Longevity insurance

Longevity insurance, insuring longevity, is an annuity contract designed to pay to the policyholder a benefit if he or she survives to a pre-established future age.

Longevity annuities are called the "reverse life insurance", meaning premium dollars are collected by the life insurance company by its policy holders to pay income when a policy holder lives a long life instead of collecting premium dollars and paying a death claim on a policy holder's short life in regards to life insurance. Longevity annuities use mortality credits to pool money and pay out the remaining policy holders' claims, this being living a long life.

The term "longevity insurance" comes from this type of annuity being insurance against unusually long life. It may seem odd to insure against an event that most people would welcome. However, living a very long time would strain many people's financial resources, just as a fire which destroys their house would strain many people's finances if they didn't have fire insurance. The logic that makes fire insurance a prevalent means for coping with the financial risk of house fires would seem to argue for greater use of longevity insurance for retirement planning: Few people will live to a very old age, so it doesn't make sense for everyone to try to cover that possibility with savings and investments. (The same type of reasoning applies to house insurance: because few people will experience house fires, therefore it is not realistic to expect everyone to save and invest specifically for purposes of house replacement.) Longevity insurance is not designed for the early retirement years, so it is not intended as a complete retirement plan by itself.

While any lifelong annuity is longevity insurance in the loose sense, in the stricter sense it is a policy that only begins payments to the policy holder at a rather high age, e.g. 85, and is purchased many years before reaching that age.

For example, a person might pay $20,000 from his or her retirement savings at age 60 to purchase longevity insurance that would pay $11,000 per year starting at age 85 and continuing until death. These numbers are made up, but are based on actual terms offered by at least one major insurance company in November 2011. Thus, in this example, if the person lived to 95, they would receive $110,000 on their $20,000 investment (10 years at $11,000/year). This is a rate of return that far exceeds that available at prevailing interest rates on government bonds. The economic reason for the high return at low risk is that one is giving up any claim on that initial $20,000 investment on behalf of one's heirs. If you die the day after buying the policy, or at any age before 85, the insurance company pays nothing to you or your estate. (Some companies offer optional features that would modify this so there would be a death benefit or so you would have the option of starting payments sooner, but taking these options would substantially reduce the annual income the policy would pay at age 85).

The benefit is generally paid in the form of a guaranteed income stream for the remainder of the individual's life (as in the above example), though alternative benefit forms may be provided depending on the terms of the actual policy. Life insurance companies in the United States that offer longevity policies include Metropolitan Life Insurance, New York Life, Symetra Life Insurance Company and Hartford Insurance among others. The main use of these products is to provide retirees with a way to stretch their retirement resources to cover the possibility of living to a very old age. The likelihood that many buyers of such an annuity will not live to collect on it allows the insurance company to pay high investment returns (i.e., higher than are available on other low-risk assets) to the fraction of buyers who do live that long. The benefits are even greater now that the Treasury Department has issued a new rule allowing the purchase of longevity annuities within an IRA, without having to include the value of the annuity in the annual required minimum distribution at age 70 1/2, which is taxable as ordinary income. That effectively reduces the amount of the IRA subject to the required distribution, resulting in a tax saving every year until the payments eventually begin. (Those payments are then also taxed as ordinary income.) The insurance company is legally obligated to make the payments stipulated in the annuity contract, but this obligation might not be enforceable if the company goes into bankruptcy. Therefore, prospective purchasers are generally advised to investigate the financial strength of the issuer before buying longevity insurance, and to consider splitting whatever amount they have earmarked for this purpose among several different contracts from different companies, so that if one goes bankrupt they will still have income from the others. In the United States, states generally require insurance companies to be members of state guaranty associations which would very likely pay at least some portion of the benefits promised if the insurance company went bankrupt. Prospective purchasers are also advised to bear in mind that inflation may dramatically increase the amount of income they will need decades into the future.