The leading edge of the largest generation in history is turning 65 this year, riding the first swell of a demographic tidal wave that will reshape not only traditional concepts of retirement but also the financial services industry. That wave of retiring Americans-stung by economic upheavals and nervous about the precarious long-term health of their savings-could breathe new life into the slumbering market for longevity insurance and spur demand overall for other types of annuities.
The concept of longevity insurance-essentially, the term refers to a long-term deferred annuity that begins paying annual dividends when the client reaches an advanced age-is still relatively new. But it's an idea whose time may have come, a time when many aging baby boomers have been hammered by recession, shrinking nest eggs and jaw-dropping stock market volatility and been plagued by understandable fears of outliving their retirement savings. That means these boomers-and their financial advisors-might be ready to give something like longevity-driven investments a look.
"This product has only been around for six or seven years," says Keith Golembiewski, director of annuity product development for The Hartford, which markets a form of longevity insurance under the product name The Hartford Income Annuity. "It's going to take some time to resonate.
"We are seeing some difficulty with this low-interest-rate environment, and that hasn't made it easy to generate business, especially with the competitive products out there that are getting more sales and attention," Golembiewski adds. "But I think as interest rates rise and advisors and clients become more educated about the potential and the need for this type of product, you're going to start seeing more sales."
The potential market for longevity insurance and annuities in general is gargantuan. According to Robert Kerzner, president and CEO of the insurance industry group Limra, U.S. retirees and workers due to retire in the near future wield more than $16 trillion in total assets. And the insurance industry, he said at the Limra 2011 Retirement Industry Conference in April, is poised to capture a bigger share of those assets.
Anna Rappaport, president of Anna Rappaport Consulting and the former president of the Society of Actuaries, refers to longevity insurance as "deferred annuities that start at an advanced age, like 80 or 85. They don't have a cash value before that, so they only pay for the people who live to that age and can start to collect." For that reason, she notes, "They don't cost very much."
Led by MetLife, insurance companies began packaging guaranteed-income annuities as longevity insurance less than a decade ago. The concept has been slow to gain much traction among seniors put off by the traditionally high up-front costs of annuities and the uncertain returns. That was especially true given the relatively high returns retirees were generating through equities and other investments until the financial meltdown of 2008.
But the pendulum has swung back after the fearsome loss of equity value on Wall Street and the rise of a more risk-averse attitude toward investments, all at a time of increasing life expectancy. Those forces will likely propel demand for guaranteed, long-term, deferred-payment investments designed to assure financial security late in life, say investment advisors and insurance experts.
"This product is a sound solution for those seeking the attributes of guaranteed income similar to the pensions that their parents once relied on," says Chris Blunt, executive VP in charge of retirement income security for New York Life Insurance Company. With some type of longevity insurance product added to his or her portfolio, he adds, "the policyholder can enjoy and spend down his savings knowing that a secure income stream will begin at age 85."
The chief allure of longevity insurance-and the reason financial advisors should be adding it to their clients' investment portfolios-is the elimination of risk and fear for older retirees, says Peng Chen, the president of Morningstar's investment management division. "In retirement, people are dealing with multiple risk factors and uncertainty," Chen says. "And stocks and bonds really don't help that much."
Longevity insurance, he says, "helps you deal with that uncertainty and how you prepare for it."
The basic concept is simple enough: Swap a portion of your current retirement assets for long-term security by purchasing a form of insurance that guarantees you income for life, beginning at some future date. Longevity insurance, notes Tom Cochrane, an industry consultant and founder of the Annuity Digest, is nothing more than "a type of deferred annuity with a single, lump sum premium and a payout period that commences well into the future."
"The long deferral period," Cochrane writes, "allows for a lower up-front purchase payment."
An annuity is like Social Security, he continues, "in that money contributed over the course of one's working years is converted into a series of periodic payments that provide income during retirement ... as a financial vehicle that converts a pool of money into a stream of income.
