July 13, 2024

Bucks: Longevity Insurance: Buying Down the Risks of Living Too Long

Most people buy life insurance to protect against the risks of dying too soon. Now, there are new products offering the same protection if you live too long.

It’s known as longevity insurance, and there’s clearly a huge market for it: Life expectancies are on the rise, cushy pensions are on the decline, and most people don’t have enough savings to carry them through two decades or more of retirement. This is not lost on insurance companies, which would like you to think about the product as a pension of sorts — albeit one that you have to buy with your own money.

I wrote about the pros and cons of longevity insurance — which, at its core, is really just an annuity — at the end of last year. But now, New York Life will roll out its own version, which it’s calling a “guaranteed future income annuity,” on July 11.

So how exactly does it work? With basic immediate annuities, also known as income annuities, you give a pile of money to an insurance company in exchange for a lifetime stream of income that generally starts right away.

What’s different about New York Life’s product is that the stream of income is deferred — you pay the premium, but agree to receive the income stream at some point in the future. But there are two distinct ways to use the product.

With the first way, you might think about it as a way to prepay for an annuity (or a pension) well before you plan to use it. That makes it cheaper than an immediate annuity, because, well, there’s a chance you’ll die before you begin to collect. In addition, the insurance company has the advantage of investing your money over a longer period of time. You might buy the annuity at age 55, but decide to begin collecting it at age 67, for instance.

But it can also be used as a pure insurance policy — hence the name, longevity insurance. You can agree to begin collecting the insurance at a much later date in the future, like your 85th birthday. So if you live past your life expectancy, you’re covered. And since most people don’t know when they’re going to die, this allows you to spend down your retirement savings more liberally because you know your payments will kick in later. The big risk, of course, is that you won’t see a dime because you die before you can collect.

“Mathematically, it makes a lot of sense,” said Christopher Blunt, an executive vice president at New York Life, referring to the lower costs of using the annuity purely as an insurance policy. “It’s probably the most efficient and effective way of taking that pure risk off the table.”

So let’s take a closer look at some of the numbers. It would cost a 55-year-old man $100,000 to buy $1,000 a month in guaranteed lifetime income that begins at age 65, compared to $103,500 for a woman. (It’s more expensive for women because their life expectancy is generally longer.)

It would cost $122,000 to cover both partners’ lives, which is much lower than the $203,000 it would cost to buy an immediate annuity (at age 65).

But if a man decides to make those payments over ten years, investing $10,000 a year, his income stream might be slightly less, perhaps closer to $880 a month. That’s because the insurance company is investing your money for a shorter period of time (and there’s a higher likelihood you’ll collect the income stream with each passing year). Also remember that your payments will be influenced by the interest rate environment: if rates rise, you’ll lock in a higher payout rate, and vice versa.

If you want to use the annuity purely as an insurance policy, it’s much cheaper. It would cost a 55-year-old man $12,100 to buy $1,000 in guaranteed monthly income that starts at age 85, compared to $13,750 for a woman. It would cost a 65-year-old man $17,740, whereas it would cost a woman $21,600. To cover them both, it would cost $20,340 if they’re both 55, and $31,240 if they’re both 65.

That seems like a decent deal, until you remember that little bug called inflation – your dollars are likely to be worth a lot less that far into the future. One option is to figure out how much you’ll need in inflation-adjusted dollars and buy that amount.

Now, for some of the rules of the game: The initial premium payment must be at least $10,000, but subsequent payments can be as little as $100. You can make payments at any time up to 2 years before you start collecting payments.

You also have the ability to change your start date. So if you were to retire early, you could start collecting earlier, though your payments would be less. You’re also given one shot at deferring your start date, though you can’t defer the start of your payments for more than 40 years from your initial payment.

As for costs, a one-time commission of as much as 5 percent of the premium amount is extracted from the amount you’re ultimately paid.

There are obviously risks associated with any annuity. The most obvious is that you’re giving up control of a big pile of money, and you may not live long enough to collect. You have the ability to buy survivor benefits, but that will lower your monthly payments. For instance, you can arrange for a beneficiary to receive the money back if you haven’t begun receiving payments, or to continue to receive the payments for a certain period of time.

And then there’s the issue of inflation. You can also buy an option that will allow your payments to rise a certain percentage each year, but again, it will cost you. (There is also a feature that says if rates rise more than two percentage points within five years of buying the contract, the company will reset your contract at the higher prevailing rate).

And then there’s always the question of the financial stability of the insurance company many years into the future. Mr. Blunt pointed to New York Life’s triple-A ratings from each of the big rating agencies and said the company had $30 billion in life insurance reserves on people over the age of 65, and $5 billion in reserves on individual annuities. And since the company is a mutual (as opposed to a publicly-traded company), he said it could stockpile as much capital as it needed since it was not beholden to Wall Street and shareholders.

But what happens if Merck invents the magic pill and we all live until 105? “Continued improvements in medicine that allow people to live longer could create losses on our individual annuity business,” he said, “but these would be more than offset by higher gains on the life insurance.” Still, he added, if something like that were to happen, “at some point, capacity might be limited.”

What’s the biggest reason you would or would not buy this guaranteed future income annuity?

Article source: http://feeds.nytimes.com/click.phdo?i=be599f2118274014194c23c19c7b0cf3

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