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Insurance Abstract
This invention provides systems, methods, and designs for two novel
life insurance products which provide many lifecycle investment
advantages compared to existing state of the art products currently
available.
Insurance Claims
1. A method, system, and life insurance product for efficient lifecycle
investing, comprising the step of: identifying multiple insured
lives to be insured in a novel universal life insurance policy,
specifying the event upon which the death benefit is to be paid
among the multivariate events of the timings of the deaths of the
insureds, calculating the corridor amount of the contract under
Section 7702 of the Internal Revenue Code, optimizing the corridor
amount responsive to the number of insureds, their age, and the
desired corridor, and specifying the duration of the contract.
2. A method, system, and annuity product for efficient lifecycle
investing, comprising the step of: identifying a plurality of measured
lives to in a novel variable annuity contract, specifying the survivorship
event or events upon which the periodic annuity payments are conditional,
providing for no cash surrender, death, or other nonforfeiture benefits
in order to maximize annuity payments to each annuity payee, calculating
the future annuity payments responsive to the survivorship probability,
interest rates, and conditional life expectancies of the measured
lives, and selection of zero coupon municipal bonds for the segregated
variable annuity investment account which have a duration approximating
the time between the annuity purchase date and annuity payment date.
Insurance Description
FIELD OF THE INVENTION
[0001] The present invention relates generally to systems, methods,
plans and products for designing and providing investment products
which are both investment and tax efficient across the lifecycle
of an individual. In the theory of financial economics, lifecycle
investing involves systematic investment planning throughout an
individual's entire lifecycle in order to help best achieve one's
financial objectives and goals. According to the well known Lifecycle
Investment Theory of Nobel laureate Franco Modigliani, every individual
passes through distinct stages in his lifecycle which are defined
by characteristic and differing marginal utilities for saving and
consumption. The first characteristic stage is the accumulation
phase, during which an individual has higher marginal utility for
consumption but constrained or limited resources. This phase is
marked by dissaving by the individual, as he spends more by way
of loans than he earns to meet his multiple needs. The second characteristic
phase in an individual's lifecycle is the consolidation phase wherein
the individual has satisfied most of his essential needs and is
looking at opportunities of incremental wealth generation. This
phase is marked by a higher marginal utility of wealth currently
or, in other words, an intertemporal substitution of consumption
whereby deferred consumption is deemed to have higher utility. In
this stage, individuals typically exhibit net saving. The third
and fourth phases are often referred to as the spending and gifting
stages, respectively. These phases are again marked by dissaving
as an individual eats into his earlier savings to meet up with his
remaining lifecycle. As an individual evolves through these stages
in his lifecycle, not only do his financial objectives and goals
change, but also his risk bearing ability, which largely determines
the feasible set of investment choices at each stage. The aim of
the present invention is to provide novel methods, systems and products
for lifecycle investment which efficiently achieve these changing
investment goals. Throughout the description of this invention the
term efficiency includes both market or pure investment efficiency
which is a function of the expected returns and volatilities of
the feasible set of investment choices, and tax efficiency, which
refers to providing investment methods, systems, and products which
produce a large after-tax source of wealth under the U.S. Internal
Revenue Code.
BACKGROUND OF THE INVENTION
[0002] A number of uses for life insurance products have emerged
in recent years to fulfill many lifecycle investment objectives.
Various types of life insurance have a dual savings and bequest
objective which reflect the demand for deferred consumption in one's
own lifetime and for the lifetime of one's beneficiaries. Recent
innovations, such as variable universal life (VUL) insurance, bundle
investment accounts together with yearly renewable term insurance.
In this product, individuals may invest in a range of securities,
mutual funds, or other types of investment partnerships in segregated
investment accounts. The accounts are nominally owned by the issuing
life insurance company. As a consequence, the owner of a variable
universal life insurance policy pays no current income tax on investment
returns. The death benefit of a VUL policy will generally increase
as positive investment returns are accumulated. If the individual
dies, this increased death benefit is paid out free of income tax
to the VUL policy's beneficiaries. If the owner of the policy makes
a withdrawal from the VUL policy prior to death, ordinary income
tax is due on any earnings in the policy. Thus, a VUL policy bundles
together the following components: (1) tax preferred growth of assets
for either the individual (tax deferred withdrawals) or the individual's
beneficiaries (tax free death benefits); (2) a layer of yearly renewable
term insurance which is responsive to the overall growth in the
investment accounts; (3) a mechanism by which the layer of term
insurance can be paid for with before tax dollars through automatic
deductions in the investment accounts.
[0003] A VUL policy is therefore a bundle of what financial economists
call contingent claims. A pure contingent claim is a non-interest
bearing security which pays out a unit of account (i.e., a dollar)
should a given state of the world occur. For example, pure term
life insurance pays out a certain quantity of dollars upon the death
of an individual. Financial economists generally recognize that
it is preferable to have a complete set of elementary (i.e., unbundles)
contingent claims from which individuals can choose to fulfill their
lifecycle investment objectives. (See, e.g., Lange and Economides,
"A Parimutuel Market Microstructure for Contingent Claims,"
European Financial Management, vol. 10:4, December 2004, and references
cited therein). It is also generally recognized that bundling of
contingent claims is generally a redundant exercise, however, bundling
may be advantageous due to transaction cost and tax efficiency.
For example, a VUL policy is a bundling of a tax deferred investment
account and a term life insurance policy. An individual might be
able to achieve the same objectives satisfied by a VUL policy by
investing in a tax deferred 401(k) account and buying yearly renewable
term insurance. Prima facie, the combination of the 401 (k) and
the term insurance appears to achieve the same objectives as the
VUL policy: tax free accumulation of investment returns available
for withdrawal at a future date and an income tax free death benefit
for beneficiaries. However, the VUL policy dominates for two reasons.
First, were an individual to attempt to replicate a VUL policy with
a 401(k) account and yearly renewable term insurance, they would
find that the premiums paid on the term insurance must be made from
after tax dollars. Section 264 of the Internal Revenue Code provides
that these premiums are not tax deductible. In the VUL policy, by
contrast, the premiums which keep the insurance portion of the VUL
policy in force are automatically deducted on a monthly basis from
the investment account. To the extent the investment account has
returns, the premiums for the insurance are paid with pre-tax dollars
since the returns from the VUL policy investment accounts accrue
free of income tax. Second, replicating the VUL policy with a 401(k)
and yearly renewable term insurance will incur significant transaction
costs as the individual must dynamically "rebalance" the
ratio of the balance in the 401 (k) versus the amount of term insurance.
The VUL policy does this type of rebalancing automatically according
to well-known and relatively efficient procedures. There is, however,
a cost to bundling in the VUL policy: the Internal Revenue Code
requires a minimum ratio of insurance to the balance in the VUL
investment account in order for the VUL policy to meet the definition
of insurance under Title 26, Section 7702. If this minimum ratio
is requirement is not met, then the investment account returns will
not receive the benefit of tax-free accumulation and the death benefit
will be free from income tax. It is an object of the present invention
to provide a variable life insurance policy which both complies
with Section 7702 and yet has more flexible minimum ratios of death
benefits to investment account balances. It is another object of
the present invention to use the novel VUL policy described herein
as a lifecycle investment product that can be used to maximize tax
efficiency for groups of affiliated individuals, such as the managers
or employees of a corporation, a group of alumni of a university
or college, or an association of benefactors bound by the common
aim of desiring to support a given charitable cause or institution.
