Longevity Insurance - What Are The Options?

Tan Kin Lian

The Government plans to introduce a longevity annuity in 5 years' time. On reaching age 55, a Central Provident Fund member will be required to use a part of the Minimum Sum to buy a longevity annuity that will pay $300 a month from age 85.

Many people think that the chance of reaching age 85 is very small. They are mistaken. According to my estimate, over 50% will survive to age 85 and beyond.

You do not believe me?

I studied the death rates published in Population Trends by the Department of Statistics. It gave the death rates for each age group over a period of 25 years from 1980 to 2005. Death rates have been falling over this period by an average of about 3 percent yearly.

I took the death rates in 2005 and projected it for the future years, assuming that this decline will continue. This is likely to be the case, at least for the next 10 to 20 years. It has been declining at this rate for the past 25 years. Why should it stop now?

Based on my projection, a male at age 55 today has a 57% chance of surviving to age 85 and 32% chance of surviving to 95. The chance for a female is higher at 70% and 42% respectively.

If you still do not believe me, you must remember this point. I am referring to people who are 55 years today and living for the next 40 years or longer. This group will have a longer lifespan compared to the older people living today. We are talking about the future, that is, the next 40 years.

What is the cost of the longevity annuity?

I assume that the annuity provider (that is, the Central Provident Fund or an insurance company) is able to earn an investment yield of 4% and that they do not make any loading to cover their operating expenses or profit margins.

I calculated the cost of the longevity annuity to be $6,818 for a male and $8,759 for a female. This is the cost to be paid at age 55 for a monthly payout of $300 from 85 for the lifetime of the annuitant.

The cost to females is higher, as they have a longer lifespan and is likely to receive the longevity payment for several years more than males.

If the annuitant lives for 10 years from 85 to 95, the total payout will be $36,000 (that is, $300 X 12 X 10 years). This will be many times of the original sum paid to buy the longevity annuity.

The longevity annuity can pay out much more for the following reasons:

Many people do not like the idea of losing their money, in case they do not survive to age 85.

It is possible to design a “full refund” annuity that will return the original sum on the death of the annuitant. But, the cost will be much higher. My estimate is $9,824 for a male and $11,594 for a female.

Under this annuity, a male pays $9,824 at age 55. On the death of the annuitant, whether it occurred before or after age 85, the original sum of $9,824 will be refunded, without any interest. If the annuitant dies at 95, he would have received $300 a month for 10 years and his estate would still get the refund of $9,824.

Compared to the “no refund” annuity, the cost of this “full refund” annuity is 44% more for a male and 32% more for a female.

There is another criticism of the longevity insurance. The sum of $300, which is already inadequate, will be further eroded by inflation. $300 a month in 30 years' time will be worth much less than $300 today.

This can be addressed by designing an “increasing” annuity. The payout will be $300 a month by 2% yearly to cover inflation. In 30 years' time, the payout will be $543 a month, instead of $300 (that is, $300 increased by 2% yearly for 30 years). The payout will continue to increase by 2% each year.

To provide this “increasing, no refund” annuity, the cost is $15,137 for a male and $19,548 for a female.

I must state that the increase of 2% yearly may not match the actual inflation rate during the year. At least, this does offer some protection, compared to a “flat” annuity.

What is the cost of an “increasing” annuity that also provides a “full refund” on death?

I estimate that it will cost $28,923 for a male and $32,991 for a female. It can get quite costly, if you wish to have a full refund, and also an increasing sum to keep up with inflation.

What is my recommendation?

Go for the “increasing, no refund” annuity, if you are in fairly good health and are not aware of any serious medical problem. Stay healthy and live a long life. Enjoy your golden years to 95 or longer.

If you are in poor health, you can buy the “increasing, full refund” annuity.

But, what is really my recommendation to the Government?

Encourage people to buy a life annuity that pays from age 65 and for a lifetime. The life annuity will give them a steady income payable for a lifetime.

They do not have to worry about managing their retirement account for 20 years and be subject to a fluctuating interest rate that is pegged to the yield on Government bonds. They will also not suffer a decline in their income when they reach 85 years old.

If the life annuity is administered by the Central Provident Fund and the annuity payout is calculated using an interest rate of 4%, the payout can be quite attractive. These life annuitants should be exempted from the longevity annuity.

Disclaimer : The calculations are based on the mortality rates taken from the population, with projection for future improvement in mortality. It assumes an investment yield of 4% per annum and ignores expenses and profit margins. These calculations are made to educate the public about the principles of a life annuity and do not reflect the commercial terms that may be offered by any specific annuity provider.

Tan Kin Lian qualified as an actuary in 1975. He served as the chief executive of NTUC Income for 30 years, prior to his retirement on 31 March 2007 . Currently, he is also the Chairman of the Centre For Seniors.