The Pension Annuity Conundrum: Death Insurance
by George Hatjoullis
Annuity rates remain very unattractive. At age 60 one can expect, on average in the UK, to live to 84. The best level annuity available today for a 60 year old (http://bit.ly/15M51zu) is around £4910 per £100k. One must live to 80 just to get the £100k one paid for the annuity back. Not everyone will, by definition, live to the expected age. Some will live longer and these people are subsidised by those that die sooner.Macabre statistics but these are the sort of calculations that make up the actuarial industry.
Of course, the annuity provider can also earn interest on your £100k. This also boosts the annuity but with rates so low the boost is not very substantial. In the UK the relevant interest rate is the yield on the long dated Gilt. This is made explicit by the Government Actuary’s Department (GAD) tables for maximum permitted drawdown from income drawdown pensions (http://bit.ly/15F1bWq). The two variables are age and a Gilt yield index. Eyeballing the 2011 table it seems that the maximum drawdown rises by £200 for a £100k contract for every 25 basis point increase in the yield index. This gives an approximation of how much annuity rates should rise as Gilt yields rise.
There are many variations of the basic level annuity but the fundamentally different method of taking a pension is via Income Drawdown. The maximum income that can be drawn is limited by various conditions and the GAD tables. The income available to be drawn is also limited by investment performance. If performance is poor then the pension may run out before death. The essential difference between drawdown and annuity is meant to be this risk, though some so-called annuity arrangements carry quite a bit of risk as well.
On September 17, 2010 the Financial Times published a letter of mine suggesting a solution to this annuity dilemma, namely death insurance (http://on.ft.com/11VJWU8).Life insurance pays out on death so why not offer individual policies that pay out on the insured living beyond a given date and call it death insurance. This kind of risk is taken by insurance companies on a corporate level already when they insure pension schemes against shortfall. To offer such policies on an individual basis completes the market and would simplify pension planning. One can use part of the pension pot to buy some death insurance beyond a specific date and then plan with certainty to exhaust the remaining pot.
Today the Daily Telegraph has published an article making precisely the same suggestion (http://bit.ly/12Jg7jf). Better late than never.