Longevity Insurance

As I have written a few times before, I consider the unpopularity of fixed annuities to be one of the larger personal finance conundrums.

Aside from the obvious problem of just not having enough money saved up, longevity risk is probably the number one challenge in planning a retirement. If you do not know how long you are going to live, how can you know how much of your kitty you can spend each year?

Park Bench Crop Annuities neatly solve this problem. You pay a lump sum to an insurance company and that company agrees to send you a check every month for as long as you are around to cash them. They even come in inflation-adjusting versions that will send you larger checks as the CPI goes up.

This sort of arrangement is practically identical to the defined benefit (a.k.a. pension) schemes that are often wistfully referred to as a part of the Good Old Days. And yet, as products, annuities are remarkably unpopular. They do exist, you can even get quotes for them online, but it is a comparatively tiny niche market. I have never seen firm numbers, but it seems safe to infer that something like only one or two retirees in a thousand buys one.

I have suggested a few explanations for this anomaly. At the top of the list is the reluctance of retirees to become broke once they exchange substantially all their assets for a stream of payments. I think they often have an ambition to leave money to children when they go, but there is also the more visceral aversion to handing over your life savings.

Into this psychological breach steps something called “longetivity insurance.” Last week The New York Times called it “a relatively new product” but all that is new is the name. This is, as the Times points out, just a plain old deferred annuity. Instead of paying you an income starting now, this will pay you an income starting some number of years from now, assuming you are still with us then.

Ignoring for the moment that this is something old in new packaging rather than a new invention, I think the pitch might just work for some older folks. Here goes:

Hey, Mr. 65-year-old, worried about longevity risk? Concerned that if you spend money now you might someday become a broke 85-year-old? Well there is a brand new product just for you: longevity insurance. Just give us a modest sum today, and if you get to 85 we will take care of you from there on out. In the meantime, all you have to do is make what you have left last until 85.

Calling it insurance counts for something. It acknowledges upfront that this is a bet of sorts that may or may not pay off, like fire insurance. You pay money to free yourself from the danger or a particular negative scenario. For the next 20 years you can manage your finances knowing exactly how long your money needs to last. If you get to 85, the insurance will kick in. If you do not, well, the kids get whatever you didn’t get around to spending. And, for now at least, you get to keep your hands on most of your life savings.

Of course, just how much of your savings you get to keep as a 65-year-old, that is, how much this longevity insurance will cost, may be a stumbling block. The Times quotes MetLife as offering a 65-year-old couple an annuity paying $1,000 a month starting when they turn 85 and going until the second one dies for $29,900. That sounds quite reasonable. A similar annuity starting right now for the couple would run about $201,000, according to my favorite annuity window-shopping site immediateannuities.com.

However, it is not as cheap as it seems. The annuity will pay $1,000 a month in 2030 dollars, not 2010 ones, and it seems reasonable to assume that the 2030 bucks will be worth a lot less. How much less? Well, the implied expected inflation rate from 20 year TIPS is 2.51%. That means that the market expects a 2010 dollar to be worth $1.64 in 2030.

So, to get an annuity that is expected to pay the couple $1,000 a month in today’s money starting in 20 years, that is, $1,640 a month in 2030 dollars, would cost $49,090. And, to be clear, that is not an inflation-adjusting annuity. That is, the payments after age 85 are fixed and will lose ground as prices rise. Further, there is no guarantee that $1,640 will in 2030 be worth what $1,000 is today. It is just the market’s best guess.

I think that what a 65-year-old couple would really want would be an annuity that was fully inflation protected, that would pay $1,000 a month in 2010 dollars starting in 2030 and continue to adjust upwards as prices rose. I cannot easily find or calculate a quote for that, but it is safe to assume that it is well above $49,090. Multiply that by how many thousands of dollars a month the couple feels they need to be comfortable and it starts to look like a pretty steep insurance premium.

Which is not to say that it is not a great idea for many newly retired folks, only that it is still a hard sell. The Times piece offhandedly and ominously tells us that New York Life “initially developed a longevity insurance product five years ago, but it never made it available because there wasn’t much demand.” Given the dizzying number of variations on life insurance offered by The Company You Keep, not enough demand to justify even offering the product must be a really small level of demand.

52 Comments

  • By Mike Piper, November 8, 2010 @ 1:23 pm

    Well, you could check what it would cost an 85-year-old to buy an inflation-adjusted annuity today. (Vanguard’s quote system is the only place I know of that offers CPI-adjusted online annuity quotes.)

    Then you could calculate how much you’d have to put into 20-year TIPS today to have that inflation-adjusted amount in 2030.

