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.

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