In America we can always find things for sale that we do not need, and for most people longevity insurance may well fall into that category. A retiree who can manage investments and control spending should be able to provide his own longevity insurance.
What Is Longevity Insurance?
Longevity insurance is a deferred annuity tailored to providing income for people in old age, often after 85.
Longevity insurance guards against the risk of running out of money. Assuming the annuity payments will be enough to cover a retiree’s annual living expenses, a person who buys such a policy needs to make his other investments last only until the age that the annuity payments begin. Insurance companies have been selling these annuities since about 2004, and they are apparently gaining popularity.
In a basic contract, when the policyholder dies, the contract expires and there are no payments. Vanguard estimates that an average 65-year-old male has a 41% chance of living 20 more years, which means there is a 59% chance of dying before 85.
In a basic contract, there is no protection against inflation—the dollar payments specified in the contract may be worth much less in 20 years if inflation surges.
Insurance companies do offer options: a death benefit for heirs, inflation protection, varying starting dates after the contract is purchased, and others. In each case, the guaranteed payments are reduced. Flexibility and options are expensive.
Internet sites offer approximations to what an individual may achieve with these policies. In each of the following examples, a male retiree who is 65 pays $100,000 now in one payment for longevity insurance that begins payouts at age 85.
A MetLife brochure suggests the annual, lifetime payment would be $58,914. That is the “maximum income” option that offers no inflation protection, no flexible starting dates, no payments to heirs, etc.
A November 2010 article in the New York Times implies The Hartford will pay $65,129.
None of the above numbers should be thought of as a “quote”—an insurance offer from a company at a specific time for a particular person. Instead, they are intended only to indicate a general range of incomes that may be purchased from various companies.
Going Naked—Insuring Yourself
A retiree might well ask himself why he could not duplicate the benefit of longevity insurance by simply setting aside $100,000 at age 65, perhaps in a separate account, and dedicating it to providing income after age 85? This would be an excellent use for Roth IRAs. Such an account is subject to none of the downsides of longevity insurance.
If the retiree dies early, the separate account is there for his heirs. If he experiences a significant health event in his mid-70s and becomes convinced he will not live past 85, the separate account is still there. If he needs to move into an assisted living or nursing home at age 80, the account can help pay the costs. If his other investments perform exceptionally well and he decides he doesn’t need the separate account, he can begin gifting it away.
A retiree can use a spreadsheet or financial calculator to forecast likely results with a separate account. Assuming a retiree sets aside $100,000 in investments averaging 6% per year for 20 years, he would accumulate $320,714. Using a 4% interest rate for the payout annuity, he would have a $61,180 annual income for 6 years. Alternatively, a retiree may use any withdrawal rate he might choose. If he is still healthy at 85, he might expect to live to 95, though Vanguard says on average he has only a 14% chance.
The “going naked” result is well within the range of insurance company contracts cited above, and it carries none of the fixed provisions of insurance contracts.
There is a danger, however, in going naked: incompetence. If a retiree manages his own money and gradually loses mental competence, he faces a danger of being defrauded or making large mistakes.
A retiree who is open and honest with family and friends should be able to recognize declining mental ability when it grows significant. At that time, he can buy an annuity or make other arrangements (trusts, help from children) for his remaining years. There are many people who lack that openness, and for them, self-management may become a significant liability.
The secret, it seems to me, is that few people will really benefit from longevity insurance. The few are people with a high probability of reaching their 90s and at the same time, with a significant probability of losing decision-making competence. The writers I’ve encountered on longevity insurance, including the insurance companies, discuss the probability of growing old, but few tackle the likelihood of declining competence. For example, Vanguard estimates only 20% of the 65-year-olds will live to 90, therefore getting 5 years of payments from a longevity annuity starting at 85. But it doesn’t estimate how many of those will also be unable to wisely manage their finances.
For me, I plan to wait until I can see declining mental ability. When that occurs, I will have more health history and more appreciation for my longevity, whether short or long. Until then, I’ll manage my own investments and retain flexibility.