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May 12, 2015 at 11:28 AM
Just like the Spring temperatures, annuity sales are also heating up. Despite interest rates remaining at an all-time low, annuity sales continue to increase. According to LIMRA’s recent report for the United States, “Immediate income annuity sales spiked 17 percent in 2014, totaling $9.7 billion.”
Boomers are learning about the importance of securing guaranteed lifetime income and, with help from advisors, they are reaping the benefits of a secure retirement. Although our industry should be content with the increase in annuity sales, we must take a step back and remind ourselves of Econ 101: supply and demand.
What do I mean? As more and more boomers approach retirement age and obtain annuities to cover their basic expenses, this demand, coupled with increasing life expectancies can have a dramatic effect on payout rates for future purchasers. Let me explain…
Last October, the Society of Actuaries (SOA) Retirement Plans Experience Committee (RPEC) released the final report of the RP-2014 mortality tables. The updated tables display a consistent trend of increased life expectancy. Dale Hall, managing director of research for the SOA stated that, “The purpose of the new reports is to provide reliable data that actuaries can use to assist plan sponsors and policy makers in assessing the financial implications of longer lives.”
Let’s start by taking a look at the chart below, which highlights the differences between the 2000 Mortality Tables vs. the 2014 Mortality Tables:
We see a 2.4 percent increase in life expectancy with 65 year old males and a 2.8 percent increase in life expectancy with 65 year old females. If we were to continue on this trend for the next 14 years, in 2028 we would anticipate to see life expectancy rise to 88.6 years (for males 65 years old) and 91.2 years (for females 65 years old). With increased improvements to medical technology, I predict that we will see significant additional growth in life expectancy and should expect it to rise even greater than the trends indicate.
The updated mortality tables will require insurance companies to lower their payout rates in order to properly reflect longer life spans. Advisors are in for a quite a shock when they see these adjustments. I’m talking about payout rates going from 14 percent to 10 percent, from 9 percent to 7 percent, and from 7 percent to 5 percent. These will not be small adjustments.
People are always asking me why they should buy an annuity in today’s low interest rate environment. I say that today’s rates are not low. These are the new rates. Today’s rates could be the highest rates you see for a very long time. (You can check out my reasoning on the video below: Tom Hegna’s 2015 Economic Summary). Income annuities are really not an interest rate play. They are a longevity credit play.
When it comes to lifetime income annuities, most people don’t realize how these products are able to offer such high cash flows and payout rates. These humble annuities offers something that no other product can offer: longevity credits, otherwise known as mortality credits. This is what separates income annuities from other investment options.
Cash flow from an income annuity hails from three different sources: interest, a return of principal, and mortality credits. Traditional investments can typically manufacture two of these components — interest and return of principal. More importantly, only life insurance companies can manufacture mortality credits.
