Don Ezra’s “Most people need longevity insurance rather than an immediate annuity” (A review)

 In a nutshell

 Ezra argues that the vast majority of retirees will be better of purchasing a longevity annuity rather than an immediate annuity.  He opines that “the so-called annuity puzzle is not a puzzle…(but) if longevity insurance were widely available but still shunned, then that would indeed be a puzzle for social scientists to investigate.” Ezra wants financial advisors to recognize the need for longevity risk mitigation and wants insurance companies in Canada/UK/Australia to start offering longevity insurance, much like in the US. Ezra’s paper in the CFA Institute’s Financial Analysts Journal is well worth reading for those contemplating annuities and longevity insurance options are available. For those in Canada you might consider writing to your minister of finance to encourage him to add this option to the CPP and encourage insurance companies to offer such products.

The details

He categorizes retirees into three groups: (1) “those with assets so large that there is no chance of their ever outliving their wealth”; they don’t need longevity insurance, (2) “those with assets so small, that together with their national retirement plan (like Social Security and CPP/OAS), they have barely enough for their essential needs”; they have no choice but getting some sort of longevity insurance, and (3) “most retirees-the middle of the road retirees, being at neither of these extremes-by definition have enough money to make choices but not so much that longevity risk does not matter to them.”

The goals of this 3rd group, the bulk of retirees, are as follows: safety, growth and longevity insurance. The most risk averse in this group may buy immediate annuities “if they are prepared to ignore inflation” and “if they prefer to downsize their lifestyle permanently to what is affordable (of course if inflation is a permanent fixture during their retirement, the downsizing will be continue progressively and indefinitely). Most retirees tend to choose to include growth investments such as equities. A few might decide to annuitize part of their assets to cover their essential expenses together with Social Security like pensions; but very few appear to take this partial annuitization approach. However to address longevity risk, which he essentially defines as living past life expectancy (for any age group is the age before which half are expected to die and half are expected to outlive), potentially up to lifespan (the maximum age), instead of an immediate annuity he recommends risk pooling using longevity insurance (e.g. deferred lifetime income stream starting at say age 85, or later, for a 65 year old).

Reminding the reader that annuities are insurance (not investment) he notes that insurance is most appropriate to mitigate low probability by high negative financial impact situations. So longevity annuities/insurance is more appropriate than immediate annuities for most individuals/couples. Ezra then quotes Hu and Scott who argued that “…purchasing an immediate annuity appears to be a gamble that increases overall risk, rather than a form of insurance that can reduce risk”.

Bottom line

Therefore he asks financial advisers to put aside their antipathy for annuities and “recognize the huge risk-mitigating effect of longevity insurance”. He also asks “life insurance companies (in Canada, UK and Australia) to consider writing longevity insurance”.

Readers of RetirementAction.com won’t find Ezra’s conclusions surprising. I have been a long-time advocate of longevity insurance, and its desirability over immediate annuities for longevity risk mitigation. Some of the blog posts may be read in the Longevity Insurance post category at this website.

The simplest implementation mechanism in Canada would be to allow a longevity payout option in Canada Pension Plan for a portion of one’s CPP income stream as discussed in PRPP or expanded CPP? Consider adding a pure longevity insurance payout option to the CPP (and this would not require engagement of the obviously reluctant life insurance companies in Canada or might encourage them to provide such products). Another approach could be to emulate the US where longevity insurance options are now permitted without affecting RMD rules in 401(k) deferred tax accounts.

For the vast majority of retirees to whom longevity risk cannot be ignored, longevity insurance is the appropriate solution, rather than an immediate annuity. Those still considering an immediate annuity might also be interested in looking at qualitative and quantitative consideration referred to in  Will that be annuity or lump-sum?.

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