Annuity contracts are life insurance products that guarantee an income to policyholders for life or for a set period. A group annuity, however, is a large annuity contract to accommodate a business. The employer owns the contract and employees sign on as subscribers to the policy. For pension plans, the employer deposits money into the annuity for the employees. For defined contribution plans, regulations allow employees to contribute.
There are two types of group annuity policies employers use to provide retirement benefits to workers. The first is a fixed annuity. This pays interest based on the insurance company's investment in bonds or bond-like investments. The issuing insurer guarantees these investments. A variable annuity is one that invests in mutual funds. The insurer does not guarantee variable annuities, and the account value fluctuates with the performance of the mutual funds in the annuity.
The significance of group annuity contracts is that instead of several smaller annuities each covering an employee, the group annuity is one large contract covering all eligible employees. The insurance company accounts for each worker’s share of the annuity.
The benefit of a group annuity is the employer can operate it at a lower cost when compared to other pension arrangements if it is a fixed annuity. In addition, annuities are not securities, but are insurance products. As such, they are not subject to as many regulatory factors as a security in terms of disclosure rules. This benefits the employer, primarily, and cuts down on administrative costs associated with managing the pension plan.
Depending on the annuity, the disadvantage to group annuity contracts is that associated fees make the contract costly, even if administrative costs are low. The most expensive of these fees, the separate account fee, pays for management of any underlying investments. For fixed annuities, there is no separate account fee. However, for variable annuities, these fees can be substantial and consume a portion of the policy’s returns.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- "Life Insurance"; Kenneth Black, Jr., Harold D. Skipper, Jr.; 1994
- "Ernst & Young's Personal Financial Planning Guide, 5th Edition"; Martin Nissenbaum, Barbara J. Raasch, Charles L. Ratner; 2004