We looked at longevity insurance as it applies to a sixty-five-year-old female purchasing a deferred income annuity with income starting at eighty-five. We may also consider the alternative of just waiting until age eighty-five and then buying an immediate annuity. During those twenty years, interest rates and mortality tables can change in unexpected ways, which will impact the future pricing calculations.
Exhibit 4.4 shows the calculated cost for this income annuity if we assume that interest rates and mortality data remain the same (an unlikely outcome, of course). An eighty-five-year-old will experience higher mortality rates and a shorter time horizon, reducing the cost of an income annuity at this age. In this case, the premium is $81,054, which raises the payout rate to 12.34 percent.
This payout rate is noticeably higher than that available at age sixty-five, but it is lower than that available with the longevity insurance contract. Longevity insurance contains two key differences: twenty years of asset growth within the contract and the survival-based discount a sixty-five-year-old receives, thanks to her lessened chance of living to eighty-five to receive income.
Waiting until eighty-five to make the purchase means sharing fewer mortality credits with the risk pool. If we discount this $81,054 premium by the 72.3 percent survival probability from age sixty-five and by twenty years of investment growth at 3 percent (a 55.4 percent discount factor), we arrive at the $32,444 premium (after rounding) for the longevity insurance contract.
Exhibit 4.4 Calculating the Cost of a $10,000 Income Stream for an 85-Year-Old Female (Life-Only)
Note: Survival Probabilities are calculated from the Society of Actuaries 2012 Individual Annuitant Mortality Tables with improvements through 2019.
This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon AMZN AMZN .
Source: Forbes – Money