Co-written by Noel Abkemeier
As annuitant mortality continues to improve steadily, it indicates a growing longevity risk for retirees. This is highlighted in the recent 2000-04 Individual Payout Annuity Experience Report
from the Society of Actuaries. The report provides insight on characteristics of people who purchase single premium immediate annuities and individuals who annuitize deferred annuities. This suggests new approaches to longevity risk management, which producers need to keep in mind for their clients.
Longevity continually improves
This is the first comprehensive study of individual annuitant mortality since 1983. The study indicates that the projected mortality improvement (estimated at the time of the earlier study) was realized for males, although only half of the expected improvement materialized for females. However, even after the slowed improvement, female mortality is still only 65 percent of that of males at age 65. The data indicate that mortality -- and therefore longevity -- improved during the five years of the current study. And, there is no reason to expect the improvement to stop.
What does this mean for retirement planning? While longevity is a known financial risk, its importance will grow year after year. The improvement is due to many factors: healthier lifestyles, environmental improvement and continuous health care improvement. It is important to note that longevity improvement will be magnified if there are significant life-extending medical breakthroughs in the future. All of these findings indicate that managing longevity risk should remain in the spotlight.
Longevity risk is dynamic
Currently, there is insufficient attention paid to addressing longevity risk. Too often, financial planning ends with addressing income needs only through average life expectancy, which is approximately age 85 for male annuitants and age 87 for females. But, planning only through life expectancy is like pretending that longevity risk does not exist. In fact, longevity risk begins at life expectancy -- the risk that someone will live longer than average. There is significant and growing probability of living to age 90, 95, or even 100 or more. When planning for the future, individuals need to recognize the possibility of a very long life and the uncertainty of how long that might be.
The life expectancy mentioned above may be higher than the ages commonly cited, but there are two important factors that elevate it. First, annuitants are healthier than the general population because annuities are generally purchased by individuals with above-average health who figure they will gain the most advantage from an annuity purchase. Another dimension that is seldom figured into life expectancy is that mortality improves each year, adding approximately 1.5 years of life expectancy that is usually overlooked.
Smart annuity shoppers?
Based on the available actuarial mortality data, annuitants -- perhaps with the help of financial advisors -- are smart shoppers. Mortality rates for purchasers of non-refund annuities (payments stop at death) are only 80 percent of those for purchasers of refund annuities (annuity includes a certain period or other refund feature). This reflects that there is an expectation of a benefit advantage among non-refund annuity purchasers, and the appreciation of a financial safety net among refund annuity purchasers. Either approach creates longevity risk protection -- one starts immediately and one starts at the end of the certain period. The correlation of annuity choice with health status suggests that retirees understand longevity. The problem is that not enough retirees purchase annuities to address the longevity risk. Perhaps the solution is not presented to enough of them.
Who are the best candidates to benefit from an annuity? The purchasers of annuities with high annual payouts show much lower mortality than purchasers of small annuities. A male, age 65, who purchases an annuity with an annual payout of more than $50,000 shows mortality one-third lower than someone who purchases an income of less than $2,500. The improvement is approximately one-fourth lower mortality for a female. Although the amount of an annuity does not necessarily indicate an annuitant's net worth, there still may be a correlation between the two. Are high income annuitants more astute purchasers or has their opportunity for a healthier lifestyle made their purchase more advantageous? Regardless of cause, there is reason to consider annuities for retirees with larger retirement assets, because they are positioned to benefit the most.
Even if an annuity is not used, the data suggest that the planning horizon should be longer for higher income individuals. At age 65, each 10 percent reduction in mortality indicates an approximately one-year increase in life expectancy.
Longevity risk solutions
What is the best way to manage longevity risk for your clients? Traditionally, it has been an annuity with a portion of the benefits payable only while the annuitant lives. Typically, this has been a life annuity with a certain period -- such as 10 years certain and life -- which is still a good solution. A more recent solution is a deferred start income annuity. For example, a small single premium paid at age 65 provides an income that begins at age 85, and there are no death benefits or surrender benefits. This is a type of "longevity term insurance" that could terminate without value, but provides a very efficient and low cost income guarantee for later years, when income management can be very challenging due to advanced age or depleted assets. Although it could terminate without value, the deferred start income annuity must be viewed in context with the balance of a retirement portfolio that it is protecting and allowing to include greater freedom of investment choices. A less direct approach to longevity risk protection is through guaranteed lifetime withdrawal benefits on accumulation annuities and some mutual funds.
When you fully understand a question, then the answer becomes obvious. Mortality experience and its impact on longevity clearly indicate that longevity is a growing risk. The issue becomes: What steps will be taken to manage this risk?