variable annuity? In the good capital market times of the nineties, many investors felt that they could beat the market returns of a fixed annuity (and some did).

Since that time, however, as we well know valuations are way down. Anyone drawing down on a variable annuity today may have far less than they thought, perhaps even less than they originally contributed!

Payment Choices. Generally, the annuity payment choices come in four basic varieties: single life, joint or second to die life, ten-year certain, 20-year certain.

Each one of these pays at a different rate for a different amount of time, but they all have one single uniting factor; once you make the choice and you sign on the contract line, you cannot later on change to another option.

It is crucial to remember this very significant point.

So how does the payment (revenue stream) structure work? Here are two examples.

Single life: You will receive a series of payments for your natural life, Once you pass away, the payments stop - there is nothing for your beneficiaries.

It's a gamble. Say you are 65 and have a $100,000 annuity; while the insurance company may calculate that statistically you will pass in 20 years and structure their payments accordingly, you actually pass away in five years. That's it. End of payments even though you did not recoup your original investment.

Conversely, the opposite may be true. You live until 105, and receive those payments every month for 40 years.

Ten-year annuity schedule. Bermuda National Pension Scheme annuity.

Your payments are guaranteed for ten years. If you pass in three years, your beneficiary will receive payments for seven years.

If you come from a longevity factor family, and live past ten years, you will continue to receive payments for your natural life, under the pension rules.

Ten-year certain. Non-pension annuity. Here the rule is different. Your payments are guaranteed for ten years. Period.

If you die before ten years, your beneficiary receives payments up until ten years - same as pension scheme above.

HOWEVER, if you live past ten years, you still only receive payments for ten years and no more. See attached chart on Page 6.

Notice how the female payout is always lower-except in ten-year certain, we live longer!

While fixed annuity payments are guaranteed, in a variable annuity structure only the stipulated death benefit maybe guaranteed by insurer.

To hedge their positions, primary insurers will generally parcel out part of the risk (of providing the variable annuity death benefit) by purchasing insurance themselves through a reinsurer.

Such a reinsurer is Cigna Corporation, a large publicly traded insurance and reinsurance company in the US markets.

In the Wall Street Journal of Thursday September 5, 2002, it was reported that Cigna had, in the early nineties, reinsured risky variable annuities death benefits, totalling more than 70% of the entire variable annuity market at that time.

As capital markets have suffered through two and a half years of decline, so too, have the values of variable annuity accounts dropped below the guaranteed death benefit.

If the annuitant dies during this time frame, the reinsurer must make up the difference.

Example: the variable annuity death benefit is $100,000, but the real value of the account is only $75,000. Cigna must make up the $25,000 loss - on each policy.

It was estimated by the Wall Street Journal that if all annuitants reinsured by Cigna passed away this year, Cigna would owe $22 billion.

Cigna had actually not taken steps to spread its own risk among other reinsurers and investment strategies, because in their own words, "they thought the market was bounding right back."

Needless to say Cigna stock has dropped in value, and now you can see why knowing the financial strength of the insurance company is important.

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Martha Harris Myron CPA CFP(tm) is a Bermudian, a Certified Financial Planner(tm)(US license) practitioner and VP, Personal Financial Services, Bank of Bermuda. She holds a NASD Series 7 license, is a former US tax practitioner, and is the winner 2001-The Bermudian Magazine - Best of Bermuda Gold Award for Investment Advice. Confidential Email can be directed to marthamyronnorthrock.bm

The article expresses the opinion of the author alone, and not necessarily that of Bank of Bermuda.

Under no circumstances is this advice to be taken as a recommendation to buy or sell investment products or as a promotion for financial plans. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.