Beware Dramatic Increases in Estimated Gift Annuity Liabilities

[NOTE: The following is based on a true story.]

Some of the numbers just didn’t make sense. It was that most wonderful time of the year for a non-profit organization – the closing of the June 30 fiscal year! Almost like Christmas in July, everyone was busy reviewing tally sheets and running various reports in an effort to provide comprehensive information about the gifts received over the previous 12 months. With outright gifts, of course, the process was fairly straightforward – whatever was received, for the most part, was counted with a few exceptions. With life income gifts, however, the process was a little more complicated, since the organization needs to report the total funding amount, the estimated liability, and the estimate of the charitable remainder.

The newest CGA had been written only a few months before the end of the fiscal year, on January 15, and had been recorded in the appropriate manner. The principal funding amount was $175,000, and according to the standard charitable deduction calculations, the estimated liability (“investment in contract”) was $94,174.50. That meant the charitable deduction was $80,825.50, because the estimated liability and the estimated charitable gift amount, by definition, must add up to the total principal funding amount.

But now came the wrinkle: when the annual FASB liability reports were run as of June 30, the report used the same discount rate of 1.2% as when the gift was funded. The report showed the estimated liability on this latest gift annuity to be $130,163.44. How could that be? How could the estimated liability go from $94,174.50 in January to $130,163.44 at the end of June? That was an increase of $35,988.94! How could the estimated liability increase by over 38% in such a short period of time?

We need always to keep in mind that the whole process of estimating the liability on a life income gift is an exercise based on many assumptions, and the amount we determine to be “the liability” is, in the end, merely an estimate. We cannot ever know when an annuitant is going to die, obviously, and further, we cannot ever know what the prevailing interest rates will be in the future.

Computing FASB Liability

Taking a closer look at the two calculations, however, allows us to see that they are, in fact, quite different calculations. The donors were 88 and 84 years old at the time of the gift, and according to the 2000CM mortality table, they had a combined life expectancy of 8.3 years. But when we review the FASB calculation more carefully, we notice that the computation relies on the 2012 IAR mortality table. That change in mortality tables has a dramatic effect on the combined life expectancy: it jumps to 12 years. That’s roughly a 50% increase in combined life expectancy.

The significant difference is the result of two aspects:

1. The 2000CM table is for the entire U.S. population, whereas the IAR table is based on a smaller select group – the people who purchase insurance products. The latter group tends to be more affluent and more highly educated, with better access to health care – which generally means they live much longer than the general population; and
2. The 2000CM table is gender-neutral, whereas the 2012 IAR table is gender specific. (Different discount rate assumptions also change the liability, but in this case, both calculations used the 1.2% discount rate.) With gift annuity programs, the majority of annuitants tends to be older females, and their relatively longer life expectancies make for significantly greater estimates of liability.

So, it only makes sense that the estimated FASB liability on June 30 would be much greater than the investment in contract amount in the original gift calculations during the previous 12-month period. It is essentially like comparing apples to oranges. But is one of the calculations better than the other? Is one number right and the other number wrong? No, they are both valid computations, and the stark contrast will only occur once, in the first year of the gift. And yet, to reiterate a point made earlier, they are merely estimates of future payment obligations. Both numbers almost certainly will be proven wrong in time, because what happens in real life almost never matches anything that we might try to estimate. But it is critically important that we estimate something reasonable, in that real monies need to be set aside in reserve to cover those estimated liabilities.