[0004] Another type of insurance product which is often used to
satisfy lifecycle investment objectives is an immediate annuity
(or SPIA which stands for Single Premium Immediate Annuity). Conceptually,
an immediate annuity is a unique type of contingent claim in that
it allocates dollars to a certain state of the world where the owner
of the immediate annuity has increased longevity. Thus, where a
pure term life insurance policy can be viewed as an elementary contingent
claim paying some number of dollars in the state of the world where
the insured dies, an immediate annuity is a contingent claim, which
pay some number of dollars should the annuity owner not die. It
is clear that together, both an immediate annuity and a pure term
insurance policy provide a complete set of continent claims for
an individual to shift wealth from "alive" states to "dead"
states or vice versa. A simple equation relates these two contingent
claims as follows: L+A=B
[0005] where L is a pure term insurance policy which pays one dollar
upon the death of the insured, A is a pure immediate annuity which
pays one dollar should the annuitized individual (the individual
whose life is used to determine the payment of an annuity is often
called the "measuring life"), and B is the sum of these
two claims. As can be seen, if B is the sum of the L and A, since
the individual is either alive or dead, B is a simple zero coupon
bond which pays one dollar at date at a maturity date corresponding
to the future date at which one determines whether the individual
is alive or dead.
[0006] In practice, one cannot currently purchase a pure annuity
like the quantity A, defined above, which pays a unit of account
should an individual survive to a given future date. SPIA's are
the closest analogue to such a claim but there are significant differences
between SPIA's and the theoretical quantity A. First, under the
Internal Revenue Code, a SPIA is a type of financial instrument
which makes periodic (e.g., monthly, quarterly, annual) payments
to the annuity payee. The pure annuity claim A, described above,
makes only a single payment contingent upon surviving to some future
date (which we may aptly call herein a "survivorship contingent
claim" as opposed to pure term insurance with may aptly be
called herein a "death contingent claim") and would likely
not qualify as an annuity (immediate or otherwise) under the Internal
Revenue Code. Second, under the Internal Revenue Code, an immediate
annuity must start making its periodic payments within 12 months
of its purchase. The survivorship contingent claim (SCC), A, may
pay one unit of account (e.g., dollar) should the insured be alive
at some future date. Conceptually, there is no reason why this future
date cannot be more than one year into the future. In fact, as described
herein below, if the SCC can pay many years or even decades into
the future, then such a claim can satisfy many lifecycle investment
objectives. One object of this invention, therefore, is to provide
a survivorship contingent claim which is both compliant with the
current Internal Revenue Code and which can satisfy these investment
objectives. Such an insurance product does not currently exist and
can be crudely approximated, if at all, using existing products.
For example, from the above equation we see that the SCC denoted
A and the death contingent claim (DCC) denoted L, both sum to a
discount or zero coupon bond B which matures at the future date
referenced by L and A. Namely, if L pays one dollar should the insured
be dead on Jan. 1, 2040 and A pays one dollar should the insured
be alive on Jan. 1, 2040, then B is simply a zero coupon bond which
matures on Jan. 1, 2040. By rearranging the equation relating L,
A, and B, we see that A is equal to B-L, which means that a pure
survivorship contingent claim is equal to a zero coupon bond less
a pure death contingent claim. Using the parlance of the financial
markets, the SCC, A, is equivalent to owning or being "long"
the zero coupon bond, B, which matures on Jan. 1, 2040, and selling
or being "short" the DCC which pays one dollar if the
insured individual is dead on Jan. 1, 2040. As one object of the
invention is to provide a practical and efficient survivorship contingent
claim and since such a claim is equivalent to the insured selling
or being short a death contingent claim-a type of life insurance
contract analogous (but not exactly) to term life insurance, we
present invention provides methods, systems and products for incorporating
a means whereby an individual by effectively "short" life
insurance on his own life. While individuals may currently sell
life insurance which they already own (called a "life settlement"
contract), we are unaware of any insurance product which effectively
allows the insured to short a long dated pure life insurance claim
on his own life. In addition, no proposals for such a claim which
are compliant with current practice and the Internal Revenue Code
have been made.
SUMMARY OF THE INVENTION
[0007] The present invention provides methods, systems and products
to solve the following problems or deficiencies facing an individual
who desires to use insurance and investment products to meet lifecycle
objectives: [0008] (1) Current products, such as variable universal
life insurance, require relatively large amounts of pure life insurance
per dollar of investment account in order to comply with the Internal
Revenue Code's definition of life insurance; [0009] (2) Current
VUL products cannot therefore be used effectively by a group of
affiliated individuals sharing a common situation, purpose or goal,
to invest with maximum tax efficiency at minimum insurance cost;
[0010] (3) Current VUL products provide for too large a minimum
net amount at risk or corridor which requires extensive medical
underwriting and usage of an individual's insurable capacity in
order to receive the benefits of tax-free accumulation and death
benefits; [0011] (4) Current insurance products do not offer a pure
survivorship contingent claim which enables an individual to effectively
short life insurance on his own life; [0012] (5) Current insurance
products do not provide for annuities paying either a lump sum or
period payments conditional upon the survival of the insured more
than 12 months from the date of purchase as currently required by
the Internal Revenue Code.
[0013] The aim of the present invention is to solve these problems
by providing methods, systems and products which accomplish these
investment and insurance objectives while satisfying all requirements
under the existing Internal Revenue Code.
[0014] A need is recognized for a new variable universal life insurance
product which allows for a design which generates a lower net amount
of death benefit (referred to as the "corridor") under
the Internal Revenue Code, section 7702.
[0015] A need is recognized for a new variable universal life insurance
product which can specify the payment of death benefit proceeds
upon a variety of contingent events other than the traditional death
of a single insured, first death of two joint insureds, or second
death of two joint insureds.
[0016] A need is recognized for a new variable life insurance product
which incorporates multiple events the duration of which can survive
much longer than life insurance products currently offered.
[0017] A need is recognized for a new variable life insurance product
which provides for efficient downside protection of the variable
investment account using a novel death benefit mechanism described
herein.
[0018] A need is recognized for a new variable life insurance product
which provides the ability of a group of university or college alumni
to be able to invest in investment accounts managed by their university
or college's endowment management company without adverse tax consequences
while providing maximum flexibility with respect to donative goals.
[0019] A need is recognized for a new variable life insurance product
whereby a plurality of individuals can be insured and whereby the
event triggering the death benefit payment can be specified in a
manner which dramatically shortened the statistical expected time
to payment.
[0020] A need is recognized for a new variable life insurance product
which does not require medical underwriting irrespective of the
size of the premiums paid into such policy and which, once underwritten,
would not impede the individuals insured from obtaining large amounts
of insurance at some future date under another policy.
[0021] A need is recognized for an annuity financial product that
is both compliant with the current Internal Revenue Code and which
can begin making lump sum or periodic payments greater than one
year from the date of purchase.
[0022] A need is recognized for a survivorship contingent claim
which pays a unit of account should the insured survive to a given
future date.
[0023] A need is recognized for an annuity product which combines
the following features: (1) a survivorship contingent claim; (2)
a payment or payments to be made greater than one year from the
date of purchase; and (3) periodic payments that are guaranteed
to be a defined amount, or no less than a defined amount, at the
time of purchase; (4) periodic payments that are largely excluded
from income tax under the current Internal Revenue Code.
