B35/1994 CLARIFICATION OF POLICY AND AMENDMENT OF PROCEDURAL POLICY REGARDING THE ASSESSMENT OF PRIVATE ANNUITIES

DATE OF ISSUE:  24 AUGUST 1994

CLARIFICATION OF POLICY AND AMENDMENT OF PROCEDURAL POLICY REGARDING THE ASSESSMENT OF PRIVATE ANNUITIES

The purpose of this Departmental Instruction (DI) is to:

• clarify current policy and legislative provisions regarding the assessment of private annuities; and

• amend procedural policy with regard to the assessment of private annuities.

Background

2.A number of assessments have recently been dealt with in Branch Offices involving the assessment of private annuities.

3.In dealing with these cases it has become clear that these were not isolated cases and that private annuities are growing in popularity as a financial investment vehicle. It has also become clear that solicitors and similar persons who specialise in such matters are devising private annuities for Department of Veterans' Affairs (DVA) and Department of Social Security (DSS) pensioners and that these annuities can be structured to partially circumvent the income and assets test.

4.In discussing cases involving private annuities with DVA Branch Office staff and DSS, it has become evident that DVA policy regarding the assessment of these investments is not as clear as that of DSS and that this may have led to some inconsistencies in the method of assessment of the annuities between DVA Branch Offices as well as between DSS and DVA.

How private annuities can be designed to partially circumvent the income and assets tests

5.Typically, the private annuities devised are arrangements where the pensioner or pensioners in question agree to "sell" a property holding (or similar) to a family trust or sometimes to a private company or family member (the "purchaser"). In consideration (payment) for the receipt of the property, the purchaser agrees to pay the veteran and spouse, for example, individual annuities which usually have a total stated "purchase price" equivalent to the value of the transferred property and have specified annual income payments.

6.The annual income streams for the annuity are usually calculated by taking the purchase price of the annuity, dividing it into individual annuity capital sums for the veteran and spouse and then dividing these sums by the individual relevant numbers (life expectancies) for the veteran and spouse as taken from a quasi life table provided in section 27.15280 of the DSS Guide to the Administration of the Social Security Act (the Guide) - see Attachment A.

7.However, DSS has advised that, in using the DSS Guide quasi life table for this purpose, the divisers of private annuities are using the table contrary to its intended purpose - paragraph 13 of this DI provides detail regarding this issue.

8.Further, in using this methodology, the persons devising the annuity merely use the life expectancies (as taken from the DSS quasi life tables) of the annuitants as an approximation for valuing the annuities, allowing for probability of survival only. This is a very simplistic calculation and bears no relationship to the industry accepted calculations as performed by financial and life insurance houses when supplying annuities for their clients.

9.DVA have been advised by the Australian Government Actuary (AGA) that annuity calculations performed by financial and life insurance houses and the AGA take into account life expectancy (according to the Australian Life Expectancy Tables as issued by the Australian Taxation Office), assumptions in respect of future inflation and interest rates (based on the long term bond discount rate) and that the fact that the death of the annuitant will occur, on average, halfway through the year of payment.

10.Application of the industry accepted calculations yields very different figures to the calculations of the divisers of private annuities as described above and can lead to a substantial amount of deprived assets being calculated for service pension purposes if assessed correctly. The following example (based on an actual case) illustrates this point:

• stated value of the property "sold" (exchanged) to$173,000

purchase the annuity

• stated purchase price of annuities for vet & sps

(as calculated by supplying solicitor) is $86,500 each

$173,000 total

• AGA valuation of annuities (based on stated $51,810 vet

income streams) is$43,210 sps

$95,020 total

• therefore calculated deprived asset amount is$173,000 "purchase price"

$95,020    less AGA

$77,980    valuation deprived

$10,000    asset  less $10,000

________ gifting limit

$67,980    deprived asset amt                                               held in assmt

NOTE that both the solicitor's and AGA valuations of the annuities are based on the annual income payments of $6,050 vet and $3,500 sps stated as being payable in the annuity agreement.

11.The above calculations show that whilst the stated purchase price of the annuity appears to match the value of the property for which it was exchanged, adequate consideration has not in fact taken place. It can be seen that the annuities have been set up such that if the purchase price is taken at face value for service pension purposes, then no disposal of an asset has taken place and a greater than appropriate pension is paid.

