The second component that you receive is an ‘interest credit’ and stems from the interest the insurer earns on the premium paid.
Thirdly, there is also a ‘mortality credit’ component, which effectively represents the unrepaid principal contributed by those annuitants who are no longer alive to receive payments. The amount of a monthly payment funded by mortality credits starts at zero, but increases exponentially over time, funding survivors’ annuity income streams long after capital has been repaid. Generally speaking, the longer you live the more mortality credits you receive.
Above I’ve been referring to average annual principal repayments and average annual interest earnings, although the actual patterns of these payments over time are not level. Neither is the pattern of mortality credits, as shown in the figure below. However, what is important to the annuitant is that the uneven pattern of the three components to each payment, combine to produce level monthly and annual payments. Generally speaking, the longer you live, the more mortality credits you will receive.
But unlike the mortgage, which may be scheduled to mature in (say) 20 years, the annuity expires only when you do. As the return of principal and interest payments dwindle away, the mortality credits take over and ensure that your payment stream is not interrupted nor reduced.
Composition of lifetime annuity payments
Extract from David Babbel and CommInsure whitepaper, Retire Smarter – new strategies towards a comfortable retirement. You can access the paper via our website.
 I emphasised above the word “average”. Over time, as the principal is paid down, a smaller and smaller component of the fixed monthly payment consists of interest and a larger component goes toward paying down principal. The pattern of principal repayment itself within the ten-year term of the mortgage does not affect the total payment, which remains level throughout the mortgage period.
 These calculations are verifiable by referencing the link below. To calculate the average annual principal repayment, you take the total size of the loan and divide by the term of the mortgage. To calculate the average yearly interest, you take the total accumulate payments over the entire term of the mortgage, subtract the entire principal, and you get the total interest payable. Divide the total interest by the term of the mortgage to get the average annual interest payable.
General advice only. This material has been prepared without taking into consideration your personal objectives, financial situation or needs. Before acting on this advice, you should consider whether it is appropriate for you. You should read the relevant Product Disclosure Statement before making a decision to buy or continue to hold a product. The Colonial Mutual Life Assurance Society AFSL 235035.