[0024] According to one embodiment of the present invention, as
described herein, a method, system and product for a multiple event
variable universal life insurance (MEVUL) policy which provides
minimal or no corridor, is compliant with Section 7702 of the Internal
Revenue Code, and has a duration that can exceed the lifetime of
any given individual comprises the steps of: [0025] 1) determining
more than one insured to be insured under the life insurance contract;
[0026] 2) selecting "reasonable mortality charges" pursuant
to Section 7702 of the Internal Revenue Code and regulations thereunder
corresponding to the lives of the insureds under the contract; [0027]
3) defining the event under which the insurance contract will pay
a death benefit as a function of the-death, survivorship, or both
of individual or multiple insureds (the "payment event")
and [0028] 4) providing for the ability of surviving insureds to
maintain the policy in force upon the payment of a death benefit
triggered by a payment event.
[0029] According to another embodiment of the present invention,
a method, system and product for providing very efficient retirement
income tax-free annuities ("VERITAS") comprising the steps
of: [0030] 1) selecting an annuity purchase date and an annuity
payment date whereby the payment date can be greater than 12 months
later than the annuity purchase date; [0031] 2) selecting a traditional
variable annuity contract containing cash surrender, death benefit
and nonforfeiture benefits; [0032] 3) removing the cash surrender,
death benefit and nonforfeiture benefits from the traditional annuity
contract to create a new contract without such benefits; [0033]
4) specifying one or more unit investment trusts or similar investment
trusts or entities to be the segregated investment accounts of the
variable annuity; [0034] 5) specifying one or more measured lives
for the variable annuity contract for determining the date at which
no death benefits are payable or the amount of lump sum or periodic
payments to be made beginning at the annuity payment date; [0035]
6) funding the unit investment trusts of step (4) with tax preferred
securities or other financial instruments such as long-dated zero
coupon insured municipal bonds which have a high credit rating (e.g.,
AAA); [0036] 7) providing a guaranteed lump sum or periodic payments
at the annuity payment date or providing that such payments may
not be below a certain level at the annuity payment date; [0037]
8) computing the exclusion ratio determining the amount of the periodic
payments, if any, which begin at the annuity payment date that are
excludable from income tax under the current Internal Revenue Code;
[0038] 9) publishing on a periodic basis (e.g., monthly), the guaranteed
lump sum or periodic payments guaranteed at the annuity payment
date or the lowest level of such payments given current market conditions.
[0039] In another additional embodiment of the present invention,
a method comprising the financing of consideration for the VERITAS
annuity described herein.
[0040] In another additional embodiment of the present invention,
a method, system, and product accomplishing the same financial objectives
of the VERITAS annuity but using a grantor trust rather than a traditional
variable annuity contract as the payment and beneficiary mechanism
under which payments are made at the annuity payment date.
BRIEF DESCRIPTION OF THE DRAWINGS
[0041] FIG. 1 is a schematic representation of a system, method,
and product for the MEVUL--a multiple event variable universal life
for minimizing corridor, providing tax efficient investment returns,
and a long duration lifecycle investment vehicle for multiple insureds.
[0042] FIG. 2 is a schematic representation of a system, method,
and product for the VERITAS, a novel annuity product providing many
lifecycle investment benefits.
DETAILED DESCRIPTION
[0043] The present invention is described in relation to systems,
methods, products and plans for the enablement of two lifecycle
financial and insurance contracts. In the first such product, described
above and named MEVUL for the purposes of the present invention,
a novel variable life insurance product is described which provides
the following benefits: (1) dramatically reducing or eliminating
insurance corridor and the costly premiums associated with such
corridor pursuant to either the cash value accumulation test (CVAT)
or guideline premium test (GPT) under Section 7702 of the Internal
Revenue Code; (2) provision of completely tax-free investment returns
along with increased liquidity of those returns and principal; and
(3) an option to maintain the contract with an "evergreen"
feature under which its duration can be extended well beyond the
duration of current insurance products; (4) the provision of multi-individual
benefits to groups of affiliated individuals such as employees,
executives, partners, or owners of a corporation or individuals
sharing a common purpose such as the desire to support a given charitable
cause or foundation; (5) the provision of the ability of multiple
benefactors of a charitable institution, such as university or college
alumni, to provide funds for the MEVUL product wherein such funds
are managed by the alumni's university's or college's endowment
management company wherein (a) the returns on such investments are
entirely tax free and (b) the benefactors need to provide any other
benefit to the university or college in the form of a gift of principal
or interest from said investment of funds.
[0044] In the second such product, described above, and named VERITAS
for the purposes of the present invention, a novel variable annuity
insurance product is described which provides for the following
lifecycle investment benefits: (1) annuitization into periodic payments
that begin greater than 12 months from the annuity purchase date
and yet which maintain a large exclusion ratio under current tax
law; (2) the ability to increase future income for later consumption
or retirement by incorporating multiple measured lives and multiple
types of payment events; (3) the ability to increase future income
for later consumption or retirement by providing no death benefits
or cash surrender benefits or other nonforfeiture benefits; (4)
the ability to provide AAA guarantees of both the investments inside
the investment account and by the issuing insurance company providing
for the highest degree of security of such future benefits.
[0045] FIG. 1 is a schematic representation of a system and method
for the creation of the MEVUL product, and a schematic illustration
of the product itself. The system, method, or product, 100, may
comprise a contract with the ability to identify multiple lives
to serve as insureds. For example, the MEVUL contract may allow
for 2 insureds or up to many hundred's of insureds under the same
policy. For example, a husband and wife may be the insureds under
a MEVUL policy or 500 alumni of a given university may be the insureds.
The MEVUL product, along with systems and methods used to design
and implement it, also comprise the identification of the event
upon which payment of the death benefit will be made, 110. Depending
upon the prior multiple lives identification step, 100, the event
may, in a preferred embodiment, be a realization of a multivariate
probability distribution. For example, assuming that the MEVUL product
of the present embodiment were to be used by 500 university alumni
and that these 500 alumni were the insureds under a single MEVUL
policy, the multiple event specification, 110, may, in a preferred
embodiment, specify the payment of a death benefit upon the death
of the first alumnus. Alternatively, the death benefit of the policy
may be paid upon the death of the 10.sup.th alumnus out of 500.
Based upon the multiple event specification step, 110, the next
step is to calculate the net amount at risk or corridor required
under the Internal Revenue Code, Title 26, Section 7702. There are
two tests for the minimum net amount at risk or corridor under Section
7702: the Guideline Premium Test (GPT) and the Cash Value Accumulation
Test (CVAT). Both tests aim to require that in order for a life
insurance policy to qualify as "life insurance" under
the Internal Revenue Code and therefore receive the income tax benefits
of income tax-free accumulation and income tax-free death benefits,
the policy must require a minimum ratio of total death benefit to
policy cash value, or, in other words, a minimum difference between
total death benefit and policy cash value, which is termed the corridor
amount. For example, in computing this minimum corridor under the
CVAT test (which generally allows greater amounts of policy cash
earlier in the life of a policy but requires a higher corridor later),
under Section 7702, the minimum corridor can be calculated using
"reasonable mortality charges" and a 4% interest rate.
The question answered by the CVAT test is: what is the minimum ratio
of total death benefit to policy cash value that needs to be in
place at any point in time for the life policy to qualify as life
insurance under Section 7702. Both the CVAT and GPT test use similar
principles in defining this requirement. Beginning with a single
premium and a net amount at risk at a given insured's age using
reasonable mortality charges the following procedure is performed
(taking the CVAT test as an example in the present embodiment) per
the Section 7702 corridor calculation step, 120: [0046] 1. Begin
with 100 dollars of cash value; [0047] 2. Assume an additional corridor
amount (e.g., 20% of 100 dollars=20 dollars); [0048] 3. Obtain "reasonable
mortality charges" such as those derived from 1980 Commissioner
Standard Ordinary (1980 CSO) mortality data; [0049] 4. At each year,
first multiply the annual mortality charge (e.g., 3%) times the
corridor amount; [0050] 5. Subtract the amount in Step 4 from cash
value; [0051] 6. Accrue the remaining cash at the 4% interest rate
specified under 7702; [0052] 7. Iterate by changing the initial
corridor amount in Step 2 until the resulting policy cash plus corridor
amount at age 100 is equal to the policy cash value plus corridor
amount at the end of the year of the age of calculation.
