On Longevity Insurance – Do You Feel Lucky?

For starters, I hate most insurance products that purport to replace investment products. But I had not heard of longevity insurance until this week, so I decided to check it out.

Here’s the concept: Pay a big lump sum to an insurance company now (before retirement), in order to draw on a hefty fixed income many years in the future – but starting past the age you might not live to see.

The idea – known as longevity insurance or a deferred annuity – is meant to fit a certain type of person concerned with running out of money in the mixed-blessing event that he or she lives long enough to outlive most of his or her savings. By deferring the income for many years, a lump sum can create a significant income-for-life in later years, alleviating the risk that retirement money completely runs out.

This recent Bloomberg article offers the example of a 60 year old man who pays $125,000 to New York Life today in order to draw nearly $45,000 a year, starting at age 80 – twenty years from now. This article says New York Life offers $17,614 guaranteed annual income after age 80 for a $50,000 premium.[1]

 

The article claims a retiree’s account must grow by an unlikely 11% to match the income available from this type of deferred annuity, without specifying exactly how that percentage was calculated.

You think this is the equivalent of 11% return?

11% return?

“Go ahead. Make my day.”

https://www.youtube.com/watch?v=cg-NNSEPClQ

I’ll use the latter Bloomberg article’s precise numbers later in this post to calculate what I think about all this, from a financial perspective.

To think about the numbers and the math behind longevity insurance, it’s helpful – regrettably – to think about the probabilities of death.

Stats about death probabilities

We know from Social Security’s actuarial tables that the risk of death between 60 and 80 – meaning in this case the risk of paying over a big lump sum and getting exactly nothing back – is significant.

The probability of death at any age each year rises, for a man[2], from about 1.1% for 60 year olds, to about 6% for 80 year olds. Combine the annual risk of death for every year between 60 and 80, and we can see – actually we know this instinctively, but still we can see – that this deferred annuity could end up worth zero.

The sum of all the one-year probabilities of death, for a man, between age 60 through age 79 is 54%, meaning that there’s a greater than 50% chance that the annuity income is never collected.

This all may seem morbid to talk about, but as my friend Clint says in The Unforgiven, “We all have it coming, kid.”

https://www.youtube.com/watch?v=XoAPKt7kbD0

Here are some other interesting and relevant, stats from the SS actuarial tables:

A 60 year old man has an expected life of 21.27 more years. This means the average man has just 1.27 years past age 80, on average, to receive guaranteed income from the longevity insurance annuity. Taken at face value, that seems like very few years, on average, to received guaranteed income after age 80.

Next, should that man make it to age 80, the expected life from that point onward is 8.1 years. That seems more palatable from a financial perspective, and instinctively the guaranteed income for 8 years sounds more reasonable. Below I will do some math, however, to move from ‘instinct’ to ‘calculation.’