Something extra: purchasing longevity insurance can extend retirees' financial good life, but the industry has to design the right product first.

Retirement financial planning includes provisions for a lifetime stream of income. But, that advice often falls on deaf ears when it comes to selecting the life insurance industry's product designed to accomplish that: an immediate annuity.

Along with setting appropriate lifestyle expectations and investing in friendships, buying a guaranteed, predictable income was one of seven essentials of a happy retirement listed by Wall Street Journal financial writer Jonathan Clements in a July 2005 column.

Clements said research suggests seniors who are receiving traditional company pension benefits are happier than those who have to rely solely on the savings they have amassed in 401(k)s and other defined-contribution retirement plans. This advice raises an interesting dilemma, however, for the wave of baby boomers nearing retirement and their retirement advisers.

For many of the boomers, especially those employed in the private sector, much if not all of their company-sponsored retirement benefits are in the form of a defined-contribution plan. Clements suggested that these people use a portion of their retirement nest egg to buy an immediate fixed annuity. Unfortunately, the consulting firm Milliman and others have found that people are reluctant to purchase a lifetime income, and there lies the problem.

In Clements' column the following week, he described what he considers a new product, "longevity insurance," that goes a long way toward solving this problem. Actuarially, the product is simply a pure deferred annuity--no surrender or death benefits. It is not really new and is described in a paper written by Moshe A. Milevsky, "Real Longevity Insurance with a Deductible: Introduction to Advanced-Life Delayed Annuities." As described by Clements, the design has more appeal to the upper-income markets, so changes are needed to make it attractive to middle-income consumers. By changing the design, along with appropriate sales and marketing efforts, longevity insurance can become a popular product.

Product Design

The policy benefit for affordable longevity insurance is a guaranteed monthly income deferred to age 85 and continuing as long as the policy-owner (or spouse) is alive. The policy is purchased at retirement in a single-premium format as discussed by Clements; prior to retirement in the form of periodic premiums terminating at retirement, as suggested by Milevsky; or in a series of payments soon after retirement. To the extent that tax-qualified money is used to pay premiums, special consideration is needed because of the minimum distribution requirements.

One of longevity insurance's design elements that may be unattractive is that there is no payout if the beneficiary dies prior to inception of the monthly income. (See "Longevity Insurance's Challenges;' pg. 82.) This design element is important because, actuarially, it's what provides the leverage for the insurance company to turn relatively small premiums into significant monthly income for survivors. The sales context of the product and the marketing terminology (focusing on income rather than savings) ought to be able to minimize this particular objection.

For the middle-income market, periodic premiums may be more attractive than a lump-sum payment withdrawn from the retiree's retirement assets. This softens the issue of loss of control of assets. It also puts this product more in the context of a defined-income retirement benefit insofar as each premium can be thought of as a purchase of more guaranteed monthly income and not a deposit into a "savings account."

If sold as an adjunct to an existing defined-contribution retirement plan, it probably makes most sense for the premiums to stop at retirement age rather than to continue until the monthly income starts.

Hypothetical Premiums

To get a sense of what a product like this might cost, Milliman developed a set of hypothetical premiums and based them on reasonable experience assumptions, significant distribution costs (higher than traditional deferred annuity), capital requirements and a 10% profit target. Since the product will not have a cash surrender option, the assumed lapse rate is zero. If a policyowner terminates his or her premium payments, the nonforfeiture benefit will simply be an appropriate reduction in the monthly income starting at age 85.

The following table shows monthly premiums, payable to age 65, for different issue ages for a 100% joint-and-survivor monthly income of $1,000 starting at age 85.

While consistent with Clements' example, the cost at issue age 64 for this product is about 8% higher. Milliman's pricing assumptions are likely to be different from those of the company in Clements' example, and Milliman is using a joint-and-survivor income benefit that is more costly than a single life annuity.

Marketing

To see how this product might be sold, particularly in the middle-income market, consider a 45-year-old couple. Assuming their retirement plan is likely to be a defined-contribution plan and they want to maximize their financial security in retirement, they should expect to purchase an immediate annuity upon retirement. The single premium for a joint-and-survivor annuity of $1,000 per month starting at age 65 would be $195,500. Given today's defined-contribution participation rates, a retirement account of this size is a reasonable expectation for a middle-income household.

Unfortunately, it is unlikely that the hypothetical couple will purchase a life annuity upon retirement. As an alternative, starting at age 45 they can divert $100 of monthly contributions to the purchase of joint-and-survivor longevity insurance that will provide an income starting at age 85. Their retirement account would be approximately $40,000 smaller, assuming their retirement plan credited an interest rate consistent with that used to determine the premiums described and adjusted for reasonable investment fees. Their fund at retirement would be $155,000. Thus, their longevity insurance is simply a reallocation of approximately 20% of their retirement savings. They would use their retirement savings to fund the first 20 years of their retirement.

After 20 years, if either were still alive, the longevity-insurance monthly income would commence. For the 20 years prior to age 65, they could either purchase a 20-year certain annuity, which based on current market rates would provide them $950 of monthly income until age 85, or manage it themselves. If they wanted to maintain control (one of the reasons given for not purchasing retirement income), they could take a monthly income of $970 until age 85, assuming a consistent interest rate adjusted for investment expenses.