[0053] The following table illustrates these values assuming 100
dollars of initial policy cash value for a 75 year old male nonsmoker
using 2001 CSO mortality data: TABLE-US-00001 TABLE 1 Section 7702
Corridor Calculation BOY EOY Age of 2001 Policy Policy Cash Policy
Death CVAT Insured CSO Cash Less COI Cash Benefit Corridor 75 2.50%
100.00 98.83 102.78 149.52 46.74 76 2.74% 102.78 101.50 105.56 77
3.01% 105.56 104.16 108.32 78 3.35% 108.32 106.76 111.03 79 3.76%
111.03 109.27 113.64 80 2.95% 113.64 112.26 116.75 81 3.23% 116.75
115.24 119.85 82 3.52% 119.85 118.20 122.93 83 3.85% 122.93 121.13
125.98 84 4.19% 125.98 124.02 128.98 85 4.56% 128.98 126.85 131.92
86 4.99% 131.92 129.59 134.77 87 5.47% 134.77 132.21 137.50 88 5.99%
137.50 134.70 140.09 89 6.62% 140.09 137.00 142.48 90 7.10% 142.48
139.16 144.72 91 7.74% 144.72 141.11 146.75 92 8.53% 146.75 142.77
148.48 93 9.33% 148.48 144.12 149.88 94 10.15% 149.88 145.14 150.94
95 10.99% 150.94 145.81 151.64 96 11.80% 151.64 146.13 151.97 97
12.64% 151.97 146.06 151.91 98 13.47% 151.91 145.61 151.44 99 14.11%
151.44 144.84 150.64 100 14.70% 150.64 143.77 149.52
[0054] In the first column of Table 1 is the age of the insured.
The second column contains the "reasonable mortality charges"
per dollar of net amount at risk or corridor amount under the 2001
CSO Tables. The 2001 CSO Tables are, as of 2004, gradually being
adopted for use to replace the dated 1980 CSO Tables. The 2001 CSO
Tables have mortality charges which are substantially lower than
those of the 1980 CSO Tables, which generally reflects the improvement
in longevity at most ages between the years 1980 and 2001 in the
United States. As expected, the annual mortality charges shown above
for a male from age 75 to 100 increase over the age range to reflect
the increasing probability of mortality at older ages. To solve
for the CVAT corridor for the end of the year at age 75 (in actual
policy calculations, the CVAT corridor calculation is typically
done monthly but here it is done annually for illustrative purposes),
an initial corridor amount is assumed. The cost of insurance ("COI")
is then equal to the initial corridor amount multiplied by the 2001
CSO mortality charge for that age as shown in column 2 of Table
1. The initial policy cash of 100, shown in column 3 of Table 1
above, when reduced by this COI is shown in column 4 above. Per
Section 7702, the amount in column 4 is accrued at the statutory
interest rate of 4%. The result is shown in column 5 of Table 1
which is the end of year policy value which reflects deductions
for cost of insurance and then accruing 4% interest on the balance.
The calculations are carried forward until age 100. The initial
corridor amount chosen is iteratively changed until the end of year
policy cash at the age of calculation (age 75 in this illustration)
plus the corridor amount is equal to the end of year policy cash
(column 5, Table 1) at age 100. As can be seen, the resulting calculation
is equal to 149.52 which is the gross death benefit required when
the policy begins with 100 in premium and grows to 102.78 in cash
at the end of the first year. The difference between the gross death
benefit and the end of year policy cash is 149.52 minus 102.78 or
46.74, which is the corridor amount. Typically, the corridor would
be expressed as 100 plus the amount divided by 100, or 1.47 rounding
to the nearest tenth.
[0055] In a preferred embodiment, the Section 7702 Corridor Calculation
step, 120, is responsive to the Multiple Life Identification step,
100, and the Multiple Event Specification step, 110. To show this,
we consider the following example of the preferred embodiment step.
First, we consider the case where the Multiple Life Identification
step, 100, identified 100 individuals all of whom are 50 year old
non-smoking males. Second, we consider the case where the Multiple
Event Specification step, 110 specified the death benefit payment
event to be the first death among these 100 insureds (a so-called
"first to die" event). Under Section 7702, "reasonable
mortality charges" must be used for each of the 50 year old
non-smoking males. Typically, at of 2004, these are 1980 CSO table
charges. However, as the new 2001 CSO tables will soon be adopted
as of the date of the present invention, the newer mortality charges,
which reflect improved longevity between 1980-2001, will be used.
Using the standard actuarial notation: [0056] q.sub.t,T=the probability
of death between time t and T conditional upon survival to time
t [0057] p.sub.t,T=the probability of survival between time t and
T, conditional upon survival to time t
[0058] As is commonly used, if the period of death and survival
is taken to be a calendar year, the shorthand, q.sub.t and p.sub.t
will be used respectively, where the second subscript, T, is implicitly
understood to be equal to t+1 year. So, for example, q.sub.50 is
the probability that a 50 year old of a given risk class (make,
nonsmoker, select) dies in the next calendar year while p65 is the
probability that a 65 year old of a given risk class survives in
the next year. For step 120 of FIG. 1, the first substep is to acquire
the q.sub.t for the given risk class which are available, for example,
from the 2001 CSO tables. Since mortality charges are proportional
to q.sub.t, we will assume, for sake of convenience, that the q.sub.t
also represent the fair cost of insurance for an individual of age
t in the given risk class. From the 2001 CSO tables, the q.sub.t
for a 50 year old male nonsmoker is equal to: TABLE-US-00002 TABLE
2 2001 CSO Mortality Rates for Male Nonsmokers Aged 50-100 Annual
Mortality Age Charges 50 0.146% 51 0.180% 52 0.216% 53 0.256% 54
0.297% 55 0.349% 56 0.414% 57 0.485% 58 0.551% 59 0.626% 60 0.717%
61 0.828% 62 0.951% 63 1.085% 64 1.226% 65 1.376% 66 1.499% 67 1.613%
68 1.757% 69 1.958% 70 2.222% 71 2.532% 72 2.869% 73 3.227% 74 3.577%
75 4.003% 76 4.413% 77 4.889% 78 5.445% 79 6.087% 80 6.787% 81 7.58%
82 8.41% 83 9.31% 84 10.30% 85 11.41% 86 12.63% 87 13.97% 88 15.41%
89 16.93% 90 18.51% 91 19.99% 92 21.54% 93 23.18% 94 24.91% 95 26.72%
96 28.38% 97 30.15% 98 32.04% 99 34.05%
[0059] As can be seen, the mortality charges increase with age
at an increasing rate. As is known to one skilled in the art, there
are relationships between the annual probabilities of death and
the survival probabilities as follows: p t , T = i = t i = T .times.