DSS legislation and policy re the assessment of private annuities

12.As mentioned in paragraphs 6 and 7 above, various persons who devise private annuities justify their methodology of annuity calculation and the validity of the stated purchase price for the annuity on the basis that it is in accordance with the provisions of the conversion table at section 27.15280 of the Guide and the annuity value calculators in the Social Security Act 1991 (SSA) and the Veterans' Entitlements Act 1986 (VEA).

13.However, Branch Office staff are advised that DSS have confirmed that private annuity devisers who state that their annuities have been structured in accordance with Section 27.15280 of the Guide are using that policy out of context and that the section's conversion table is a quasi life table which is intended only as a quick guide as to whether a pensioner has received adequate consideration in buying a granny flat interest or similar. DSS have stressed that the table is not to be used to assess adequate consideration for all property exchange transactions and is not to be used as tool to calculate the value of an annuity relative to a selected income stream for that annuity.

14.DSS have further confirmed that sections 27.33000 and 27.33001 (see Attachment B) of the Guide are in fact the appropriate sections to be applied when assessing private annuities. These sections state that in considering the value of private annuities for pension purposes and the issue of whether adequate consideration has occurred, the case should be referred to a Complex Assessment Officer who will in turn refer the annuity to the Australian Government Actuary for valuation and any shortfall in the value of the annuity should be treated as a disposed ("deprived") asset. This clearly implies that it is up to the person who devises the annuity to ensure that the annuity conforms with industry standards if they are to be sure that the annuity represents adequate consideration for pension purposes.

15.DSS legislative provisions related to the assessment of annuities and disposal of assets are identical to that of DVA as discussed below.

Current DVA legislation

16.The income stream provided by an annuity is assessable for service pension purposes as "ordinary income" as defined by subsection 5H(1) of the VEA.

17.The asset value of an annuity is assessable for service pension purposes according to the provisions of sections 52A and 52B (dealing with the value of annuities) of the VEA, subject to the provisions of subsections 52A(1), (2) and (3), which stipulate that the asset value of certain annuities is to be disregarded. Generally speaking, the asset value of the private annuities being discussed in this DI will be assessable for service pension purposes.

18.Point 52A-1 (the annuity value calculator) of the VEA details the method statement by which the value of an assessable annuity is calculated. The annuity value calculator is basically a simple calculator designed to work out the remaining capital value of an annuity after allowing for return of capital as included in income payments for the annuity. The methodology which point 52A-1 uses to calculate the value of an annuity is based upon a number of factors including the "purchase price" of the annuity. "Purchase price" is defined in subsection 5(J)(1) of the VEA as follows:

" 'purchase price', in relation to an annuity, has the meaning that it has in Subdivision AA of Division 2 of Part III of the Income Tax Assessment Act;"

19.Part III, Division 2, subdivision AA of the Income Tax Assessment Act 1936 reads as follows:

" 'purchase price' means-

(b) in relation to an annuity - the sum of -

(i)payments made solely to purchase the annuity; and

(ii)so much as the Commissioner considers reasonable of payments made to purchase the annuity and to obtain other benefits:"

20.As well as stating that their annuities are legitimate because they have been calculated in accordance with section 27.15280 of the Guide, persons who devise private annuities frequently state that the annuity value calculator provided at section 52A-1 of the VEA alone must be used to value the annuity and that the stated, face value purchase price must be used in these calculations. The above-mentioned Income Tax Assessment Act definition of purchase price is usually cited as the authority for this statement.

21.However, the mere existence of a stated purchase price for a private annuity does not mean that such a stated purchase price is a true and accurate valuation of the annuity's worth and that it may not be subject to revision for taxation and/or service pension purposes.

22.It is therefore legitimate to seek a valuation of the private annuity in order to accurately establish the asset value of the annuity. Once accurately established, the revised asset value of the annuity must then be applied to the annuity value calculator.

23.Subsequent to establishing the value of the private annuity, where it is deemed that the purchase price represents a disposal or inadequate consideration according to sections 52E and 52F (dealing with disposal of assets) of the VEA, the extent of disposal (ie., shortfall in the value of the annuity) must be calculated so that the disposal provisions of sections 52G to 52J (dealing with limitations on the amounts of disposals and length of time to be held in assessment) may be accurately applied.

