also incurred to a large extent on a periodic basis. Food must be purchased daily, rent must be paid monthly and when we have asked and received credit we are usually billed monthly. It is understandable that the holder of mutual-fund shares might choose to have them liquidated to provide him with a monthly income. The length of time he will need this income is uncertain, depending upon how long he will live. Naturally he would prefer an assurance that he will receive these payments as long as he lives, whether that be for one month or thirty years, or longer. The duration of his need is a variable, depending upon his span of life. These desires have caused many persons to be interested in receiving life-annuity payments.

Following the decision of the Supreme Court in the case of SEC v. Variable Annuity Life Insurance Co.,1 holding that the variable annuities sold by the companies involved therein were investments within the meaning of the Securities Act of 19332 and the Investment Company Act of 1940, it was inevitable that mutual funds would resort to the variable annuity as a means of distributing mutual-fund shares. Two different methods may be used, pension trusts and individual purchases. The Keystone Retirement Equity Trust was established January 1, 1957, as an open-end multiple-employer pension trust. The pension trust is open to any employer approved by the trustee. The trustee invests exclusively in mutual-fund shares which in turn invest exclusively in common stocks. One of the options at retirement provides that the value of the employee's accumulation will be transferred to an "annuity fund" in which will also be deposited the accumulations of all other employees electing this option. Each employee who elects the annuity option at retirement is assigned a certain number of so-called annuity units. The employee receives monthly retirement payments for life based on the number of assigned annuity units and the dollar value of the units. The dollar value of the units will vary from time to time depending upon the value of the underlying shares, the combined mortality experience of all employees electing the option, the earnings on the shares held by the annuity fund, and the expenses charged to the annuity fund. There is no assurance that the amounts that the annuitants receive will exceed the amount in the annuity fund. Thus, the annuity is

1 359 U.S. 65 (1959).

2 48 Stat. 74, as amended, 15 U.S.C. §§ 77a-aa (1958), as amended, 15 U.S.C.A. §§ 77b-u (Supp. 1959).

3 54 Stat. 789, as amended, 15 U.S.C. §§ 80a-1 to a-52 (1958), as amended, 15 U.S.C.A. §§ 80a-2 to a-45 (Supp. 1959).

charged against the assets in the fund, not against the person of the grantor.

The other method by which mutual funds may use the variable annuity is to liquidate mutual-fund shares held by individuals on the variable-annuity principle. This proposal is being considered by Waddell & Reed, Inc., a large national retail distributor of mutual-fund shares of United Funds, Inc. The proposal will differ from the variableannuity method used by the Equity Annuity Life Insurance Company (EALIC) and the Variable Annuity Life Insurance Company (VALIC), participants in the recent Supreme Court case, in at least six important particulars as follows:

(1) EALIC and VALIC are incorporated as life insurance companies. United Variable Annuities Fund, Inc. is incorporated as an investment company and proposes to function through unit investment trusts which are fully regulated under the Investment Company Act of 1940.

(2) EALIC and VALIC purported to be life insurance companies and used insurance literature and language in their contracts and in their sales material. United purports to be an investment company and will use investment company language in its prospectus, annuities contracts, and sales material.

(3) EALIC and VALIC specifically agree to indemnify the participants against mortality gains or losses, i.e., that such gains or losses affect the stockholders only and not the policyholders. In the United program, no mortality guarantees will be made. There is no agreement to indemnify the participants against mortality gains or losses. Such mortality gains or losses will be shared by all annuitants on a fully mutual basis.

(4) EALIC and VALIC agree to indemnify the participants if certain expenses should exceed prescribed limits, i.e., they agree that these expense limits will be borne by the stockholders only and not by the policyholders. There is no guarantee or indemnity agreement in the United program. Any expense increases will be borne by the participants on a fully mutual basis.

4 The prospectus for an issue of Waddell & Reed, Inc. stock, dated Sept. 30, 1959, states at page 13:

Waddell & Reed, Inc. has incorporated a mutual fund in the State of Delaware, known as United Variable Annuities Fund, Inc. It intends to make application to the Securities and Exchange Commission and to the securities department of various states for registration of the annuities contracts of such Fund. It is expected that United Variable Annuities Funds, Inc. will not be a life insurance company in the conventional sense. It is intended that it will issue only annuities contracts, under which the annuities payments will be variable in accordance with the Fund's investments which may be largely or wholly in equities.

(5) EALIC and VALIC not only furnish fixed-dollar term life insurance coverage, but provide that some term life insurance must be included with certain variable-annuity contracts. United does not propose to write any life insurance coverage.

(6) EALIC and VALIC write fixed-dollar waiver-of-premium benefits in the event of total and permanent disability. United does not propose to write waiver-of-premium benefits.

The Supreme Court recognized that items 3, 5 and 6 were insurance features and that items 1 and 2 served to characterize the transaction as one of insurance.5 It is important to note that all six items are absent in the proposal by United Variable Annuities Fund, Inc.

In a conventional fixed-dollar life insurance program, three factors are considered in establishing the rates and the amount of the benefits to be paid, viz., the mortality element, the investment element and the expense element. In the variable annuities provided by EALIC and VALIC, two of these elements remain fixed and only one is variable, i.e., the mortality and expense elements are fixed and guaranteed while the investment element is allowed to vary without a guarantee. But with regard to the annuities with which this article is chiefly concerned, all three elements are variable; there is no fixed guarantee of any kind. The problem relating to the regulation of this fully variable-type annuity by state insurance departments is now pressing for solution. This compels legal scholars, lawyers, insurance men and others who will play a role in the solution to take a fresh look at the annuity to determine its true character.