.times. ( 1 - q i )
[0060] That is, the probability of surviving from time t to T is
the product of one minus the probability of dying in each year from
t to T. Similarly, the probability of dying between t and T is the
probability of dying in the first year, plus the probability of
surviving in the first year multiplied by the probability of dying
in the second year, and so forth as follows: q t , T = i = t i =
T .times. q i .times. t i = T - 1 .times. ( 1 - q i )
[0061] If the event defined in step 110 of FIG. 1 is "first
to die" the step 120 of FIG. 1 entails computing the first
to die mortality charges. Since it is assumed for the purposes of
simplicity of description that the annual mortality charges are
equal to the annual probabilities of mortality, the probability
of a first death in a given year beginning at time t for N insureds
is equal to, in the first year, one minus the probability that all
the individuals survive. In the second year, the probability of
a first death in year two is equal to one minus the product of the
probability that all survived in year one and the probability that
all survived in year 2, less the probability that all survived in
year 1. In the standard notation, and assuming that the probability
of death of each individual is statistically independent this is
equal to the probability that all insureds survive to time T-1 and
then not all survive at time T or: q t , T n = i = t i = T - 1 .times.
.times. ( 1 - q i ) N .times. ( 1 - ( 1 - q T ) N )
[0062] For annual mortality rates, the formula reduces to q.sub.t.sup.n=(1-(1-q.sub.t).sup.N)
[0063] Using this formula on the 2001 CSO mortality rates in Table
2, yields the Section 7702 reasonable mortality charges for 50 insureds
(N=50) each of whom is 50 years old: TABLE-US-00003 TABLE 3 2001
CSO Mortality Rates for Male Nonsmokers Aged 50-100: First to Die
Annual Mortality Age Charges 50 7.04% 51 8.61% 52 10.25% 53 12.03%
54 13.82% 55 16.04% 56 18.73% 57 21.58% 58 24.14% 59 26.95% 60 30.22%
61 34.01% 62 37.98% 63 42.04% 64 46.03% 65 49.98% 66 53.01% 67 55.65%
68 58.78% 69 62.79% 70 67.49% 71 72.26% 72 76.67% 73 80.60% 74 83.82%
75 87.03% 76 89.53% 77 91.84% 78 93.92% 79 95.67% 80 97.02% 81 98.06%
82 98.77% 83 99.24% 84 99.56% 85 99.77% 86 99.88% 87 99.95% 88 99.98%
89 99.99% 90 100.00% 91 100.00% 92 100.00% 93 100.00% 94 100.00%
95 100.00% 96 100.00% 97 100.00% 98 100.00% 99 100.00%
[0064] As can be seen from Table 3, the annual mortality charges
for the first to die event for fifty 50 year old male nonsmokers
is very high compared to the charges for a single male. To finish
the example computation per step 120 of FIG. 1, the corridor calculation
using these mortality charges under Section 7702 yields: TABLE-US-00004
TABLE 4 Section 7702 Corridor Calculation for Fifty Insureds: First
to Die BOY Policy EOY FTD FTD 2001 Policy Cash Less Policy Death
CVAT Age CSO Cash COI Cash Benefit Corridor 51 0.070449 100.00 99.48
103.46 110.85 7.39 52 0.086143 103.46 102.82 106.94 53 0.102477
106.94 106.18 110.43 54 0.120291 110.43 109.54 113.92 55 0.13819
113.92 112.90 117.41 56 0.160379 117.41 116.23 120.88 57 0.18733
120.88 119.49 124.27 58 0.215799 124.27 122.68 127.58 59 0.241386
127.58 125.80 130.83 60 0.269469 130.83 128.84 134.00 61 0.302178
134.00 131.76 137.03 62 0.340137 137.03 134.52 139.90 63 0.379839
139.90 137.10 142.58 64 0.420428 142.58 139.47 145.05 65 0.460325
145.05 141.65 147.32 66 0.499815 147.32 143.62 149.37 67 0.530071
149.37 145.45 151.27 68 0.556508 151.27 147.16 153.04 69 0.587826
153.04 148.70 154.65 70 0.627944 154.65 150.01 156.01 71 0.67487
156.01 151.02 157.06 72 0.722602 157.06 151.73 157.79 73 0.766712
157.79 152.13 158.21 74 0.806041 158.21 152.26 158.35 75 0.83818
158.35 152.16 158.24 76 0.870317 158.24 151.81 157.88 77 0.895301
157.88 151.27 157.32 78 0.918429 157.32 150.53 156.56 79 0.939155
156.56 149.62 155.60 80 0.95672 155.60 148.53 154.47 81 0.970227
154.47 147.31 153.20 82 0.98062 153.20 145.95 151.79 83 0.987656
151.79 144.49 150.27 84 0.992445 150.27 142.94 148.66 85 0.995639
148.66 141.30 146.95 86 0.997656 146.95 139.58 145.17 87 0.998833
145.17 137.79 143.30 88 0.999461 143.30 135.91 141.35 89 0.999768
141.35 133.96 139.32 90 0.999906 139.32 131.93 137.21 91 0.999964
137.21 129.82 135.01 92 0.999986 135.01 127.63 132.73 93 0.999995
132.73 125.34 130.36 94 0.999998 130.36 122.97 127.89 95 0.999999
127.89 120.50 125.32 96 1 125.32 117.93 122.65 97 1 122.65 115.26
119.87 98 1 119.87 112.48 116.98 99 1 116.98 109.59 113.97 100 1
113.97 106.58 110.85
[0065] As can be seen from Table 4 in comparison with Table 1,
the Section 7702 CVAT corridor mandates approximately 7.39 dollars
of insurance for every 100 dollars of initial (beginning of first
year) cash value for fifty 50 year old male nonsmokers under the
2001 CSO reasonable mortality charges. By comparison, a single 75
year old requires under Section 7702 approximately 46.74 dollars
of insurance per 100 dollars of initial premium. So the first to
die corridor as an event defined per step 110 of FIG. 1 combined
with multiple lives per step 100, can produce, in a preferred embodiment,
dramatically reduced corridors under Section 7702. Effectively,
the first to die event specification combined with numerous lives
produces mortality charges commensurate to that of an individual
much older than each constituent individual insured under the first
to die even specification, per step 110 of FIG. 1. Thus, in a preferred
embodiment, one goal and aim of steps 100-120 is to reduce the corridor
amount for a group of younger individuals while satisfying the statutory
requirements of Title 26 Section 7702.
[0066] Referring again to FIG. 1, step 130 represents a program
which optimizes the corridor amount under Section 7702 by varying,
in a preferred embodiment, such variables as (1) the number of insureds
pursuant to step 100 of FIG. 1; (2) the age and variance of the
insureds ages, again pursuant to step 100; (3) the risk class of
the insureds, again pursuant to step 100; and (4) the event at which
the death benefit is paid under the policy pursuant to step 120.
The objective function of optimization program, 130, might be to
minimize the corridor amount, subject to constraints such as (a)
having no more than a given number of insureds; (b) having no insured
being older than a certain age; (c) having the standard deviation
of the expected time to the first death benefit payment date be
no greater than certain exogenously specified amount (e.g., "10
years"); and (d) having the expected time to the first death
benefit payment date be no greater than a certain amount. Such a
program would have the following structure in a preferred embodiment:
min N , x j .times. C .function. ( N , x j , q i j .function. (
x j ) ) subject .times. .times. to N .ltoreq. .alpha. x j .ltoreq.
m EV .function. ( First .times. .times. Payment .times. .times.
Date ) .ltoreq. .tau. STD .function. ( First .times. .times. Payment
.times. .times. Date ) .ltoreq. s
[0067] where EV stands for "expected value" and STD stands
for "standard deviation" as computed under the multiple
event probabilities (e.g., first to die event) pursuant to the procedure
described above. This event and corridor optimization program, as
described above in a preferred embodiment, can be solved using nonlinear
programming techniques.
