The revolution in product designs over recent years has revived certain product concepts whose demise was welcomed way back when. One interesting example is pension maximization (PM).

When an employer provides a defined benefit upon retirement, the Employment Retirement Income Security Act requires that the default option be a joint and survivor (J&S) option. Under this option, the primary retiree and spouse get a monthly benefit at a certain level while both are alive. If the retiree’s spouse dies first, the pension benefit does not change, but if the retiree dies first, the spouse’s pension reduces. A common reduced level is 50%.

Under PM, a retiree chooses a single life annuity. His benefit ends when the retiree dies, so the spouse is completely exposed. However, the higher initial benefit is appealing, and of course it continues should the spouse die first. The PM concept says, “Eureka! Buy an insurance policy on the retiree’s life that would provide enough proceeds to purchase an annuity (at time of death) equal in value to the J&S benefit the spouse would have received under the primary J&S option.” (In our example above, it would be the 50% level.)

If the structure is efficient, then only a portion of the excess of the single life annuity over the starting amount of the J&S annuity is needed to buy the required insurance amount. Additional excess can be used to fund valuable and needed coverage such as long term care insurance. (If acceleration LTC is purchased, one would need to make sure the required amount of insurance, to cover the required purchase at the retiree’s death, is always present.)

PM fell upon hard times for very legitimate reasons back in the late 1980s and 1990s. Basically, life insurance premiums to fully guarantee the death benefit were too high, so implementation relied on programs using non-guaranteed premiums. Then, when actual premium payments required rose because interest rates fell (or for other reasons), this exposed the faulty underpinning behind the program.

The result was legitimate customer and regulatory disapproval and dissatisfaction. (If the program also used non-guaranteed rates when it came to assuming purchase rates for the annuity purchase upon the retiree’s death, that also was a risk factor, and the risk was realized when interest rates fell and the purchase rates rose.)

That’s a pretty dismal introduction to the PM story. Yet, today, PM is a very attractive concept because one can now use secondary guarantee universal life contracts. Lower guaranteed premiums on these ULs make revitalization possible and legitimate. To illustrate, consider 2 65-year-olds, 1 male and 1 female. Assume the male is the retiree.

1. On a unisex basis, the annual initial benefit on a joint and 50% to surviving spouse is $72,000, while a single life annuity on the retiree would net $78,000 annually.

2. Assuming a 25% tax bracket for the couple, the extra $6,000 nets around $4,500 after taxes.

3. Under PM, a life insurance death benefit must fund an annuity paying $36,000 annually.

4. Annuity purchase rates (income amounts per $1,000 of death benefit proceeds) are prudently based upon an insurance contract’s guaranteed settlement option rates. Using non-guaranteed rates is unacceptable.

5. As rates rise each year with advancing age, age 65 is used to determine the required death benefit (death in first year.)

6. In this example, the required amount of insurance purchase is $57,000.

7. The amount of secondary guarantee UL purchased by $4,500 (our maximum expenditure) depends upon the retiree’s underwriting class. Even the assumption of a smoker tobacco class resulted in a very favorable result. Some observations to note:

First, the better the risk, the more efficient is PM. This is the mortality arbitrage inherent in this program. Producers, make sure the sale is based upon actual underwriting classes, not a hoped-for class used in illustrations.

Second, it’s possible that under certain circumstances, the approach has minimal value. Underwriting issues might be a contributing factor, as might significant age differences. So base the decision to use PM upon actual underwriting offers.

Third, the agent and client have the choice about whether to buy more insurance or just enough. The less purchased, the more dollars are available during the life of the retiree. The more purchased, the better off will be the surviving spouse.

Fourth, make sure to use a secondary guarantee UL or some other low cost guaranteed cost permanent plan.

Finally, use a guaranteed settlement option rate structure, such as the structure in the secondary guarantee UL that is used to buy the needed death benefit.

The prudent use of PM techniques, done conservatively and with care, will optimize a family’s retirement income stream.