The most frequently cited definition of an annuity is that of Lord Coke, who defined it as "a yearly payment of a certaine summe of money granted to another in fee for life or yeares, charging the person of the grantor onely." Blackstone defined it as "a yearly sum chargeable only upon the person of the grantor." While many American courts have reiterated these definitions, in recent years there has been a necessary broadening of the definition in several respects. Annuities need no longer be paid annually, although they are paid periodically. Fre

8

5 See the concurring opinion of Mr. Justice Brennan where he discusses the various features of the VALIC and EALIC policies. 359 U.S. at 80-91.

6 I Coke, Institutes 144b (1st Amer. ed. Hargrave & Butler 1853).

7 2 Blackstone, Commentaries *40.

8 E.g., Bodine v. Commissioner, 103 F.2d 982, 984 (3d Cir. 1939); Bartlett v. Slater, 53 Conn. 102, 107, 22 Atl. 678, 679 (1885); Bacon v. Commissioner of Corps. & Taxation, 266 Mass. 547, 549, 165 N.E. 664, 665 (1929); Dwight Estate, 389 Pa. 520, 525, 134 A.2d 45, 48 (1957).

quently the payments are made monthly, quarterly or semiannually. One writer has said, "In a strict sense, the word annuity infers that the interval of payment is one year, but by gradual usage its meaning has been extended to include other exact recurring intervals of time, such as six months, three months, or one month."

9911

At one time the distinction between an annuity and a rent charge was considered important. An agreement to make periodic payments which were charged not only against a person but also against land was first termed a rent charge.10 In Routt v. Newmann, however, the court utilized Coke's definition and added the following: "It is used in a broader sense to designate a fixed sum payable periodically . . . and it may be charged on real estate as well as on the person.' It is reasonably clear today that an annuity need not be chargeable solely against the person of the grantor but may, for example, be made a fixed charge on real estate12 or on a specific fund.13 Even when the distinction between an annuity chargeable against a person only and a rent charge had some vitality, the courts held that if a deed of land were given in consideration for the payments to the grantor of an annual sum until his death the payments were an annuity notwithstanding the fact that there was a lien against the real property to support the payments.1 The same rule would be applied where the grantor rented the land and applied the rent on the annuity payments.

Without further elaboration of the shiftings and embellishments of the definition it should be emphasized at the outset of this discussion of annuities and especially of the variable brand, that modern problems cannot be solved by resort to definition plucked from cases involving problems of another day and of an altogether different nature. This is the first pitfall that must be avoided. There simply is no comprehensive definition that will fit every set of facts.15 The attempted definitions are unreliable guides and the better approach requires a pinpointing of the type of annuity involved, an analysis of its elements, and a look at the

9 Crobaugh, Annuities and Their Uses 25 (1933).

10 E.g., Bartos v. Skleba, 107 Neb. 293, 185 N.W. 1002 (1921); 3 C.J.S. Annuities 1(b) (3) (1936).

11 253 I. 185, 188, 97 N.E. 208, 209 (1911).

12 Parsons v. Parsons, 167 Va. 374, 189 S.E. 448 (1937).

18 In re Supreme or Cosmopolitan Council, 193 Misc. 996, 86 N.Y.S.2d 127 (Sup. Ct. 1949).

14 E.g., Nehls v. Sauer, 119 Iowa 440, 93 N.W. 346 (1903); Lynch v. Houston, 138 Mo. App. 167, 119 S.E. 994 (1909).

15 See Northwestern Mut. Life Ins. Co. v. Murphy, 223 Iowa 333, 336, 271 N.W. 899, 900 (1937); Commonwealth v. Beisel, 338 Pa. 519, 521, 13 A.2d 420, 421 (1940).

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historical background and development. Only if this is done will some semblance of order be brought to a much confused area.

I

SOURCES OF ANNUITIES

To put the matter of annuities in its proper perspective an appreciation of the scope and diversity of the annuity in contemporary life is the first essential. For that reason, a cursory listing of the various annuity programs extant today will be undertaken.

Government Annuities

Life annuities of several different types are payable by governments. These annuities may be funded, unfunded or partially funded.16 Throughout history governments have sold annuities to the public. In the earlier days such annuities were usually not funded, the government relying upon the general revenues and the taxing power to enable it to meet its commitments. In an excellent article on the early history of the annuity, the author observed:

Where the Italian cities needed money for conducting their wars and for their other usual pursuits, they had recourse to "compera" or loans re-payable as annuities, and chargeable against the credit of these cities. Genoa, Florence and Venice used this form of funding. In 1470 Genoa had outstanding obligations of this type for more than 11,000,000 lire and in 1597 this annuity debt was 43,700,000 lire. This practice of the Italian cities lead (sic) later to the montes pietatis. In Germany this form of municipal financing was so lucrative that private enterprise in the annuity field was forbidden in some cities (1350).17 In the United States today life annuities of several types are payable by the federal government. Millions of Americans are covered by the social-security program which provides life annuities calling for unconditional payments on a fixed-dollar basis after age 72. Thousands of railroad employees are covered by a similar program and the Civil Service Retirement System provides millions of federal government employees with an annuity program.

Actuaries for the last three government systems use the same.

16 It might be well to note here that annuities are said to be funded when the grantor has set aside certain funds to be used in paying the annuity. Such funds may merely be set aside in an account or they may be set aside in an actual trust fund. An annuity is said to be partially funded where the amount of the fund is not expected to cover the complete cost of the annuity.

17 Kopf, The Early History of the Annuity, XIII Proceedings of the Casualty Actuarial Soc'y 225, 237 (1927).