[0068] Referring again to FIG. 1, step 140, shows the process of
a life insurance company, rated Standard and Poor's claims paying
AA or better in a preferred embodiment (though it may be rated lower
in alternative embodiments) issuing the MEVUL contract, a variable
universal life contract designed according to the steps described
above, 150. As designed pursuant the preferred embodiment described
above, the issuing insurer, 140, will need to get approval for the
MEVUL contract, 150, in states where the contract is offered for
sale. In an alternative embodiment, the issuing insurer, 140, may
be an offshore life insurance company domiciled outside the United
States (e.g., Bermuda) and therefore no such state approval is required.
In this embodiment, the MEVUL contract, 150, as described here in
is a novel multiple event, multiple insured, variable universal
insurance policy that would be privately placed in the private placement
offshore insurance market.
[0069] Referring again to FIG. 1, owner identification step, 180,
identifies the legal MEVUL life insurance policy owner. Specification
of the owner is important since it (1) determines whether the owner
has insurable interest; (2) whether the variable contract may qualify
as life insurance under the owner control portions of the Internal
Revenue Code, Title 26, section 817 (and regulations thereunder).
In a preferred embodiment, if the multiple insureds are employees
of, for example, a corporation, or are members of a partnership,
both the state law insurable interest requirements and the Internal
Revenue Code investor control requirements would be met if either
the individuals own a respective share of the policy or the corporation
or partnership, respectively, provided that neither the individuals
nor the business entities are responsible for the day to day management
of the MEVUL's segregated accounts. The segregated accounts are
specified in 190. In a preferred embodiment, this step may be selecting
various mutual funds, hedge funds, or other types of investment
partnerships. The segregated accounts themselves may contain entities
which are invested in life insurance policies and annuities. In
a preferred embodiment, the specification of the segregated accounts
and the account managers are related to the multiple lives identification,
100, and owner identification step, 180. In such an embodiment,
the segregated investment accounts may be selected to be those managed
by an nonprofit institution such as a university or college. For
example, step 190, may specify that Stanford Management Company
or Harvard Management Company will manage the segregated account
of the MEVUL in a manner similar to how these management companies
currently manage their endowments. Recently, there has been substantial
demand by alumni and other supporters of these institutions for
the institutions' management companies to manage their assets. For
example, both Stanford Management Company (SMC) and Harvard Management
Company (HMC) both have Charitable Remainder Unitrust (CRUT) programs
whereby supporters of the respective universities may invest capital
into the CRUT, receive the returns earned by the respective management
companies, and then, upon the death of the CRUT grantor, the principal
of the CRUT reverts to the respective university. There are a number
of problems with this method of investing in the same manner as
SMC, HMC and similar institutions. First, CRUTs entail the entire
or substantial portion of a gift of principal to the respective
nonprofit foundations. Second, because sophisticated management
companies such as SMC and HMC use debt-financing (leverage) in managing
their assets, such activity results in Unrelated Business Taxable
Income (UBTI). Until recently, the CRUTs could not maintain their
entirely tax-free status and participate in the endowment management's
use of debt-financing. In a recent IRS Private Letter Ruling, however,
the Harvard Management Company asked the IRS to allow its CRUT assets
to be able to participate in its debt-financed strategies, provided
that HMC paid the UBTI on behalf of the CRUTs (see "IRS Rule
Helps People Put Their Trust in Harvard," New York Times, Jan.
16, 2004). The method, system, and product of the present invention
provides a superior means by which alumni and other supporters may
receive investment returns generated by the respective endowment
management companies without strict charitable donation requirements
or complications related to UBTI. For example, in a preferred embodiment,
the segregated account specification step, 190, may select various
funds managed by an endowment management company such as SMC or
HMC. These funds would have to be available only within a segregated
life insurance policy account pursuant to the Internal Revenue Code,
Section 817 (and regulations promulgated thereunder). A number of
alumni may be specified as the insured lives pursuant to step 100
of FIG. 1. For example, 50 alumni may be named the insureds. Pursuant
to step 110, the payment of the death benefit may be due upon the
first death among the 50 insureds. If, for purposes of illustration,
each alumnus were 50 years old, then by step 120 the corridor is
very small compared to the initial amount of premium put into the
policy (the 50 alumni may divide the initial premium among themselves).
For example, for each 100 dollars of premium which the 50 alumni
put into the policy at policy inception, the corridor requirement
under Section 7702 of the Internal Revenue Code is approximately
only 7.4% of the initial premium. When the death benefit is paid,
it will be free of all tax, including UBTI. Referring to step 195
of FIG. 1, the duration of the MEVUL contract is specified. For
illustrative purposes, the expected time to first death for a first
to die event specification for fifty insureds each of whom is aged
50 is about 6.7 years. So, the surviving 49 insureds and the estate
of the deceased insured will split the death benefit according to
their initial premium contributions or in another manner agreed
by them, on average, in 6.7 years. A significant advantage, then,
of the method and systems proposed to design and offer the MEVUL
contract is a relatively short time for the MEVUL contract to mature
and provide liquidity for the owners of the contract. In addition,
pursuant to step 195, another advantage in a preferred embodiment
is to have an "evergreen" feature of the MEVUL by which
the surviving insureds (e.g., 49 in this example) will automatically
be insured in a reinstatement of a new death benefit which is responsive
to the amount of premium that the surviving 49 insureds and/or the
owner of the contract desired to rollover to insure the survivors.
In a prefefred embodiment, such a rollover feature might be automatic.
In another embodiment, the default rollover might be the initial
premium invested, whereby any accumulated earnings or death benefit
in excess of the initial premium might be rolled over at the election
of the insureds and/or the owners of the MEVUL. In another preferred
embodiment, an additional insured may be added to the existing number
of insureds. In another preferred embodiment, the initial underwriting
of the insureds will not require medical examinations or other invasive
information from the insureds due to the modest net amount of insurance
risk or corridor of the contract, per steps 120 and 130.
[0070] Referring to FIG. 2, a schematic representation of a system
and method for the creation of the VERITAS product, and a schematic
illustration of the product itself is shown. VERITAS, for the purposes
of the present invention, is a novel variable annuity insurance
product is described which provides for the following lifecycle
investment benefits: (1) annuitization into periodic payments that
begin greater than 12 months from the annuity purchase date and
yet which maintain a large exclusion ratio under current tax law;
(2) the ability to increase future income for later consumption
or retirement by incorporating multiple measured lives and multiple
types of payment events; (3) the ability to increase future income
for later consumption or retirement by providing no death benefits
or cash surrender benefits or other nonforfeiture benefits; (4)
the ability to provide AAA guarantees of both the investments inside
the investment account and by the issuing insurance company providing
for the highest degree of security of such future benefits.
[0071] Referring to FIG. 2, step 200 is the measured life identification
step whereby the measured lives-the individuals whose lifespans
determine the payments under the VERITAS contract-are identified.
For example, pursuant to step 200, the measured life might be a
50 year old male nonsmoker. As another example, there might be two
measured lives, e.g., a husband and wife. As another example and
in a preferred embodiment, there might be many measured lives. For
example, a group of 50 employees, partners, or alumni of a given
university be identified as the measured lives.
[0072] The survivorship event specification, 210, in FIG. 2 specifies
the event that must occur in order for the annuity to make payments
at the annuity date. For each VERITAS contract, there is purchase
date at which time the consideration or purchase price for the contract
is due, and an annuitization or annuity date, at which point the
contract begins, in a preferred embodiment, to make periodic payments.
