To Insure Longevity Risk Or Not: That Is The Question

The base case (see Table A) does not insure against longevity risk. So, two alternative cases were developed mixing a single premium immediate annuity (SPIA), life only option, with the SWP. The SPIA insures against longevity risk by converting part of the nest egg into a guaranteed lifetime income stream. Alternative I (Table B) allocates $125,000 (25%) of the $500,000 nest egg to an SPIA, and Alternative II (Table C) allocates $250,000 (50%) of the $500,000 nest egg to an SPIA.

Conclusions: A client can draw more income at the same 90% target success rate when an SPIA is added to the SWP. The percentage increase in income ranges from 6% to 13% in Alternative I (25% SPIA), and from 11% to 25% in Alternative II (50% SPIA). Generally, the income increase is greater for older ages.

Also, the SPIA alternatives provide a floor of guaranteed income for life while the base case (SWP only) does not. In the scenarios that fail, the base case SWP income generally falls to zero. For Alternative I (25% SPIA), there is a guaranteed lifetime income floor that ranges from approximately $10,000 to $14,000 per year. For Alternative II (50% SPIA), there is a guaranteed lifetime income floor that ranges from approximately $20,000 to $28,000 per year. With the SPIA alternatives, the client’s income level never falls to zero. This guaranteed lifetime income floor provided by the SPIA product helps to insure against the risk of living too long, i.e., longevity risk.

In summary, adding an SPIA to the SWP provides higher income (at the 90% target success rate) and provides downside protection (longevity insurance) with a guaranteed lifetime income floor.

But, there are trade-offs.

1. The SPIA product entails the client giving up liquidity. Most clients will need to maintain liquidity on a portion of their assets in order to fund life’s unexpected events. So, only a portion of the assets should be allocated to the SPIA.

2. The SPIA alternatives provide lower remaining asset values at death. In effect, by mixing in the SPIA, the client is trading some “estate” value for protection against outliving their assets. Intuitively, this trade should be attractive for most clients since maintaining financial independence during one’s lifetime generally has a higher priority than leaving an inheritance at death. (Note: Adding a certain period or refund feature to the SPIA can help offset the loss of “estate” value.)

In view of the case study, here are a few practical thoughts on insuring against longevity risk: Clients are often concerned about giving up control of their assets. However, one of their greatest fears is outliving their nest egg. The SPIA product can address this fear by providing the security of a guaranteed paycheck for life.

In addition, it may be helpful to establish a budget for longevity insurance. Some advisors suggest that a client have guaranteed lifetime income sources that cover basic (non-discretionary) expenses. If the client’s Social Security benefits and defined benefit pension payments are less than their basic expenses, they can fill that gap with an SPIA.

Finally, the SPIA product is best described as “living insurance.” The longer one lives, the more it pays.

This article originally appeared in the July 2007 issue of Income Planning, an online publication of National Underwriter Life & Health. You can subscribe for free to this monthly e-newsletter by going to .

Dennis L. Carr, FSA, CLU, ChFC is chief actuary with Lifetime Income Solutions Group, Louisville, Ky., a member of Western & Southern Financial Group, Cincinnati. His e-mail address is HYPERLINK “mailto:[email protected]” [email protected]