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Should You Buy Longevity Insurance?
By JLP | July 24, 2007
First off, here’s a reading assignment:
More Dollars Later In Life (Business Week)
Extend Your Retirement Savings (SmartMoney)
Both of these articles talk about a relatively new product (actually the idea itself isn’t new but the name is) called longevity insurance. In its simplest terms longevity insurance is an annuity that begins paying income once you reach a certain age - usually 80 to 85. According to the Business Week article a 65-year old man who pays $250,000 into a longevity policy, could expect an annual income of $210,000 at age 85. Sounds pretty good doesn’t it?
There’s just a few problems with this:
1. According to this page (pdf) from Social Security Administration, the average lifespan of today’s 65-year old male is 16.1 years, which puts death at around 81 years. According to this article in Forbes, a 65-year old male has a 50% chance of living to age 85. In other words, there’s a chance that this person won’t live long enough to collect the first payment. And, according to most policies, if he dies before he reaches 85, he will lose the entire $250,000 unless he opts for a policy with a death benefit which will reduce his monthly income. If he lives to 85 but dies at 86, he will have received one year’s worth of income and lost the rest.
2. Although $210,000 sounds like a lot of money now, 20 years of inflation will reduce that $210,000 to $114,000 in purchasing power. Yes, you can purchase an inflation rider but it too will reduce your benefit.
3. Once that $250,000 is invested, it is gone for 20 years. In other words, you lose that flexibility.
4. Finally, as I understand it, the $250,000 only covers one person (I could be wrong but I couldn’t find a definitive answer either way).
Is there an alternative?
Of course there is an alternative to longevity insurance but it isn’t without its own risks. First, let’s look at some numbers:
According to my research, the average annual real return (that’s after inflation) of the S&P 500 over all the 20-year rolling periods from 1926 - 2006 was 7.27%. Let’s say you take $250,000 and invest it in the S&P 500 Index for 20 years and you get an average return of 7.27%. At the end of 20 years, your $250,000 would be worth around $1,017,433. Remember this number is adjusted for inflation. At a 5% withdrawal rate, your $1 million could give you nearly $51,000 in income (in today’s dollars). And, if you died before you reached age 85, your beneficiaries would inherit whatever balance you had in your account.
The flaws with this strategy:
1. There’s no guarantee that you are going to get the average rate of return during those 20 years.
2. The $51,000 in income is less than half the income you would receive with the longevity policy.
I think if it were me, I would rather invest in a long-term care policy than a longevity policy.
If there’s any longevity insurance experts out there, I would love to hear your thoughts.
Topics: Retirement Planning |
July 24th, 2007 at 2:12 pm
Isn’t this basically sort of a voluntary social security? We put money into a system now and we don’t know if we will live long enough to get anything back. In fact, the best argument I have heard in favor of private accounts in social security is that minorities and the poor get less out of the system because they don’t live as long and when they die their heirs get nothing from the years of payments into social security, while at least with a private account you can pass something on to your heirs to try to break the cycle of poverty (I am pro-”ownership society”).
But anyway, I think the idea is generally fine - you put $250,000 up and know that you are secure in very old age and that you can use whatever you have left between 65 and 85. The biggest risk in retirement is you don’t know how long you will live, and this eliminates that risk. But a real number cruncher would have to figure out whether a soecific deal is good in terms of return and fees.
July 24th, 2007 at 7:45 pm
This type of insurance strikes me as a remarkably bad idea. An 85 year old is not likely to be able to enjoy an income of over $250,000 a year unless he is fortunate to enjoy exceptional health. My own father was very active for most of his retirement, but health started slowing him down rapidly at about 85. My guess is that he would have preferred to spend $200,000 one time at 65 than to have had 250,000 payments from 85 to 91, when he died. There was simply no way he could have spent 250,000 a year in those last several declining years.
On the other hand, if an 85 year old has reached the point that he might need expensive nursing home care, he is not likely to live much longer so would not gain significant benefit from the lifetime payments. To guard against long-term care costs eating up an estate, long-term care insurance seems a better idea.
In your example, a 5% draw strikes me as extremely conservative. If an 85 year old was up to spending the money, it seems to me more than reasonable to draw the money out to deplete the capital in 15 years, which would last him to 100 years old, a very unlikely lifespan. He could draw nearly $100,000 a year. This is still more than most 85 year olds could spend.