Since, in a preferred embodiment, the VERITAS product is designed
to maximize periodic payments which commence at a future date, the
survivorship event specification will typically specify the number
of measured lives that must survive to the annuitization date in
order for benefits to be payable. If the survivorship condition
is not met, then, in a preferred embodiment, no benefits may be
payable (for example, death benefits to a beneficiary). As an example,
there may be a single measured life as specified in step 200. Assume,
for sake of illustration, that this single measured live is a 50
year old male nonsmoker. The survivorship event specification step,
210, then might require the 50 year old to survive to age 70 in
order for benefits to be payable. Alternatively, where there is
a husband and wife as the measuring lives per step 200, the survivorship
specification step, 210, might specify that both must survive to
age 65 in order for benefits to become payable. As yet another example,
a group of 10 alumni of a university may serve as the measuring
lives per step 200. The survivorship event specification step, 210,
might specify that payments are to begin only if all 10 alumni survive
to the age of 60. Another such even involving 10 alumni might be
that benefits will be payable at a given future annuitization date
should no fewer than 8 alumni survive to the annuitization date.
Clearly, there are many combinations of annuitization dates and
survivorship event specifications that are possible and would be
apparent to one of ordinary skill in the art. Using 2001 VBT (Valuation
Basic Tables) data, a result of the survivorship specification step,
210, would be a matrix showing the probabilities of survival from
annuity purchase age to the specified annuitization age as illustrated
in the following table: TABLE-US-00005 TABLE 5 Survivorship Probabilities
for Age of Annuity Purchase and Annuitization Date Age of Annuitization
50 55 60 65 70 75 80 85 90 Age of 30 0.970 0.951 0.919 0.868 0.790
0.679 0.526 0.338 0.158 Purchase 35 0.977 0.958 0.927 0.876 0.797
0.685 0.531 0.341 0.159 40 0.984 0.966 0.937 0.888 0.808 0.694 0.538
0.345 0.162 45 0.992 0.977 0.948 0.901 0.827 0.710 0.551 0.353 0.165
50 1.000 0.989 0.965 0.920 0.847 0.731 0.567 0.364 0.170 55 1.000
1.000 0.984 0.946 0.875 0.762 0.594 0.382 0.179
[0073] In Table 5 and pursuant to step 210 of FIG. 2, the probabilities
of survival from age of purchase to age of annuitization are calculated
using 2001 VBT mortality rates. For example, for an individual who
is 40 at the age of annuity purchase, there is a 0.808 probability
that this individual (male, nonsmoker, select class) will survive
to age 70. The probability of survival goes down as the number of
years between age of purchase and age of annuitization goes up.
Referring again to FIG. 2, step 220 specifies the nonforfeiture
benefits available under the contract. Under state law, most annuities
(typically both variable and nonvariable) comply with minimum benefits
upon either early surrender of the annuity or upon the death of
the measured life. Such benefits are typically referred to as nonforfeiture
benefits under state law as the state insurance laws typically mandate
that a certain amount of benefits must be paid either upon surrender
or to a beneficiary upon death. Generally, variable annuities, however,
need not provide either surrender or death benefits under state
law. For example, under the New York Insurance Code, section 4223(b)(1)(D),
excepts variable annuities from the nonforfeiture requirements.
Since, in a preferred embodiment, the VERITAS annuity product of
FIG. 2 is a variable annuity, it therefore generally is not required
to have either cash surrender or death benefits under state law.
Step 220 of FIG. 2 specifies whether a given VERITAS contract has
either cash surrender or death benefits (or both). In one preferred
VERITAS embodiment, there are neither cash surrender or death benefits.
The rationale for excluding both such benefits is that the periodic
annuitization payments that can be made commencing at the annuity
payment date can be maximized in the absence of such benefits. Referring
again to FIG. 2, step 230 is the annuitization specification and
optimization step. This step involves: (1) specifying the date of
annuitization; (2) providing for a guarantee of the exact or minimum
interest rate to be used for annuitization; (3) calculating the
conditional expected life span of the measured lives, conditional
upon survival to the annuitization date; (4) calculating the periodic
annuity payments per dollar of initial purchase consideration to
be made at the annuitization date based upon (a) the survivorship
probability calculated in step 210; (b) the minimum or exact or
range of annuitization interest rates provided or guaranteed; (c)
the relevant discount factors between the age of purchase and age
of annuitization to be used which is, in a preferred embodiment,
responsive to the segregated account specification step, 270 described
below; (d) calculation of the exclusion ratio which determines the
amount of the periodic annuity payment that may be excluded from
gross income for a period of time under the Internal Revenue Code;
and (e) other actuarial considerations known to one of skill in
the art. In a preferred embodiment, step 230 specifies the exact
annuity payment based upon the age of the measured life at the annuitization
date to be received. This may be specified on a monthly, quarterly,
annual or other periodic basis. In a preferred embodiment, this
rate will be guaranteed by the issuing company, 240, so that, should
interest rates decline in the interim between the annuity purchase
date and the annuitization date, the annuity payee will receive
periodic annuity payments with the higher guaranteed rate. In the
same preferred embodiment, if interest rates are higher at the time
of the annuitization date, the annuity payee will receive the guaranteed
rate and will not have the option to receive a lump sum from the
issuing company. In this way, the annuity payee receives the benefit
of a guaranteed rate should future rates decline, but gives up the
benefit of a higher future interest rate should rates go up. In
this arrangement, since the annuity payee benefits from lower interest
rates but does not benefit from higher rates, the issuing company
is effectively short a long dated interest rate forward contract
and the annuity payee is effectively long a long dated interest
rate forward. By not giving the annuity payee the benefit of higher
interest rates, the issuing company, 240, takes less interest rate
risk and can therefore guarantee the highest possible annuity payment
to the annuity payee. In another preferred embodiment, the issuing
company, 240, may guarantee a minimum annuity periodic annuity payment
and allow the annuity payee to have the benefit of higher future
interest rates by, for example, electing to take a lump sum distribution
at the annuity payment date. In this preferred embodiment, since
the annuity payee is effectively long a floor on future interest
rates and the issuing company, 240, is short this floor, making
the guarantee more risky for the issuing company.
[0074] To illustrate the embodiment in which the issuing company,
240, guarantees an exact period annuity payment at the annuity payment
date and using 2001 VBT tables for select nonsmoking males, the
following table shows the conditional expected life span and the
annual annuity payments that would be made at each annuitization
age (annuity payment date): TABLE-US-00006 TABLE 6 Annual Annuity
Payments at Annuity Payment Date Assuming Interest Rate of 5.5%
Age of Annuitization 50 55 60 65 70 75 80 85 90 Cond Exp LE 31.058
26.915 23.053 19.672 16.415 13.661 10.600 7.725 5.020 Annual Annuity
Rate 6.79% 7.21% 7.76% 8.45% 9.41% 10.60% 12.70% 16.24% 23.34%
[0075] For simplicity, Table 6, assumes a constant annuitization
interest rate of 5.5%. In a preferred embodiment, the interest rate
to be guaranteed for the purposes of calculating the guaranteed
periodic annuity payments will differ depending upon the duration
(conditional life expectancy) of the measured life at the annuity
payment date. Typically, this rate will be higher for measured lives
which are younger at the annuity payment date and lower for measured
lives which are older in order to be consistent with the typical
upward sloping character of the U.S. Treasury curve. As can be seen
from the illustrations of Table 6, the annual payment for an annuity
payee based upon a measured life which is 50 years old at the annuity
payment date is 6.79% per annum of annuity purchase price and increases
to well over 20% for a measured life who is 90 years old at the
annuity payment date.
