Longevity Annuity

[FIRE'd@51]

There was an interesting article in Sunday's Washington Post Business Section, which talked about a new product - the Advanced Life Deferred Annuity. Basically, one makes a payment today, and the annuity kicks in at age 85. It's an insurance policy against living "too long". I haven't done a thorough analysis of the numbers in her example, but I do think it is potentially an interesting product, which, if priced competitively, could have a place in a retirement portfolio. It's basically pure "longevity insurance".

Longevity Annuity

 

[haha]

I've been watching web re-broadcasts of Consuelo Macks's Wealthtrack. She had a couple of guys talking about this producta few weeks ago.

Depending on how many are offered, what the terms are, etc.- it sounds like it could be quite an interesting product. An inflation indexed one could fund itself with TIPS, but because of the insurance aspect and the deferred payout the purchaser should should get a much better cash stream if he makes it to pay out. And if he doesn't- so what?

Ha

 

[ERD50]

I haven't run the numbers either, but wouldn't you be better off setting aside that amount now, and buying an annuity at age 85 if you thought you might need it, and if the numbers made sense at that time?

Advantages to delaying:

1) You knock off X years of uncertainty about the creditworthiness of the annuity provider.

2) If you die before 85, the $ go to your heirs or charity as you wish.

3) You will have a clearer picture of your needs as you get closer to 85.

The company is just going to invest your money between now and age 85 - why not do it yourself and maintain control? If you are concerned you may not have your wits about you to do this at 85, get it in writing with whomever would be managing your finances at that time.

I guess the only advantage I could see is if the company can assume that a lot of people who buy these policies will die prior to age 85 - then they could afford to pay you more. Would need to dig into the numbers and make some assumptions for that analysis.

-ERD50

 

[Nords]

Basically, one makes a payment today, and the annuity kicks in at age 85.

Sounds like the solution to saving Social Security...

 

[justin]

Sounds like an interesting product that would be worth considering in my case. The article says that the product sold by the Hartford insurance company costs $10,000 at age 40 for a stream of payments of $2550/month at age 85. I'm assuming they aren't inflation adjusted. That is, I'm assuming $2550/month is in nominal dollars 45 years in the future. And then I'm assuming the $2550 doesn't increase annually with inflation.

That $2550 (for males, btw) works out to $30,600/yr. Using 3% inflation, after 45 years, this is equal to $8091/yr in today's dollars. I figure I might need $40,000 per year (in 2007 dollars) after SS payments (assuming I'm still up and running at the bright young age of 85). So that works out to $49,440 I'd have to pay at age 40 to get the "longevity insurance" at age 85. Without doing the math, it seems like a pretty small price to pay in order to have all my spending needs after age 85 covered. That amount would represent less than 5% of my nest egg I would plan to have at age 40 to FIRE. Plus, if times got really hard, I could deplete my portfolio in the 45 year period from age 40 to age 85, knowing I had my backup longevity insurance in place.

Is it a good deal? $10,000 up front at age 40 gets you $8091 per year. Male life expectancy at age 85 is somewhere around 5-7.5 years depending on which actuarial table you look at. Say 6.25 years of collecting $8091 per year. That's around $50500 in real dollars you'd expect (which includes the longevity insurance of payments as long as you live). You would need a 3.65% real rate of return after taxes to get from $10,000 today to $50500 in 45 years.

One would think 3.65% real return after taxes would be highly likely to occur given a portfolio containing mostly inflation linked or nominal bonds plus 20-40% equities. Given the real chance of insurance companies going bust after 45+ years, I don't know that a 3.65% real rate of return is very good given that you're locked in for such a long time period. Seems like waiting till age 85 and then getting an immediate annuity would make more sense and might get you a higher payout?

Bottom line - seems like a good product in theory, but the product offering mentioned in the article doesn't seem good from an investment point of view.

 

[aenlighten]

My problem

with something of this sort is, is it really needed? Unless you are an adopted orphan, by retirement you should have a good idea of how long you will live and what you will probably die of. Then you should no longer be using a general statistical distribution, but one tailored to your genetics and behavior.

 

[Sam]

Basically, one makes a payment today, and the annuity kicks in at age 85.

Makes absolutely no sense using their numbers: 10K invested for 45 years and 8K annual payment (today dollars, 3% inflation).

Assuming one dies at 90 (5 years payment). That would be the equivalent of investing the 10K for next 45 years with an average annual ROI of 3.5%. or 0.5% more than inflation!

