it an increased risk of people outliving their retirement savings.
US insurers have addressed this problem with the introduction of
longevity insurance products designed to provide a substantial
income boost in an insured’s extreme latter years. Charles
Davis reports.
Americans are living longer than ever before, as medical marvels
and a focus on wellness combine to stretch longevity to extremes
that baffle actuaries and create real strain on household
finances.
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An estimated three million, or about one percent of Americans,
will reach 100 years of age, according to research from university,
the Boston College’s Center for Retirement Research. But even
people who do not live into the triple digits will have decades of
retirement to fund.
With insurers now expecting at least one in three baby boomers
to live into his or her nineties, the risk of running out of money
looms large. A handful of insurers have recently responded to this
emerging business niche with a new annuity product: longevity
insurance.
Longevity insurance enables clients who expect to live past
their late eighties to use a small portion of current savings to
buy income for their later years of retirement. It is a bit of a
gamble – longevity insurance generally requires 10 percent to 15
percent of an insured’s savings, depending on age and deferral
period – but the payoff is a fixed future income stream that
becomes crucial in advanced age brackets.
Guaranteed future income
According to industry body the National Association of Variable
Annuities “the defining characteristic of these products is that
they provide… guaranteed future income, generally starting at an
advanced age such as 85, to those who are still living. The idea is
that longevity is a risk that can be pooled and diversified much
like life insurance”.
Those who die prior to age 85 ‘subsidise’ the income stream paid
to those who reach 85. With these products, a relatively small
portion, for example 10 percent, of the retiree’s nest egg is
invested in annuities. The remaining 90 percent can be used to fund
retirement prior to age 85 as the longevity insurance will provide
an income stream to cover the years after age 85.
The product itself is quite straightforward. The client selects
a date to begin collecting income, based on family history and
financial needs. Once the payouts begin, they provide payments for
the rest of the client’s life. And until that age, the client
retains total, unrestricted control of the rest of his or her
retirement portfolio.
Longevity insurance can be viewed as the opposite of life
insurance. The product is protection against the financial risk of
living too long, rather than dying too young. Much like a
conventional annuity, longevity insurance converts a lump-sum
payment into guaranteed monthly income.
Because the insurer has held the money for a long time, the
payouts are very substantial: a 65-year-old who puts $250,000 into
a longevity policy today can expect to receive as much as $210,000
a year from age 85 on. With a traditional income annuity, he would
get just $20,400 per year.
Insurers can sell those payouts, and the client facing old age
is calmed by the knowledge that they will be able to withdraw a
greater percentage of their savings earlier in retirement than
would otherwise be prudent. And because the late-in-life income is
guaranteed, the client may feel comfortable investing a higher
portion of their portfolio in equities, which have outperformed
bonds over the long run.
Longevity insurance also addresses one of the biggest worries
clients have about conventional annuities, the fact that the
typical annuity means that once purchased, the client’s heirs
cannot get it back. Assuming the client wants the highest payout
possible, the same rules apply to longevity contracts. But because
it takes far less money to secure a specific income with a
longevity plan than with a regular annuity, the client has far more
cash left over in liquid assets to spend in their sixties and
seventies.
Limited availability
Only a handful of insurers have entered the longevity insurance
market to date, but several initial offerings demonstrate the
potential of the product.
New York Life Insurance’s Lifetime Income Annuity with Changing
Needs Option issues modest payouts immediately that can jump as
much as fivefold on a designated date the policyholder selects at
the outset.
MetLife’s Retirement Income Insurance offers tantalising
payouts: a 65-year-old man who invested $50,000 in the product
would receive $3,405 per month starting at age 85. That is $40,860
per year, which buys a lot of security, and almost reaches the
initial investment in the first year of payouts.
Compare that to an 85-year-old man investing $120,000 in an
immediate annuity, and the difference is striking, as the client
would get about $1,600 per month for the rest of his life.
Each carrier also offers add-ons to the basic contract. These
include inflation protection, a death benefit to be paid to heirs,
early payments for nursing home care and a cash withdrawal
option.
For insurers, the risk is more than manageable, because they are
certain many policyholders will never collect a dime. There is no
early withdrawal option without a steep price, and heirs will not
get death benefits if the client dies before he or she begins to
collect.
Variations on the theme
In yet another model, Sun Life’s Income On Demand annuity,
introduced in 2006, is a big moneymaker for the insurer.
Instead of withdrawing a certain percentage every year for the
rest of his or her life, a customer also has the option of storing
that value and taking a much bigger lump sum later.
Income On Demand clients can also potentially increase that
withdrawal sum, depending on market performance. And once that
amount increases, such as due to a good year in the stock market,
that new level becomes the minimum level.
Another attractive alternative combines long term care (LTC)
insurance with longevity insurance. Longevity insurance provides
deferred immediate annuity coverage, with initial payments
commencing at some age well into the future, such as 85 or higher.
Combining such annuities with LTC will help the retiree cover later
year expenses at modest cost.
