Longevity annuities can provide lower-cost alternatives to fixed income annuities while also appealing to some public retirement plan sponsors who might want to cut their longevity risk exposure.
That’s the word in a study from the National Institute on Retirement Security (NIRS), which examined the potential that longevity annuities offer in providing a secure retirement to public employees.
Although defined benefit plans are both more cost-efficient and provide significant consumer protections while focusing on retirement income, the study said, the shift to defined contribution plans has exposed workers to longevity risk — the risk that their retirement savings may not be enough to last throughout retirement — and to adequacy risk — that their savings are not enough to meet their financial needs.
In addition, other risks — investment risk, in which retirement assets don’t earn enough, or actually lose value, and inflation risk, in which higher prices will outpace what retirement income can buy — also threaten their ability to retire financially confident.
While public-sector DB plans have been able to handle these risks successfully, said the study, “[p]ublic retirement systems regularly review their investment, economic, and demographic assumptions and trends to assess how these trends impact funding and retirement readiness.”
One trend that’s having an effect is longevity, and some systems have looked to annuities to help balance the risk inherent in paying more monthly income to retirees over longer lifespans.
In looking at annuities as potential solutions to the longevity problem, the study found that it’s not only more difficult to “generate a given level of monthly income from fixed annuities than from public DB pensions,” the price for doing so is considerably higher. “Depending on the interest rate used in the pricing of the annuity, the cost of using fixed income annuities to fund DB pension benefits can be anywhere from 57 percent to over 175 percent more than the cost under a public pension’s diversified portfolio,” the study said.
In addition, laws and regulations governing fixed annuities are substantially different from those governing public pension plans, varying widely from state to state, providing less protection for the recipient and “shifting the ultimate cost of protection against insolvency to state taxpayers.”
Longevity annuities, however, “focus on the insurance value and are less expensive than fixed income annuities.” Because they start paying out at a much older age than standard annuities, “[t]his allows individuals to capture most of the insurance value of immediate annuities, but at a fraction of the cost.”