"Annuities are unique in the financial world because they can provide protection against the risk of outliving one's assets ... by guaranteeing income payments in perpetuity or any other selected amount of time," writes Cochrane. "Longevity annuities are relatively new, but they represent a very powerful and efficient form of insurance ... as a type of personal pension plan."
Selling Peace Of Mind
One of the biggest selling points of longevity insurance is the fact that it eliminates uncertainty by capping the length of time retirees will have to rely strictly on their own investments to generate income when they're no longer working.
"In many cases, especially with our generation, which has no pension, an annuity is a way to replicate a pension and transfer the longevity risk away from the investor to the insurance company," notes one financial advisor who markets annuities and other investments for Smith Barney. "Their actuarial tables tell them you'll live, say, another 25 years. If you live more, you win."
"It does give retirees some additional flexibility," agrees The Hartford's Golembiewski. "You're able to have the peace of mind to say, 'We can invest in the equity market to outpace inflation, and if it doesn't work out, at least we have this protection.'
"You don't want clients to have most of their money in CDs today and Treasurys, earning no money," he adds. If they do, he says, "they're not going to outpace inflation, and if they live to age 90 or 95, the assets they have today are going to be worth a lot less than 20 years from now."
Retirees and older workers were handed a painful lesson in "the value of having a guarantee" with the hit their assets took during the economic crisis of 2008 and 2009, says Bennett Kleinberg, a senior actuary for MetLife, which pioneered the concept of longevity insurance in 2004. "We don't recommend anybody spend 100% of their assets on this type of product, but for a portion of your assets, it can help you do a lot by turning managing retirement into a defined time line and a more manageable product.
"The fact that you have that income covering you from age 85 onward allows you to take out more in retirement, and spend down your assets over a 20-year period and give yourself a higher level of income than if you didn't have the longevity insurance."
Kleinberg says that for a typical 65-year-old on the cusp of retirement, that kind of peace of mind could be bought for as little as 10% or 15% of his or her total investment portfolio.
Longevity instruments are "not a substitute for long-term care insurance," notes Rappaport, who now chairs the Society of Actuaries' Committee on Post-Retirement Needs and Risks. But they do provide an income stream at an advanced age "when you're most likely to need help" with additional medical costs, she says, adding that a client can also use longevity products to provide extra funds when he or she is likely to need paid help.
The Age Of Insecurity
Despite those pluses, those in the business of marketing annuities as longevity insurance to older Americans know they've been running uphill. They're pushing against the powerful headwinds of human nature: the inclination we all have to procrastinate and avoid unpleasant realities.
"Most of the actuaries I know think it's a wonderful idea, but from all I've heard from the companies that have tried to sell it, it hasn't sold very well," Rappaport observes. "Even though it helps people in the long run, a lot of people don't really understand it-or they don't think about the long run."
That avoidance is part of a larger problem. "It's apparent that Americans, specifically the baby boomer generation, have not saved enough money for retirement," says Rappaport. "With the challenges in the housing and financial markets over the past few years, coupled with the fact that people are living longer, many baby boomers are finding themselves unprepared to maintain their lifestyle in retirement."
Numerous surveys bear that out. Nearly half of Americans age 45 to 70-a full 48%-"have no financial plans in place to protect themselves against outliving their assets and the rising cost of health care should they live longer than they expected," according to a report early this year from the Society of Actuaries, which polled Americans on their retirement plans and financial preparations. And while more than a third of respondents told SOA researchers that they're worried about running out of money during retirement, "only 20% plan to purchase an annuity or other form of guaranteed lifetime income to protect their assets."
But that resistance is beginning to fall away, financial advisors and insurance specialists say. One big reason: the wrenching economic upheaval of 2008-2009 that tore a trillion-dollar hole in the retirement nest eggs of older Americans and spawned a profound and widespread sense of financial insecurity.
That insecurity could persist for years to come. According to a recent MetLife poll, 75% of baby boomers and 88% of financial advisors remain concerned about market volatility.
These things are especially concerning to those with the lowest incomes and assets, who are the least prepared to handle additional unexpected costs during retirement, says Marie Rice, the corporate vice president of Limra Retirement Research.
