California Loosens Restrictions on Investment of Gift Annuity Reserves

California Loosens Restrictions on Investment of Gift Annuity Reserves

Article posted in Charitable Gift Annuity on 6 October 2004| comments
audience: National Publication | last updated: 18 May 2011
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Summary

California Governor Arnold Schwarzenegger recently signed legislation to amend the provision in the California Insurance Code which restricts the asset classes in which California gift annuity reserves may be invested. In this article, Los Angeles attorney David Wheeler Newman describes the new law and its effect on gift annuities for California residents.
by David Wheeler Newman

California Governor Arnold Schwarzenegger recently signed legislation to amend the provision in the California Insurance Code which restricts the asset classes in which California gift annuity reserves may be invested.

To better understand the need for this change, and its impact, it is helpful to place the entire issue of investing California gift annuity reserves in context by remembering that California law requires that a reserve account must be maintained for each gift annuity issued to a California resident.  This reserve must be held in a trust, legally and physically segregated from the other assets of the charity.  This effectively prohibits the practice used by charities in many other states of investing gift annuity reserves in an investment pool that includes endowment and other funds of the institution.  For most gift annuity issuers, this California segregation requirement means that there will be less opportunity for diversification in the gift annuity reserve trust than in the investment pool.

The California Insurance Code further restricts allowable investment of gift annuity reserves by specifying what types of investments are allowable.  Prior law required 90% of the required reserves to be invested in insured bank deposits and government bonds.  The remaining 10% could be invested in equities consisting of securities listed and traded on the New York and American Stock Exchanges and NASDAQ.  These restrictions apply only to the required reserves ("commensurate values" in California insurance law lingo).  The majority of issuers retain not only the required reserves throughout the term of the annuity but also retain all additional funds received by the donor in exchange for the gift annuity.  The restrictions in the Insurance Code do not apply to this "surplus" portion of gift annuity funds.  As a result, in practice, the surplus funds gave the issuer of gift annuity contracts the opportunity to invest additional funds in equities (and indeed, in asset classes other than exchange-traded equities, such as mutual funds, hedge funds, private equity and even real estate).

The California Legislature amended these restrictions by allowing exchange-traded securities to comprise up to 50% (as opposed to the prior limit of 10%) of the required gift annuity reserves held in trust.  This change will give issuers far more flexibility in portfolio allocation across asset classes to invest gift annuity reserves for total return.

While this is terrific news for charities issuing annuities to California residents, it is important to keep in mind what the restrictions still do not allow.  Required reserves may not be invested in mutual funds or bank common trust funds, even if those funds consist entirely of qualifying government bonds or exchange traded securities, without the written consent of the California Insurance Commissioner.  While not impossible, it has been our experience that this permission has recently become more difficult to obtain. On the other hand, reserves may be invested in exchange-traded funds without the Commissioner's consent, since ETFs fall within the statutory category of "securities listed and traded" on the NYSE, American Stock Exchange or NASDAQ.

This important change in the law came about through the efforts of the Legislative Affairs Committee of the Northern California Planned Giving Council, including Abby Mason, Earl Blauner, Heidi Strassburger, and Jeff Shields.  This tireless band of charitable gift planners has demonstrated that a focused effort can result in favorable legislation that benefits the entire field of charitable gift planning.  We owe them our gratitude.

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