Time to revisit Death Insurance
by George Hatjoullis
The pension reforms announced by the UK Chancellor of the Exchequer in the Budget suggest it is time to revisit the concept of Death Insurance. I first suggested this in a Letter to the Financial Times dated 17/09/2010 (http://on.ft.com/1fLP0uE) and revisited in an earlier blog when I discovered that the Daily Telegraph had also mentioned the idea without so much as a nod to my original suggestion .
Death Insurance is a simple concept and the dual of Life Insurance. The latter pays out a defined sum on death in return for a regular income stream until death or policy expiry. Why not offer a product that pays out a lump sum if the named party lives beyond a fixed date and call it Death Insurance? This would enable the now liberated holders of defined contribution pension pots to better plan their retirement. A portion of the pension pot could be paid to the insurer as a lump sum from the pension pot. In general, the further ‘Death’ date beyond the actuarial life expectancy the smaller the premium. The pensioner can then manage the remaining pension pot to a specific date in the knowledge that if she out lives her pot there will be a lump sum coming in at the end of her plan date.
Of course, the devil is in the detail and the pricing. However, this is not a new concept to actuaries or insurance companies. They already offer insurance to Institutional pension plans for shortfall and when insurance companies take over a plan at a price, Death Insurance is priced into the arrangement. Indeed, every annuity has a Death Insurance element embedded and the thrust of my earlier blog was that the opaque nature of annuities means no one could tell what the insurers were actually charging without a bit of maths. The pension reforms provide an opportunity, and incentive, for insurance companies to offer an explicit policy to individuals. Then it is about pricing.
The pension reform announced by George Osborne was lauded as dramatic. In practice it was the logical culmination of the trend towards defined contribution pension plans in the private sector. The individual has already been forced to take responsibility for her own retirement. She chooses how much to save and how to invest the pot. It is logical to allow her complete freedom on how to deploy the pot in retirement. The pension saving goes in at the marginal tax rate and now, apart from the tax-free lump sum, comes out at the marginal tax rate. This is how it should be (though I suspect the tax-free lump sum may not survive). The main problem for the individual pensioner is the uncertainty surrounding the date of death. It is worth her while sacrificing some of the pot in exchange for Death Insurance.