    Of course, when 2030 actually rolls around, the amount you have when it comes time to buy that annuity may provide more or less income than you’d hoped — due to changes in real interest rates, life expectancies, or other factors I might not be thinking of. :)

  • By Chuck, November 8, 2010 @ 1:35 pm

    The longevity insurance premium could be paid annually.

  • By Mr. West, November 8, 2010 @ 1:53 pm

    Posts without pictures are better … then we can read it at work and not worry about someone seeing us goofing off.

  • By jim, November 8, 2010 @ 4:06 pm

    In general it seems like a compelling idea and a good compromise for people.

    Life expectancy at age 65 is 17 years for men and 19.7 for women. So about half the couples would not live to 85 and would get nothing and the other half would get the value of the $1000 per month immediate annuity at age 85. I think that the $30k today should get you about $1150/month annuity in 20 years to be competitive.

  • By Stagflationary Mark, November 8, 2010 @ 8:31 pm

    I’ll offer my reason for what it is worth.

    I don’t trust insurance companies all that much.

    I do not trust them to remain solvent over the life of the annuity. I do not trust them to pay me what I’m owed. I do not trust all the fine print that comes with the contracts.

    I actually bought an annuity product once. I was promised 7.5% per year risk free.

    Thankfully, I was able to back out the next day (I had a three day window) after I double checked all the math and reverse engineering the payout schedule. It turns out I was not going to be earning anywhere near 7.5%.

    They were not happy that I’d bothered to look. It seems they excluded many of the fees from the number they quoted me. Go figure.

  • By Frankie, November 8, 2010 @ 9:38 pm

    Stagflationary Mark,

    What that a variable annuity?

    People hear bad things about various variable annuity products and think it applies to single premium fixed annuities. The two things are wildly different products.

    Also, has anyone lost money on a single premium fixed annuity that was covered a state guarantee fund? I don’t think anyone ever has.

  • By Stagflationary Mark, November 8, 2010 @ 10:23 pm

    Frankie,

    1. Just because nobody has lost money in the past doesn’t mean they won’t in the future. We live in a world where it is/was possible to lose money on something as simple as a money market fund.

    http://www.nytimes.com/2008/09/17/business/worldbusiness/17iht-17fund.16227852.html

    “This is only the second time in history that a money market fund has “broken the buck” — that is, reported a share’s value was less than a dollar.”

    2. State guarantees don’t mean much to me. Many states are already on the edge of default as it is. Who insures the insurer?

    http://www.businessweek.com/news/2010-06-02/buffett-expects-terrible-problem-for-municipal-debt-update1-.html

  • By Frankie, November 8, 2010 @ 10:43 pm

    Just because nobody has lost money in the past doesn’t mean they won’t in the future.

    Yes, but of all the retirement options available this is one of the safest. What to you propose people invest in? Real Estate, Gold, t-bills? Everything has a risk.

  • By jim, November 8, 2010 @ 11:23 pm

    Annuities are backed by state guarantee associations for minimum $100k. Very much like FDIC insurance.

  • By Stagflationary Mark, November 9, 2010 @ 9:14 am

    For what it is worth, I prefer long-term TIPS and I-Bonds. No middleman. No fees. Both are tied to the CPI. Rates have dropped considerably, but that’s pretty much true of everything right now. I also owned a great deal of gold and silver from 2004 to 2006, but at these prices I have no interest.

  • By Stagflationary Mark, November 9, 2010 @ 9:19 am

    http://www.safemoneyplaces.com/guaranty.htm

    “Is an annuity as safe as an FDIC insured bank account? No, because federally insured is by definition superior to a state guaranty.”

  • By Stagflationary Mark, November 9, 2010 @ 10:01 am

    I want to point out that I do like the idea of longetivity insurance in general. I’m just not all that willing to trust insurance companies. One option I might consider late in life would be a reverse mortgage on my home. It pays off if I live longer than expected. If I die early it isn’t like I will complain. I’ll be dead. I won’t even know I lost money on the deal.

  • By Stagflationary Mark, November 9, 2010 @ 10:04 am

    I meant longevity. Oops. It’s been a long night.

  • By Frankie, November 9, 2010 @ 8:43 pm

    For what it is worth, I prefer long-term TIPS and I-Bonds.

    The ones with the negative yields?

    What is your withdrawal going to be?

  • By Frankie, November 9, 2010 @ 8:46 pm

    I’m just not all that willing to trust insurance companies.

    Also, you’re not trusting the insurance companies, you’re trusting the state guarantee funds.

  • By Stagflationary Mark, November 9, 2010 @ 9:50 pm

    Frankie,

    “The ones with the negative yields?”