Legal advice regarding disposal provisions and the effect of definition of purchase price

24.Legal advice has confirmed that the net effect of the above-mentioned Income Tax Assessment Act definition of purchase price is not necessarily that the Commissioner of Taxation (and by implication the Repatriation Commission) must accept the face value purchase price of an annuity as being the purchase price for the purposes of the Income Tax Assessment Act. That is, for service pension purposes, the disposal provisions of the VEA effectively override the issue of the definition of purchase price and the issue of accepting face value purchase price of an annuity.

Current DVA Assessment policy

25.Stated DVA policy is not as specific as DSS policy with regard to the assessment of private annuities. No specific reference is made in the GOSP to private annuities and assessing if adequate consideration has taken place where a pensioner has purchased one of these investments. Neither is there a direct reference to seeking an actuarial valuation in order to establish the true value of an annuity.

26.However, there is general direction regarding the assessment of the value of assets in the GOSP in the "Valuation of Assets:Asset Value" chapter which reads as follows:

"In general, the net market value of a saleable asset will be used in the assessment of service pensions under the assets test.  The net market value is the sum which could reasonably be expected to be obtained for an asset if offered for immediate sale on the open market, less any debts owed on the asset."

27.Annuities may be described as a marketable asset, particularly since it is possible to sell an annuity, with its attached income stream, on to another party. In addition, since private annuities are not usually purchased from recognised financial and life insurance houses it is difficult to ascertain if the quoted purchase price of the private annuity is an accurate reflection of the annuity's market value. In accordance with the policy quoted above, it is therefore legitimate to seek an actuarial valuation of a private annuity in order to establish an accurate asset value for the annuity for service pension assessment purposes.

28.The following extract from the "Valuation of Assets:Valuations" chapter of the GOSP links the above-mentioned policy regarding the value of assets with the issues of adequate consideration and disposal of assets and/or income for service pension purposes:

"Where a person has disposed of property for less than adequate consideration or has reduced its value in order to obtain pension or fringe benefits, the property may be valued to ensure the assessable amount held as deprivation is fair and reasonable."

29.In turn this reference links up to the GOSP chapter titled "Disposal of Assets and/or Income", which extensively details policy regarding the treatment of assets and income which have been disposed of for less than adequate consideration.

30.All of the above references in the GOSP reflect the intention of the provisions of the VEA as discussed earlier in this Instruction. That is, it is legitimate to seek an actuarial valuation of a private annuity in order to establish an accurate asset value for the annuity. Where such a valuation shows that adequate consideration has not been given for that annuity, any shortfall in the value of the annuity must be held in the assessment under the disposal of assets provisions.

Amendment of DVA procedural policy - referral of private annuity cases to Australian Government Actuary

31.In order to eliminate the potential for assessment inconsistencies and to ensure consistency of policy and assessment parity between DVA and DSS, effective immediately all private annuity cases must be referred to Branch Office Investment Policy Officers who in turn must in all instances seek an actuarial valuation of such annuities from the Australian Government Actuary in order to establish an accurate asset value for the annuity.

32.Where it is determined that adequate consideration has not been given for the annuity and it is established that the disposal of an asset has occurred for the purposes of sections 52E and 52F of the VEA, the disposal must be treated according to the provisions of sections 52G to 52J of the VEA.

33.IPO's should note that whilst there are offices of the AGA located in each State (co-located with offices of the Insurance Superannuation Commission), all valuation requests submitted to State Offices are forwarded to the AGA Central Office in Canberra. Therefore, in order to minimise delays in getting an annuity valuation, it is suggested that such requests be sent direct to the AGA's Canberra office. The current contact officer at the AGA in Canberra regarding annuity valuations is Kevin Deeves.

34.The address of the Australian Government Actuary is as follows:

The Australian Government Actuary

GPO Box 9836

Canberra

ACT 2600

fax.06-2676862

ph.06-2676893 (Kevin Deeves)

Update of the GOSP

35.The GOSP will be amended (with the next update of the GOSP due September 1994) such that the intent of existing policy and legislation in the instant of the assessment of private annuities and the assessment of disposal of assets is clarified and reflects both the amended procedural policy detailed above and DSS policy related to the assessment of private annuities as stated in sections 27.33000 and 27.33001 of the Guide (see Attachment B).

