As discussed in a recent post, ultra low interest rates are an enormous burden for retirees. Low interest rates make it difficult to produce reasonable levels of yield and increase the present value of future liabilities (retirement spending is a liability).
One positive associated with low interest rates is the relatively low cost of debt. This is clear to anyone who has or will consider refinancing a mortgage. The problem is that, in general, retirees are at a stage in life where they are assuming less debt than those in their 20s and 30s.
There is, however, a potential silver lining to the low interest rates environment in the form of what is referred to as mortality yield.
Income annuities provide their owners with a yield component that is in addition to what is provided by fixed income securities (bonds). This mortality credit or mortality yield is attributable to the premiums paid other annuity owners (who are part of the same insurance “pool”) who die earlier than expected.
The mortality yield increases with age and can result in an overall yield that is significantly higher than what is available through other fixed income investments.
In a nutshell, the total return provided by an income annuity has two parts. The first is the fixed income yield and the second is the mortality yield.
When interest rates are very low as they are today, the fixed income portion of the overall yield is very low. The flipside of this, though, is that the absolute level of the mortality yield is very high.
Moshe Milevsky's Implied Longevity Yield provides some indication of the value of the mortality yield. Milevsky writes that during the period between 2000 and 2004, the Implied Longevity Yield (ILY) value varied from a low of 5.45 percent to a high of 6.9 percent for males, and from 5 percent to 6.42 percent for females.
For retirees who are starved for yield, it might be worth taking a look at an income annuity because low interest rates magnify the importance of the mortality yield.
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