How to Think About Longevity Insurance

A recent article discusses whether it makes sense to consider buying a longevity annuity.

The author addresses the question from an investing perspective.  He provides an example of a 65 year old person who uses $10,000 to purchase a longevity annuity that begins payments at age 85.  At 85, this person would begin receiving monthly payments of $700 that last for a lifetime.

The author notes that this person has about a 50/50 chance of actually living to age 85, so it is quite possible that they may not live long enough to see a return on their $10,000 "investment."  That said, it is suggested that it will only take about a year and a half for this person to recoup their entire $10,000 "investment" should they live until age 85.

There is a fundamental problem with thinking of annuities as investment products.  Annuities are insurance products, and their core purpose is to provide guaranteed income.   The "guaranteed" part of guaranteed income is where the insurance is really useful because it addresses all sorts of nasty risks--such as longevity risk, market risk, sequence of returns risk--that people face in their retirement.

Think, for example, about homeowners insurance.  People buy it because they cannot deal with the remote yet quite possible risk of having their home destroyed by fire, flood, wind, etc.  They understand that a relatively small monthly insurance premium in exchange for a big financial backstop is reasonable and responsible.

It is useful to think of a longevity annuity in the same way.  While the possibility of living until age 105 may seem remote at age 65, who wants to be in the position where they outlive their money?  Doesn't it make sense to take a portion of your savings to buy an insurance policy that guarantees you will always have income? 

With investments, people naturally think in terms of gains, losses and terminal or ending levels of wealth.  This approach really does not make sense when applied to annuities and guaranteed income. 

The reality is that looking at annuities through an investment lens likely creates psychological barriers to prudent actions that are necessary to deal with real concerns such as longevity risk.