    There are no long-term TIPS or I-Bonds with negative yields.

    I buy and hold until maturity. As I have said, yields have dropped. My last TIPS purchase was a 2%+ 30 Year TIPS earlier this year though. That same bond’s rate has dropped to 1.6% as of today. I’d still be a buyer (if held to maturity).

    As for my withdrawal, it is quite minimal I assure you. I am perfectly fine with tapping principal. I believe that a penny saved is a penny earned and no more than that (at least in this economy and the one I project forward).

    “Also, you’re not trusting the insurance companies, you’re trusting the state guarantee funds.”

    Of course I am trusting insurance companies. You should see all the denials of coverage my girlfriend continually gets when trying to get her medical bills paid. Insurance is insurance.

    I’ve also made it fairly clear that I don’t trust state guarantees all that much.

    Let’s put this another way. If I had owned AIG annuities when AIG was going through enormous financial stress, I too would have been enormously stressed out. I just don’t need that in my life.

    I turned bearish in 2004. I started my bearish blog in 2007. I’m still bearish. I don’t see anything that’s going to change my opinion long-term. I therefore value safety first and foremost.

  • By Stagflationary Mark, November 9, 2010 @ 10:04 pm

    As a side note, here’s what I posted today and why I am still bearish long-term.

    http://illusionofprosperity.blogspot.com/2010/11/total-household-liabilities.html

  • By Frankie, November 10, 2010 @ 2:55 pm

    You should see all the denials of coverage my girlfriend continually gets when trying to get her medical bills paid.

    Hum, never had a problem with any kind of insurance. Car, home, health, all paid promptly and without question. Even AMEX was a delight to work with and paid up when I crashed a car I rented with my card.

  • By Stagflationary Mark, November 10, 2010 @ 7:21 pm

    Frankie,

    Hum, never had a problem with any kind of insurance.

    Lucky you.

  • By Dangerman, December 26, 2010 @ 8:18 pm

    I know this article is some ~two months old now, but I was researching this topic and found that you can get all on the online quotes you want from Symetra.

    Check out here: http://www.symetra.com/financial/salestools/quotes.asp and click “Go” under quote for the “Freedom Income Annuity”

    @Frank Curmudgeon: “65-year-old couple would really want would be an annuity that was fully inflation protected, that would pay $1,000 a month in 2010 dollars starting in 2030 and continue to adjust upwards as prices rose.”

    Although one has to use “the market’s best guess” for inflation instead of an explicit inflation protection guarantee, using the same 2.51%… the cost for this is currently $67,663.30.

    A pretty good deal, I think.

  • By Murf, May 2, 2011 @ 5:04 pm

    so you pay $29K to get $12K per year in income. if instead they invest $29K and earn 8%, then pull from that at 4% a year starting age 85, they get $5.4K per year, using 4% as the standard rate that allows savings to ‘last a lifetime’. so the longevity brings over twice as much income per year starting at 85, unless the person somehow earns over 12% per year for 20 years. Hmmm, folks who are 65+ probably won’t be investing in things that earn 12% per year.

  • By John doe, July 27, 2011 @ 8:22 pm

    Guy,

    One or two in a thousand purchase annuities. Are you hiding under a rock or do you just make poorly researched statements for a living? About 999 out of 1,000 have annuities. Some are good, others aren’t. It depends on the particular person’s situation. Annuities are VERY popular because of the guarantees provided. There are thousands out there so I have to ask, which are the unpopular ones you speak of?

    Thanks,
    John

  • By شات بنات مصر, October 12, 2011 @ 12:23 pm

    I’ve been looking into different types of investments like dividend stocks, bonds, and internet properties but i would never drop alot of money before i felt like i knew what i was getting into.

    To be honest i don’t know anything about forex, but i’m sure if you know it well enough, there are some safer ways to do it.
    It just becomes a problem when people that are novices jump in things like forex and the stock market thinking that they will make easy money

  • By CapVandal, May 26, 2012 @ 2:22 pm

    I was just reading in today’s Barrons that NY Life (A++) offers a contract for a 60 year old male that pays out @ age 85 — an annual amount of $38,369.

    It sounds like a good product to me. Payouts for contracts that guarantee return of principal, include a joint/last to die feature, &c are going to pay a lot less.

    In fact, it has a significant insurance component — you die before 85, the money disappears. Which is the real value here.

    Even though a person might want more guarantees — inflation adjustments, etc., a married couple, for example, might buy enough to simply reduce the financial risk of living to 100. Not eliminate it.

    In fact, mortality is a transferable risk. And an insurance company can offset its mortality risk to some extent with a portfolio of life and annuity products.

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