Indeed, millions of retired and soon-to-retire boomers are waking up to the sobering realization that the sum total of their current savings may not be nearly enough to carry them through decades of retirement and reduced income.
It doesn't help, says Rice, that so many lawmakers are talking about cutting costs as federal and state governments grapple with long-term budgetary shortages. According to a Limra survey, more than half of retirees age 55 to 79 fear that changes to Medicare and Social Security, coupled with likely increases in federal and state taxes, will affect their ability to afford retirement. Separately, an SOA survey found that nearly three-quarters [71%] of respondents plan to claim Social Security before the age of 70.
The Limra poll found that more than 85% of retirees rely on Social Security and three-quarters benefit from a traditional pension plan for their income. "More than half of their income is used to pay for basic living expenses," the insurance group reported.
For that reason, "A significant change in public policy like Social Security and Medicare benefits could be disastrous for many retirees-particularly those with lower income and asset levels," says Rice. "For future retirees who will likely not have a pension plan to rely on, it will be important that they increase their current savings patterns and think about retirement income solutions including guaranteed investments that will adjust for inflation."
The Limra study also found that less than half of retirees worked with a paid professional advisor to make investment decisions and only 22% had a formal written plan, even though "retirees who have a formal written plan are far more confident in their financial well-being than those who don't."
Rappaport says, "As actuaries, we cannot stress enough the importance of having a plan in place that addresses all of the risks individuals may face in retirement." Without a plan, she says, retirees may spend available assets too soon. They may not be able to meet financial care needs, pay for the rising cost of health care or adjust financially to the loss of a spouse.
Not Everybody Should Buy These
Given those realities, whom should the financial community be targeting for longevity insurance investments? They aren't for everybody, advisors and insurance specialists agree.
"All people in retirement or close to retirement should take a look at this," Chen says. "I'm not saying everybody should buy these. But in the new defined contribution world, you have to think about longevity insurance and [stock] market risks, and this is one way for individual investors to get some protection relatively easily."
The ideal candidates for such a retirement instrument, says Peter Katt, CFP, LIC, a fee-only life insurance advisor and founder and principal of Katt & Co., are middle-income investors nearing retirement age who have accumulated some savings but are worried about how long those assets will last.
Katt says he was initially skeptical of the concept of longevity insurance, but adds, "When I did the calculations, I was impressed with how well income annuities would do for a person who's on the cusp with their nest egg and who doesn't want to outlive it."
Bob Littell, an insurance industry consultant and author, says that an annuity should be one of the tools available to a retiree, but like every other financial instrument, it should be based on the risk profile of the individual. "The more conservative the risk profile of that investor, the more they're going to feel comfortable sticking it into an annuity."
Noel Abkemeier, a Society of Actuaries consultant, says longevity insurance should be approached holistically, as part of a comprehensive retirement-planning strategy. "You have to look at your basic needs-a roof over your head, bread on your table, transportation and a few other things. Those are the things you want to protect for the rest of your life. You look at the combination of what Social Security does for you, plus your own funds in 401(k) rollovers, personal savings, defined benefit pension plans, whatever. Those have to work together to cover you.
Unfortunately, he says, a lot of people with smaller accounts are not approached by financial advisors. "A financial advisor is happier with somebody who has more assets, on whom they can get a larger fee."
What financial planners should be aware of, according to industry insiders, is the vulnerability their clients will face in their later years. "Our parents' generation had pensions," the Smith Barney advisor pointed out. "Our generation doesn't have that luxury.
"With a 401(k), they can't handle the investment risk when they get into the distribution phase," he adds. "If they run into a [period like] year 2000 through 2002 at the beginning of their retirement, their retirement picture is changed completely. The annuity allows them to essentially create a pension surrogate, without having to worry about the investment risk. And that's why they're good tools.
"They're not the first line of offense," adds the advisor. "You should max out your 401(k) and save as much as possible in every other instrument, and then when you get to that point of putting some of your income into a guaranteed phase, that's when you need them."