All other things being equal, the best deal for the hypothetical couple is to maximize their retirement plan contributions and purchase an annuity. If they want to maintain control, either complete or partial, and provide a residual estate until they reach the end of their life expectancy but hedge their longevity risk, the cost is approximately $30 to $50 in reduced monthly income during the first 20 years of retirement. Alternatively, they could increase their retirement contributions $13 to $21 a month and still have $1,000 of monthly income.

Institutional Reluctance

Milevsky also detailed a number of institutional impediments to successfully implementing this product. It is worth reviewing his list and commenting on possible solutions.

Monthly Premiums--Traditionally, income annuities are purchased with a lump sum. Administrative and valuation systems do not anticipate annual, let alone monthly, premium payments. (In fact, Milliman had to modify its pricing software, MG-ALFA, to handle the reserve calculations for its hypothetical product.) This should simply be a modification to the administrative system using logic currently used for universal life policies.

Delayed Period--Again, traditionally the benefits for an income annuity commence almost immediately, so a delay of 30 to 50 years is not the norm for the annuity line of business, but this is not unusual for permanent life insurance. Life insurance companies have managed the administrative issue of longer term business. They also have managed the investment risk associated with 50-year guarantees.

Inflation Indexing--This is a common feature available for life insurance and, while it adds some complications to the product, there are various approaches that can be taken. Another option would be a feature analogous to a participating whole life dividend-purchased paid up addition. There would be a guaranteed income starting at age 85, but prior to that, if company experience were better than assumed in the pricing, credits (dividends) would be applied to purchase additional guaranteed monthly income.

No Death Benefit--There is a concern that the policyowner may pay premiums for 30 or 40 years and then die right before the benefits start, potentially a public relations nightmare. Limiting premium payments to age 65 and clear communication of the benefits are a part of the solution. Actuarially, it would not be very difficult to add some type of death benefit--for example, a return of premiums for death either prior to age 65 or prior to the commencement of the income payments. On the other hand, such additional benefits have a cost.

These do not seem to be insurmountable problems and are very similar to those faced by permanent life insurance companies for years.

While the name "longevity insurance" may be new, the actuarial concept is not, and versions of it are currently available. As Milevsky has pointed out, the current designs do not go far enough to solve the shortcomings of current retirement-income annuities, especially for middle-income retirees.

Building on his design with features such as short premium-payment periods and appropriate distribution margins for marketing and training, this product can be made attractive to the middle-income market and the financial advisers who serve that market.

Key Points

* The policy benefit for longevity insurance is a guaranteed monthly income deferred to age 85 and continuing as long as the policy-owner (or spouse) is alive.

* Pre-retirees and retirees are reluctant to purchase lifetime income.

* Longevity insurance can become a big seller if its design is changed to be more appealing to the middle-income market.

Contributor Douglas Bennett is a consultant and actuary in the Hartford, Conn., office of Milliman Inc.

Joint-and-Survivor
Longevity Insurance

                       Issue Age

                      45        55        64
Monthly Premiums    $100      $260    $3,000

Longevity Insurance's Challenges

Although an immediate annuity could provide many of the same benefits
as longevity insurance, people are not currently annuitizing their
retirement nest eggs. Marketing longevity insurance requires overcoming
some of the objections to annuities.

Why Retirees Don't                  How Longevity Insurance
Want to Buy Annuities               Addresses These Objections

1. Typically, an annuity doesn't    1. If a premature death occurs,
provide a death benefit so there    there is no need for retirement
is no residual estate associated    money. Also, if the children were
with this solution, which is        the intended beneficiaries, they
important to many of today's        should have their own retirement
retirees.                           plans by the time their parents
                                    are 85 years old.

2. Retirees don't like              2. For the first 20 years after
transferring control of their       retirement, the policyowners can
retirement assets to an insurance   continue to manage their
company, even though it appears     investments. After reaching 85
retirees aren't exercising much     years old, it might not be a good
control over their retirement       idea for them to manage their
planning.                           investments.

3. Consumers dread the              3. Longevity insurance is a bet
possibility of purchasing a         between the policyowner and the
lump-sum annuity and dying before   insurance company. Nevertheless,
getting their money back.           with this product, it is a much
                                    smaller bet in terms of dollars
                                    the policyowner has wagered.

4. Consumers admit to being         4. Longevity insurance is a simple
confused about their options,       product that includes a significant
which keeps them from doing         distribution margin, which should
anything.                           allow for training sales
                                    representatives to address the
                                    perceived consumer confusion about
                                    retirement options.

5. When presented with a            5. If, through product marketing,
guaranteed income option,           the consumer value proposition
retirees believe the monthly        consistently communicated is
income is low relative to the       "monthly premium needed to purchase
lump-sum purchase price of the      monthly income," the lump-sum
annuity.                            purchase disappointment is avoided.

6. Financial advisers seldom        6. The redesigned product's
recommend the guaranteed income     significant distribution margin
option.                             provides the resources to train and
                                    motivate financial advisers/agents
                                    to talk to customers about
                                    longevity insurance.