Bonds Have Interest Rates, Stocks their Dividends, Annuities Longevity Credits

Mortality Credits the New Alpha

There is no other investment or savings funding tool that can guarantee lifetime income except annuities. As an individual the average male lives 86.6 years and the average female lives 88.8 years. The surviving spouse in a marriage averages living to age 93.  87% of the time the surviving spouse is a female. Half of all Americans will live longer than those averages.  If the surviving spouse average is age 93 that’s 31 years from age 62 which is the starting age for many guaranteed lifetime annuities. So the average internal rate of return for lifetime annuities is benchmarked at age 62 for 31 years. Those returns could be somewhere around 3% net of all product expense loads. It could be 4%+  if those at age 93 live to age 100. How can annuity manufacturers guarantee lifetime income? The answer is mortality credits.

The theory uses the law of large numbers and those who don’t survive the averages are credited to those who did survive the averages. Mortality credits are not correlated to the market returns like those of bonds and their credited interest or stocks and their dividends earnings. They’re based on surviving the odds. If Jeanne Calment owned a guaranteed lifetime annuity, every day past her 79^th birthday was beating the bank or in this case, the insurance company who issued the policy. That’s 43 years beyond the actuarial mortality projection. Had she owned an annuity, the rate of return would have been staggering. At that time annuity carriers were paying significant returns on the basis of high interest rates.

Let’s say that five women formed an investment club. In addition to their investments they decide to put aside $100 each into a box and seal it until a year has lapsed. But during that year, one of the investment club members died. The surviving four women split the money up 4 ways and experienced a 25% return, each receiving $125. There was no market risk, just mortality credits. Guaranteed lifetime annuities take the longevity risk off the table, but for those living past the averages it pays a great return. And one last point: if the guaranteed lifetime annuity is non-qualified, the original basis comes out tax-free and partially FIFO (first in first out.) You have guaranteed bills forever in retirement that should be paid by guaranteed income and not the potential of market returns.