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Top story: Are longevity annuities ready for prime time?

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Imagine making the following pitch to a prospect: “Mr. Client: I have an annuity that, beginning at age 85, will pay you the retirement income you need every year for the rest of your life–guaranteed. You need only set aside from 5% to 15% of your investable assets to purchase this product. There’s just one catch: If you die before reaching age 85 you get…nothing.”

If this sounds like a killer product for the advisor’s portfolio, you could be onto something big. But if you think it won’t attract many sales, you’re probably not alone.

The product is commonly referred to as longevity insurance and (in academic circles) the advanced life delayed annuity. It has been on the market only a few years, but by most accounts, it has been slow to gain traction.

Sources tell Annuity Sales Buzz that only a handful of insurers carry it, among them MetLife, The Hartford and New York Life. Not many producers know about the product, they say, and fewer still understand this annuity’s true power and how it should be marketed to clients.

As a percentage of single premium immediate annuity (SPIA) sales–itself a small part of the overall annuity marketplace–longevity annuities constitute but a miniscule slice of the pie.

Yet, to hear John Olsen tell it, longevity insurance has the potential to transform distribution planning as we know it. “In my view, this represents a genuinely new paradigm, a wholly different way of perceiving the retirement income landscape,” says Olsen, a chartered financial consultant and principal of Olsen Financial Group, Kirkwood, Mo.

“Unfortunately, it is generally looked at–and grossly misunderstood–using glasses that have been forged with an investment mindset.”

By that, he means that too many producers and clients focus on the prospect of losing their investment or on the longevity annuity’s internal rate of return in assessing the product’s merits. The appropriate point of reference, he says, should be the product’s value as a risk management play–i.e., its ability to provide, at potentially much lower cost than alternative solutions, a hedge against living too long.

Longevity insurance thus eliminates one of two “imponderables” that can make retirement distribution planning notoriously difficult: not knowing how long one will live.

The other imponderable, says Olsen, is that clients don’t know what their future investment returns will be. Perhaps just as importantly, they don’t know the sequence in which investment returns will occur, which can yield dramatically different results, depending on the sequence.

“Because of these imponderables, you don’t know the period over which you’ll be taking withdrawals or the appropriate withdrawal rate,” says Olsen. “And you want to avoid the one big risk in retirement income planning, which can be stated as a question: What are the chances that my account balance will fall to zero before my blood pressure does?”

Part of the beauty of longevity insurance, sources say, comes from its leverage: the ratio of the benefit to the amount one has to pay to get that benefit. The greater the ratio, the greater is the leverage.

A second key benefit can be measured in the product’s large “mortality credits.” Because only a fraction of all policy holders will live to the requisite age to begin receiving income (or to recover the premium they paid), the insurer can charge each individual in the “risk pool” much less than would be necessary for a conventional single premium immediate annuity.

A third benefit stems from the promise of a lifetime payout. Because the product provides income at advanced ages, clients can boost IRA distributions in the early years of retirement when they’re more likely to enjoy and take advantage of an enhanced income. They also can be more aggressive with their portfolio allocation of other investments.

“What is really compelling about longevity insurance is the behavioral aspect,” says Moshe Milevsky, the executive director of The IFID Centre and an Associate professor of finance at the Schulich School of Business at York University in Toronto, Canada. “You can engage in different behaviors with confidence–perhaps going to Europe more often during the early years of retirement–because the later retirement years have been taken care of.

“The ideal candidates for this product are clients who are depending on an IRA, 401(k) or 403(b) account to carry them through retirement. People who have a defined benefit plan, and the affluent, are not prospects.”

But Milevsky and Olsen lament the fact that, because, longevity annuities are not well understood by producers and clients, few of the products are sold in the pure form that yield maximum benefit. To win over potentially skeptical prospects, the few manufacturers that market longevity annuities supplement (or substitute) the basic offering with solutions featuring enhanced benefits, such as a death or survivorship benefit, commutation of the income stream, or return of premium.

Example: New York-based MetLife. A pioneer in longevity insurance, the carrier supplements its pure offering, dubbed the Maximum Income Version, with a Flexible Access Version. The FAV product offers a death benefit to named beneficiaries should the policy owner die before taking income. Beneficiaries receive a death benefit equal to purchase payments compounded at 3% annually.

Kevin Penrod, an Omaha, Neb.-based financial services representative for MetLife, says the two versions fill a niche, clients in the 78- to 82-age bracket, whose product alternatives are few, being limited chiefly to SPIAs and very short-term deferred annuities. And while acknowledging the MIV product provides greater bang for the buck, the FAV version remains the overwhelming–indeed, unanimous–favorite.

“Since I began selling longevity insurance, I’ve not encountered a single client who chose the version which doesn’t offer the death benefit,” says Penrod. “Yes, the death benefit-free product is lower-cost and offers higher income. But none of my clients has favored this option.”

Result: these clients have denied themselves the uniquely high leverage and mortality credits that longevity insurance provides. By opting for these enhanced benefits, says Olsen, clients betray a fundamental misunderstanding about the value and purpose of the product.

“Conceptually, adding a death benefit amounts to hedging two diametrically opposed, mutually exclusive conditions,” says Olsen. “Either you’ll live to age 85, in which case the original risk will materialize and you’ll need the money to offset that risk; or you won’t live to that age.

“Well, it’s one or the other. When you use a single instrument to provide a benefit to satisfy mutually contradictory conditions, then it does neither of them very well.”

If establishing an inheritance for heirs is also desired, Olsen insists, the better option is to supplement a longevity annuity with life insurance. He also endorses, depending on the client’s financial circumstances and objectives, incorporating longevity insurance into an annuity laddering strategy.

Case in point: Pair the product with a variable annuity that has a guaranteed minimum withdrawal benefit. When the VA account balance runs out after, say, 15 years of retirement, the longevity product kicks in.

Ultimately, Olsen and Milevsky contend, the pure longevity offering will prevail in the marketplace against its diluted variants. But that doesn’t rule out other product permutations taking a share of the pie.

One that Milevsky has devised (but is not being manufactured) is called the Ruin Contingent Life Annuity, a product that would pay income if the policy holder lived to age 85 and suffered a portfolio loss during the early, critical years of retirement.

“The creation of a standalone ruin contingent life annuity would be a triumph of insurance and financial engineering,” says Milevsky, echoing the conclusions of a white paper he authored on the subject in September of 2007 with two other York University professors.

“On the one hand, it is a type of long-term equity put option, but it also provides true longevity insurance.”


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