Golembiewski cautions that the idea of longevity insurance is a tougher sell among younger investors. "We all wish our clients would start thinking about retirement and longevity protection when they're 30 or 40 years old, but that typically doesn't happen," he says. More often, "we're talking to a late 50s or early 60-year-old who might be within that five-to-ten-year window to retirement. But when you talk to clients about systematic withdrawals or spending down some of their assets, a 20-year time horizon is a good metric to follow.
"Some clients might be skittish to wait to age 85 [to begin withdrawals]; it is a long time away. So maybe 80 years old to start some income might be an easier pill to swallow," he says.
Timing The Interest Rate Trends
Given the current rock-bottom interest rate environment, now is not a good time to buy or sell longevity-structured annuities that lock in returns at current interest rates, all sources agree. "An astute advisor who's not just chasing commissions might tell clients, 'It might be worthwhile to hold off on income annuities for a while to see if we do get spiking interest rates, because spiking interest rates will then cause the guaranteed lifetime income to go up, because that's what insurance companies are going to base it on," Katt says. "If the market changes to 8%, they'll start pricing their income annuities based on a much higher internal interest rate assumption."
For that reason, he says, it might be wise to hold off a year. "The embedded interest rate is about 2.5%. If it goes to 6.5% in a year, the person buying it now has really made a bad deal."
Morningstar's Chen agrees. Seniors, he says, "need to be careful of when they buy it. If you buy a fixed annuity, you don't want to lock in an interest rate at one point. You probably want to spread it out [over] time. It's like dollar-cost averaging."
Rappaport urges a similar approach for brokers and their clients. "If you're going to buy annuities in a significant amount, you may want to buy them in four or five pieces. That way you reflect changes in the market. And if you're concerned about so much risk in one company, you might spread [annuity purchases] among companies."
Another Brick In The Wall
Abkemeier says the forces propelling the need for long-term deferred annuities and other forms of longevity insurance-an aging population, Wall Street's financial upheavals, clients' need for long-term financial security and guaranteed income-should also drive a shift in the way the financial industry serves the public. Brokers and financial consultants, he says, need to adopt a broader view.
"There are too many financial advisors and not enough retirement advisors," Abkemeier says. "All too often, somebody who's viewed as an advisor is interested in advising a client about how to allocate and diversify your investments-'Let's take what's in our lap and get the most out of it'-and not necessarily getting into the issue of where you have to be and how we get you there. People who are advising should advise for retirement purposes more than they are right now.
"The retirement advisor has to put it in the context of a total retirement plan," adds Abkemeier. "Say you have a million bucks, and we're going to put 5% of that into a deferred-start income annuity, and it will be there when you need it. In the context of the big picture, it's just another brick in the wall, and it makes a lot of sense. It's really just one more allocation."
Given those realities, Chen and other experts detect a growing interest in the concept. "A lot of financial planners and advisors still have no idea about annuities and their pros and cons. But you are seeing more and more of them embracing this as part of their tools to help the individual investor," he says.
"Some still view annuities as a tax-deferred mutual fund with high fees. But more and more people are giving them another look," Chen adds. "Five years ago, when I'd talk about these things, I'd get a handful of people listening. Now I get standing room crowds, because people have really started looking at these, especially after the 2008 downturn."
"It's emerging," agreed The Hartford's Golembiewski. "As the market expands, I think we'll see more broker-dealers and advisors selling this product.
"It is such a new concept, I think the industry is still trying to figure out where the niches are and how you market this type of product. The Hartford believes in this concept, and we just hope over time that as the demographics change and folks get more educated around its value, the market will grow alongside it."
MetLife's Kleinberg also predicted a steady rise in demand. "In addition to the demographics being favorable for this product, I think that as more and more firms incorporate multiple products into financial planning, and develop tools that show how longevity insurance as a portion of your retirement assets can really help ... that will be a key impetus for increasing sales of this product," says Kleinberg.
"And higher interest rates wouldn't hurt either," he adds, laughing.