 

[justin]

with something of this sort is, is it really needed? Unless you are an adopted orphan, by retirement you should have a good idea of how long you will live and what you will probably die of. Then you should no longer be using a general statistical distribution, but one tailored to your genetics and behavior.

For those of us that are planning to retire at age 40 or 50, we may not really know our expected death date with much accuracy. I don't think family history is any more than a general guide as to longevity. The random variability in longevity is probably more significant than family history or personal medical history 40 years before the average mortality.

If the fundamentals of the insurance product were much better, I'd be willing to buy it. If I could fork over 1-2% of my nest egg at age 40 to cover all expenses from 85 on, it would be very attractive. I would only need to make sure I have 45 years of expenses covered instead of "forever".

It sounds like only a few companies are offering this longevity annuity product now. Probably not a lot of competition at this point. Which means poor pricing for consumers of this product.

 

[justin]

Makes absolutely no sense using their numbers: 10K invested for 45 years and 8K annual payment (today dollars, 3% inflation).

Assuming one dies at 90 (5 years payment). That would be the equivalent of investing the 10K for next 45 years with an average annual ROI of 3.5%. or 0.5% more than inflation!

I think you are mixing real and nominal amounts in this case. The $8k/yr future payment is in real terms. $8k over 5 years is $40k in real dollars. To get from $10k to $40k in ~45 years is equal to a ~3.2% ROI in real terms.

 

[Sam]

Geez... You're right Justin.

 

[chinaco]

Interesting product. It might make sense. I need to study it further. Here is another thread on the subject posted awhile back.


http://www.early-retirement.org/forums/f28/longevity-insurance-does-it-make-sense-27511-2.html

 

[2B]

Here's a hint.....

If it is offerred by an insurance company, it is not a good investment.

 

[chinaco]

Here's a hint.....

If it is offerred by an insurance company, it is not a good investment.

Great point! And the annuity is not an investment. If you look at it that way, you will come to the wrong conclusion. The question is what problem do you need to solve! In this case it is intended to be a vehicle to avoid longevity risk.

 

[justin]

If anyone read the Ibbotson/Milevsky paper posted here, there's a good section on "mortality credits" (page 68, table 6.2 for those who didn't read ).

Basically, the underlying benefit of an annuity arises when other folks in the annuity pool die and you don't. You (in theory) are collecting more money because the dead people are giving you what they would have gotten. Table 6.2 shows the increase above regular interest rates you should expect at a given age for starting an immediate annuity. For example, at age 65, you get an 83 basis point boost to your interest rate (presumably the risk free rate of return). If you wait to annuitize till age 85, you get a 725 bp boost to returns. When you consider expenses on most annuities might run 100-300 bp's (just a wild guess), it probably doesn't make sense to annuitize at 65 for a meager 83 bp boost in returns (which will more than get eaten by expenses) but it probably does make sense to annuitize if you get 725 bp boost to returns (which might still net you 400-600 bp after expenses).

Ibbotson, et al state in their paper that annuitizing at age 60 is too early, and age 90 is too late. They recommend dollar cost averaging into annuities starting around 65-70 and continuing until 80-85.

I think the often heard complaint against annuities comes from the folks on here who define retirement as around age 50 or so (typical early retirement). Ibbotson, et al would say don't get an annuity at that age or any where close to that age. Instead they recommend waiting 15-20 years.

In their paper, they also explain that if you have even a modest "bequest motive" (desire to leave assets to others or to charity - ie - not die broke), and a modest to aggressive risk tolerance, your optimum allocation to annuity products would be 14-24%. And that is for a 60 y.o. male. My guess is that an even smaller allocation to annuities would be expected at younger ages, which many folks here are able to retire at.

The notion of longevity insurance is an interesting notion. At this point it is hard to get excited about the potential for a 3-3.5% real return for a locked in 45 year investment with no liquidity and company specific risk of the insurer (not to mention the fact that there's a ~50% chance we won't make it to age 85!!!). It still seems like it would be cheaper to "roll your own" and/or annuitize at age 85 if you really wanted longevity insurance.

 

[aenlighten]

The random variable in longevity

is that you can die sooner. I think there is little that can extend it. My mother's family all died within 3 years age of one another. Only her mother died earlier in a fire. Risky behaviors and failure to take care of yourself can certainly take their toll. It could be difficult to have enough information at 40 though without enough relatives.