July 25th, 2007 at 12:12 am
A couple of thoughts…
Life expectancy has increased by around 4 years from 1980-2004 (http://www.cdc.gov/nchs/data/hus/hus06.pdf#027). Are we more likely to reach ages above 85 with the technological changes that will come in the next 20 years?
Do you receive the income regardless of your mental/physical condition? If so, is there any risk in someone keeping grandpa on life-support in a vegitative state so that they can continue to take his checks?
July 25th, 2007 at 3:21 am
In a way, this is a bet that life extension technologies will come to pass, in which case people could well live to 150 or more and be hale and hearty most of their lifetime. But if this happens, the entire “retirement assumption” will collapse, and doubtless this insurance company will go bankrupt if it sells many policies.
Lots of our assumptions about personal finance will get truly weird if LE techs move as quickly as they appear to be.
July 25th, 2007 at 4:08 pm
Jordan,
I would think that you are entitled to the income no matter what your mental faculties. And yes, I suppose keeping someone alive is a possibility. However, I would think the cost of care would be prohibitive in the long run.
July 25th, 2007 at 10:14 pm
JLP,
I think the name “longevity insurance” is a misnomer. With other insurance I have, I always hope I don’t need them. With logenvity insurance, I hope to use it:-)
Seriously, I’ve been looking into this and am working with my financial advisor on this. There are some pros to a “deferred longevity annuity,” which is shared in Stephan Pollan’s book Die Broke - i.e. not burdening one’s children should one outlive one’s nest egg.
One main risk that I see it that most annuities are dependent on the stock market. Associated with the stock market risk is the other main risk of whether the company will be around or able to pay in 20 years.
Since I am still young, I do not need to make the decision yet. But I am still considering, especially if the product improves by the time I am 65.
September 5th, 2007 at 3:03 pm
[...] Back in July I wrote a post titled “Should You Buy Longevity Insurance?” When I Google that title, my post doesn’t show up until four pages deep into the search results. Yet, Nickel’s post, which doesn’t even match the my title exactly, shows up at number one. [...]
September 5th, 2007 at 7:31 pm
[...] Back in July I wrote a post titled “Should You Buy Longevity Insurance?” When I Google that title, my post doesn’t show up until four pages deep into the search results. Yet, Nickel’s post, which doesn’t even match the my title exactly, shows up at number one. [...]
September 6th, 2007 at 2:55 am
[...] Back in July I wrote a post titled “Should You Buy Longevity Insurance?” When I Google that title, my post doesn’t show up until four pages deep into the search results. Yet, Nickel’s post, which doesn’t even match the my title exactly, shows up at number one. [...]
September 6th, 2007 at 3:37 am
A little spammy, you may get docked PR from google for repeated content. Google does not like duplicate content.
October 7th, 2007 at 11:04 pm
Longevity Insurance allows folks to take part of their retirement (or deferred compensation plan) and send it into the future. Its straight forward guarantees of reliable income have caught the attention of many including myself. As stated in Business Week taking 10-15% of retirement benefits would give you about 2/3 the income you would receive by annuitizing your entire portfolio thus allowing one to live on roughly 80% of income over the next 20 years while waiting on the Longevity Insurance to begin. Such an approach would allow retires to be more aggressive with the remaining funds and I would think it would also free up some of the anxiety of retirement.
I believe the first key to longevity insurance is the fact that the centurion is the fastest growing segment in society. 30 years ago it was almost unheard of for someone to live to age 100 and today it’s a daily occurrence. The life insurance industry re-evaluated their life expectancy tables to increase the tables from age 100 to age 120 to accommodate the aging society. Also, many of the problems with the noted options for Longevity Insurance can be overcome by newer designs. For example, the WSJ article by A. Todorova appeared to accept the idea, but had concerns over several issues like: death benefit, inflation, and liquidity. The good news is that there are now options outside of MetLife, John Hancock, Integrity and New York Life that do allow for a full death benefit and potentially some inflation should the insured die prior to income. They will also guarantee a full return of premium once payments begin if the appropriate option is chosen. Finally one policy says that should the insured need access to cash in an emergency then they would be allowed to up to 30% of all future payouts in a lump sum.
I obviously have embraced the idea of Longevity Insurance. It’s not for everyone and it’s definitely not appropriate for the bulk of one’s retirement, but it’s a great way to diversify and create an ‘ace in the hole’ for tomorrow.