Contact Officer

36.The contact officer regarding inquiries related to this Instruction is Martin Dibb - telephone 06-2896706.

KAY GRIMSLEY

ASSISTANT SECRETARY

INCOME SUPPORT

ATTACHMENT A

Extract From DSS "Guide To The Administration Of The Social Security Act" (As Contained In Opal Research Version 3.24, 30 June 1994)

NOTE:This extract from the DSS Guide is reproduced for information only and is only used by DSS in assessing whether a pensioner has received adequate consideration in buying a granny flat interest or similar. This policy is not intended to be applied to the assessment of private annuities (refer DI text).

PART G: ASSESSMENT OF ASSETS

Other exempt assets

Assessing whether an amount is reasonable

27.15270 — For those situations which do not come within the automatic exemptions outlined in the preceding section, a test is to be applied to the value of the property transferred. This test is to be used only for administrative purposes to assess reasonableness and should not be used for any other purpose.

27.15271 — The test is a quasi-actuarial valuation of the value of the life interest or right to reside. The value to be adopted for administrative purposes is:

• combined married pension rate x conversion factor;

Note: The combined married pension rate is the rate which is current at the date the right is established and is to be used irrespective of whether the client is married or not; and

• the conversion factor is to be taken from the table following. In the case of a married couple, the life expectancy to be used is that of the younger partner.

Conversion factors

27.15280 — The following table has been developed from Australian Life Tables published by the Australian Government Actuary. Whereas the tables provide different life expectancies for males and females of the same age, a common factor has been adopted by this department for administrative expediency. For this reason, these tables should not be used for any purpose other than the current application.

Extract From DSS "Guide To The Administration Of The Social Security Act" (As Contained In Opal Research Version 3.24, 30 June 1994)

NOTE:This extract from the DSS Guide is reproduced for information only and is only used by DSS in assessing whether a pensioner has received adequate consideration in buying a granny flat interest or similar. This policy is not intended to be applied to the assessment of private annuities (refer DI text).

AGE NEXT BIRTHDAY	CONVERSION FACTOR	AGE NEXT BIRTHDAY	CONVERSION FACTOR
51	27.04	71	11.92
52	26.18	72	11.31
53	25.33	73	10.72
54	24.48	74	10.15
55	23.65	75	9.60
56	22.82	76	9.07
57	22.01	77	8.56
58	21.21	78	8.06
59	20.41	79	7.59
60	19.63	80	7.14
61	18.86	81	6.71
62	18.10	82	6.30
63	17.36	83	5.92
64	16.62	84	5.55
65	15.90	85	5.21
66	15.20	86	4.89
67	14.51	87	4.58
68	13.84	88	4.30
69	13.18	89	4.04
70	12.54	90	3.79

27.15281 — Where the amount calculated in accordance with the test is less than the amount transferred, the deprivation provisions will apply in respect of any excess amount, ie the excess after allowing the 'gifting' amount, will be counted as an asset and deemed income at the rate of 10% will be assessed from the date of the transfer.

ATTACHMENT B

Extract From DSS "Guide To The Administration Of The Social Security Act" (As Contained In Opal Research Version 3.24, 30 June 1994)

PART P:  DEPRIVATION OF INCOME AND ASSETS

Purchase of an annuity from family members

27.33000 — Where a client purchases an annuity from someone other than a recognised issuer of annuities, eg from a relative, particular attention should be given to whether the client has received adequate financial considerations. To establish adequate consideration in such cases the capital value of the annuity must be determined. These cases should be referred to the Complex Assessment Officer in your Area Office for referral to the Australian Government Actuary's Office. Any shortfall should be treated as a disposed amount if the arrangement was made on or after 1 June 1984 (pensions), 14 May 1987 (benefit) or 15 May 1988 (additional family payment).

27.33001 — Family arrangements may be entered into which are similar in nature to the purchase of an annuity. For instance, a client may transfer real property to a child who in return agrees to pay a certain amount per annum to the client for life. This type of situation is to be treated on the same basis as the purchase of an annuity from a family member and should be examined to establish that adequate consideration has been received.