[0076] Another step in the annuitization specification is to calculate
the discount factors between the age of annuity purchase and the
date at which annuity payments begin. To illustrate, the below Table
7 shows such discount factors for various illustrative annuity purchase
dates and annuitization dates. For purposes of illustrative simplicity,
a flat 5.5% interest rate has been used for all of the calculations:
TABLE-US-00007 TABLE 7 Discount Factors Assuming a Flat Interest
Rate of 5.5% Age of Annuitization 50 55 60 65 70 75 80 85 90 Age
of 30 0.343 0.262 0.201 0.154 0.117 0.090 0.069 0.053 0.040 Purchase
35 0.448 0.343 0.262 0.201 0.154 0.117 0.090 0.069 0.053 40 0.585
0.448 0.343 0.262 0.201 0.154 0.117 0.090 0.069 45 0.765 0.585 0.448
0.343 0.262 0.201 0.154 0.117 0.090 50 1.000 0.765 0.585 0.448 0.343
0.262 0.201 0.154 0.117 55 1.000 1.000 0.765 0.585 0.448 0.343 0.262
0.201 0.154
[0077] As can be seen, the longer the time between annuity purchase
and annuitization age, the smaller the discount factor. As is shown
below, in a preferred embodiment, the smaller the discount factor
the greater the annuity payment that can be made beginning on the
annuity payment date.
[0078] As another step in annuitization specification and optimization,
230, of FIG. 2, the annual annuity payment per dollar of annuity
purchase price at the annuity purchase payment date is calculated
using the following formula: a t , T = a T p t , T .times. D t ,
T
[0079] where a.sub.t,T represents the annual annuity payment that
to be made, as a percentage of annuity purchase price, for a measured
life of age t at annuity purchase date and age T at annuity payment
date, a.sub.T is equal to the annual annuity payment that may be
paid to the annuity payee based upon a measured life of age T at
the annuity payment date, p.sub.t,T, as defined above, the probability
of the measured life surviving from age t to T, and D.sub.t,T are
the interest rate discount factors from time t to T.
[0080] To illustrate using the above data in Tables 5 (p.sub.t,T),
Tables 6 (a.sub.T) and Table 7 (D.sub.t,T), the following annual
annuity payments may be made for a VERITAS annuity of the present
invention purchased on the indicated annuity purchase date and annuity
payments paid on the indicated annuitization date (annuity payment
date) as expressed per dollar of purchase price at the annuity purchase
date: TABLE-US-00008 TABLE 8 VERITAS Illustrative Annual Annuity
Payments Per Dollar of Annuity Purchase Age of Annuitization 50
55 60 65 70 75 80 85 90 Age of 30 20.4% 28.9% 42.1% 63.4% 101.3%
173.7% 350.8% 913.4% 3667.0% Purchase 35 15.5% 21.9% 31.9% 48.0%
76.8% 131.7% 266.0% 692.7% 2780.7% 40 11.8% 16.6% 24.2% 36.3% 58.0%
99.4% 200.9% 523.0% 2099.7% 45 8.9% 12.6% 18.3% 27.4% 43.4% 74.4%
150.3% 391.2% 1570.5% 50 NA 9.5% 13.7% 20.5% 32.4% 55.3% 111.7%
290.7% 1167.1% 55 NA NA 10.3% 15.2% 24.0% 40.6% 81.5% 212.1% 851.5%
[0081] To illustrate step of 230 of FIG. 2, a 35 year old male,
under the assumptions of the present invention, can receive 131.7%
of every dollar of annuity purchase each year for the rest of his
life provided the individual (if the measured life and the payee)
survives to age 75. Thus, if the annuity purchase price at age 35
were, for example, $100,000, and if the measured life and payee
were the same person and the measured life survived to age 75, the
payee would receive $131,700 per annum for the rest of his life.
As can be seen the VERITAS has very powerful lifecycle savings features,
particularly as a source of retirement income where individuals
are in a consumption rather than saving phase of their lives.
[0082] In a preferred embodiment, the data in Table 8 would be
published to prospective buyers of the VERITAS annuity periodically.
[0083] Referring again to FIG. 2, step 260, is the owner identification
step. The interested parties to a VERITAS annuity include the owner,
the measured life, and the annuity payee. These need not be all
the same individual nor need the owner or payee be natural persons
(the measured life is a natural person). The owner of the VERITAS
may, for example, be the measured life, a partnership, a corporation,
or a nonprofit organization. An advantage of the present invention,
is that, in a preferred embodiment, the segregated accounts of the
VERITAS, contain income tax free financial instruments or securities,
such as municipal bonds. Under the Internal Revenue Code, no current
tax would therefore be payable by a non-natural owner of the VERITAS.
[0084] Referring to step 270, in a preferred embodiment the segregated
account of the VERITAS will contain zero coupon municipal bond securities
the duration of which matches the time between the annuity purchase
date and the annuity payment date. Other types of investment instruments
or securities may be used. However, zero coupon municipal bond securities
have many advantages notwithstanding the tax-free accumulation of
taxable financial instruments within a variable annuity account
(for natural person owners). First, zero coupon municipal bonds
(which may, in a preferred embodiment be either zero coupon bonds
issued by state and local governments or may be "strips"--a
zero coupon bond constructed by separating the principal portion
of a coupon bearing municipal bond from its coupons) are tax-free.
While segregated accounts accumulate tax-free within an annuity
such as VERITAS (a variable annuity), income taxes are due at the
annuity payment date. If municipal bonds are used inside the segregated
account, there are no taxes due at the annuitization date in a preferred
embodiment. As a consequence, the portion of the periodic annuity
payments that are excludable from income tax are much larger. For
example, at age 70, the exclusion ratio--that portion of the periodic
annuity payment not subject to income tax--would be approximately
65-70% or more. If the segregated account contained taxable investments,
this percentage could be 10% or lower depending upon investment
returns. Second, long-dated zero coupon municipal bonds are relatively
inexpensive in relation to long term Treasury securities. For example,
on May 24, 2004, the 30 year Treasury bond yield was equal to 5.45%.
A 30 year zero coupon municipal bond, rated AAA, had a similar yield.
Thus, the numbers illustrated in Table 8 are plausible illustrations
based upon market data. Third, municipal bonds can be insured and
are typically issued to have a AAA rating, which, when included
inside a AAA annuity issued by an issuing insurance company, 240,
provides credit security comparable to a U.S. Treasury bond. Referring
above to Table 8, a 30 year old concerned about retirement can derive
a large amount of utility from the VERITAS product of the present
invention which he cannot do with current products. If this individual
desires to retire, for example, at age 70, every dollar invested
in a VERITAS annuity at age 30 will product one dollar of annual
income at age 70 for the remainder of the individual's life. Furthermore,
the annual annuity payments beginning at age 70 will be largely
free of tax for many year (until the measured life attains his Internal
Revenue Code defined life expectancy). And the individual will have
security comparable to the U.S. Treasury securities or other government
obligations in a preferred embodiment if AAA zero coupon municipal
securities are used in step 270 and a AAA issuing insurer (e.g.,
Jefferson Pilot, AIG) is used per step 240.
[0085] In the preceding specification, the present invention has
been described with reference to specific exemplary embodiments
thereof. Although many steps have been conveniently illustrated
as described in a sequential manner, it will be appreciated that
steps may be reordered or performed in parallel. It will further
be evident that various modifications and changes may be made therewith
without departing from the broader spirit and scope of the present
invention as set forth in the claims that follow. The description
and drawings are accordingly to be regarded in an illustrative rather
than a restrictive sense.
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