December 1, 2010 / 6:07 PM / 9 years ago

Do you need longevity insurance?

(REUTERS) - We insure our homes against the risk of theft and fire, and our cars for the risk of an accident. But how about insuring ourselves for the risk of living too long?

An elderly women rests on her wheel chair in a hall of the senile dementia building of the Canevaro old people's home in Lima March 25, 2010. REUTERS/Enrique Castro-Mendivil

The odds are rising that more Americans will run out of money in old age. Average longevity is rising dramatically at a time when many older Americans are struggling with damaged retirement accounts, unemployment and rising expenses for healthcare.

Meanwhile, Social Security is on track to replace less pre-retirement income in the years ahead, due to a higher full retirement age mandated back in 1983 and Medicare Part B premiums; any further cuts implemented now as part of deficit-cutting would erode Social Security’s value even further.

Earlier this year, the Employee Benefit Research Institute (EBRI) reported that many American households in all income brackets won’t have enough cash in retirement to meet expenses in retirement. EBRI’s 2010 Retirement Readiness Rating study projected that almost one-third of Americans in the second-highest income bracket will run out money after 10 to 20 years in retirement. And, nearly two-thirds (64 percent) of Americans in the two lowest pre-retirement income brackets will run short 10 years out.

Think longevity insurance sounds like a good idea? If so, you’re in league with a handful of major insurance companies who have started offering such policies in the past few years. Longevity insurance policies are deferred income annuities that issue payments only when - and if — you hit an advanced age. It’s a variation on the plain-vanilla single premium immediate annuity (SPIA), wherein you fork over a chunk of cash to an insurance company at retirement, in return for lifetime checks that start immediately.

Longevity policies are much less expensive than SPIAs because of the deferred benefit feature - the insurance company gets to invest your money for a longer period, and if you don’t hit the target age you’ll never collect. For example, Hartford Financial Services Group quotes a joint and survivor longevity policy for a married 65-year-old couple at $49,779, which would pay a $1,500 monthly benefit when they reach age 85. That’s far less than the $314,913 it would charge that same couple for an immediate annuity offering the same monthly payout.

The idea is to insure that couple’s income in the event of advanced age. But they would also gain more flexibility in the way they spend down their assets in the intervening years.

“The power of this product isn’t what it does at age 85,” says Robert E.

Sollmann, Jr., executive vice president for retirement products at MetLife. “The power is what it does right away because having that liability for longevity taken off table gives you much more flexibility in how you invest money and what you take from savings from retirement up until age 85.”

Pat Harris- Hartford Financial Services GroupStill, the market for longevity insurance has been slow to take off. “Relative to some other areas, it is still a small segment,” says Pat Harris, director of retirement income products at The Hartford. “We have found that people generally underestimate how long they will live. They aren’t thinking of living into their nineties, ninety-five or even 100 years.”

Concern about asset diversification also is a worry in the wake of the 2008 financial meltdown, even though insurers are regulated at the state level and policies are backed up—to a varying extent—by industry-financed guarantee funds. “Safety is a very legitimate concern,” says Harold Evensky, president of Evensky & Katz Wealth Management. “You’re talking about an investment you won’t be relying on for 20 years before you begin collecting, and then another ten or 15 years after that.”

SPIA risk can be hedged by buying annuities from several different carriers, but diversification is more difficult with a longevity policy, since so few insurance companies sell them. (The key players in the market are the Hartford and MetLife.)Harold Evensky - Evensky & Katz Wealth Management

Timing is another issue. Although Evensky likes the concept of longevity policies, he isn’t recommending them to clients just now because the ultra-low interest rate environment has pushed premium prices upward. “Since rates are at a historic low, we don’t think the decision to wait to buy is very risky,” he says. “We’re waiting for interest rates to start moving up to more normal levels.”

Longevity policies could play a bigger role as industry and government policymakers look for ways to beef up sources of guaranteed retirement income in the years ahead. In September, the Department of Labor, Internal Revenue Service and Treasury Department held hearings expiring ways to add lifetime income options to workplace retirement plans.

That could be an uphill battle. Most employees offered an annuity option at retirement don’t take it. Even TIAA-CREF, whose plans for teachers have long had annuity features - says only one-third of its participants choose to annuitize some portion of their assets.

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