Ask any group of retirees what their biggest financial concern is, and the vast majority will give you the same answer: running out of money. With lifespans gradually getting longer, the threat of outliving your retirement nest egg becomes increasingly dire all the time. And with a huge generation of retirees and near-retirees continuing to age, that threat is going to get a lot of attention in the years to come -- both from financial media sources and from Wall Street companies trying to profit from it.
As hard as it is to plan for the uncertainty of how long you'll live into your retirement years, a relatively new financial product has gotten a lot of attention lately, as it seeks to address the problem of potentially running out of money. As a variation on another product with a long and sometimes controversial history, so-called "longevity insurance" has some unusual characteristics that are hard to find in any other type of investment.
A pension for a pension-less world?
Longevity insurance gets its name from the associated problem it was designed to fix: longevity risk. Just as longevity risk defines the potential financial problems that arise from living too long, longevity insurance seeks to protect against that risk by focusing on solving those problems.
In the most basic terms, longevity insurance is a form of deferred annuity. Unlike immediate annuities, in which you pay an upfront premium and then start getting monthly payments in return right away, longevity insurance involves delaying those monthly payments for a period of time that can range from one to 40 years or more. The result of waiting is that your eventual payments are larger. For instance, an example cited in the Wall Street Journal cited a longevity policy that would pay nearly 10 times more than an immediate annuity -- but would only start making those payments 20 years in the future, when the insured turns 85.
Relatively few companies offer longevity insurance -- MetLife (NYSE: MET ) , New York Life, Symmetra (NYSE: SYA ) , and Hartford Financial (NYSE: HIG ) are the major players, and Hartford is planning to stop selling annuity products later this month. The reason may have to do with current economic conditions that are providing challenges to insurance companies generally.
The bane of low interest rates
Low rates are great for borrowers, but when you have money you're trying to put to work, they make it very difficult to generate strong returns over the long run. That's a challenge not only for you in your own saving but also for insurance companies selling products that promise returns in the future.
With even iShares Barclays 20+ Year Treasury (NYSE: TLT ) and similar investments in the longest-maturity, highest-yielding Treasury bonds paying only 3.5% or so, money that an insurance company invests in them takes 20 years to double in value -- and that doesn't even take inflation into account. The real yield on the inflation-indexed iShares Barclays TIPS Bond (NYSE: TIP ) is even lower, leaving investors with little or no increase in purchasing power over time. Moreover, that slow growth results in much lower annuity payments down the road, which in turn makes products like longevity insurance look less attractive than they would under a more typical interest rate environment.
In addition to current adverse conditions, longevity insurance has the same drawback as regular annuities: If you die before you reach the starting date for benefits, you'll typically lose your entire investment.
In addition, if you want payments that will rise with inflation, you'll need to accept lower initial payments or pay larger upfront premiums. Finally, once that money is invested, you typically can't get it back, meaning that you're out of luck if unforeseen financial problems leave you in a bind.
The smart part of your overall strategy
So technically, owning longevity insurance means you'll never run out of money in your old age. As soon as those payments kick in, you'll get them for life. Whether they'll be enough to live on is of course another question entirely.
Perhaps the best strategy for longevity insurance is to mix it with more conventional investing strategies. That way, you aren't betting everything on living well into old age, and you'll have some liquid assets available to handle any cash crunches. But especially if you have reason to believe you may live longer than average, looking into longevity insurance could make your retirement planning a little easier to handle.
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