There has been increased press about a new type of annuity, longevity insurance. It is designed to pay benefits starting at a later age, like age 85. Thus, if you plan for your assets to last for a normal retirement (20 years or so), the longevity benefits can kick in to pay benefits in case you live longer than expected. So, is this a good idea or not?

The idea sounds good because it reduces one of the larger risks in retirement, mortality (expected lifetime). Thus, if you can find a cheap insurance to cover an additional 10 to 20 years in retirement (from 85 to 95 or 105), it, in theory, could help reduce the money you need to save for retirement.

In a BusinessWeek article, it states that a 65 year old can invest $250,000 and expect to receive $210,000 per year at age 85. So, if you can live on $50,000, then this amount would be significantly less (maybe $60,000 to $70,000), right? Before you go out and jump on this opportunity, there are a few things to consider.

1) Inflation – Even with 3.5% inflation, the amount you need at 65 will more than double by the age 85; $50,000 at age 65 will be equivalent to $100,000 in 20 years (and more the longer you live). If you get a longevity annuity indexed for inflation, expect to pay at least double what you would pay without inflation protection.

2) Married – If you are married, the cost of a policy paying benefits as long as either one of you is alive past 85 could almost double (if not double) the price policy again. What good is a policy if it only pays a benefit if you are alive and not your spouse? Thus, a hypothetical $60,000 policy (for $50,000 of benefits) could easily be worth $200,000+ if married and indexed for inflation (note, this is very dependent on your spouse’s age and time when the policy is purchased).

Yet, the benefit of having a policy that covers benefits after age 85 is a lot cheaper than buying a $50,000 annuity that starts immediately at age 65 which can easily cost $1 million (indexed for inflation and payable as long as either spouse is alive).

The key for longevity insurance is that it is suppose to lower the amount you need to save for retirement. If you are factoring in a 30+ year retirement (age 65 to age 95+), you will need to save $1 million or more to receive ($50,000 a year). Yet, to save for a 20 year retirement (age 65 to 85), the amount is reduced.

20-year annuity (6% investment return and 3% inflation) = 15.2 times the amount you need (e.g. $760,000 for $50,000)

30-year annuity (6% investment return and 3% inflation) = 20.1 times the amount you need (e.g. $1,000,000 for $50,000)

You will need to save an additional $240,000 by age 65 for the additional 10 years of retirement and more if you live past 95 where the longevity insurance can guarantee this for life. The key is if it is worth the price and that depends on how much the insurance policy will cost (remember the $60,000 policy may be $200,000 or more once inflation and marital status is reflected).

So, maybe the price of the policy is not as good as we once thought. It is still good if you live past age 95, yet not so good if you die before age 85 and thus receive nothing. Yet, the difference between a

Yet, before you make a decision, there are a few other things to consider:

1) Expense Load – With all insurance, there is a commission paid to the agent who sells the policy and to the insurance company for profit and administrative expenses. Be cautious of expenses called longevity benefit expenses. In one prospectus, there was a 1% charge of the premium each year until the longevity benefits commenced. Thus, if you buy the policy at age 55 and start the benefit at age 85, 30% of the premium could go towards paying this expense, in additiona to the standard mortality and administrative expense (which was an additional 1.35% per the policy that I saw). So, it seems there is an expense for the “benefit” of delaying the start of the annuity which can wipe out part if not all of the benefit of a longevity insurance policy.

2) Death benefit – Some policies come with a rider where you can get your initial investment back, called a cash refund. However, in getting the rider, you are reducing your monthly benefit to pay for this death benefit. I never like these cash refund because the $200,000 you invest now is worth a lot more than the $200,000 your heirs get back when you die in the future. So, is it worth it? If giving money to your heirs is important you should reconsider your financial plan because this cash refund rider is an ineffective way to provide an inheritance because too much of it goes to the insurance company.

3) Expenses later in life – Some people say a lower cost option is to buy an annuity for the fixed living expenses (needs) and use savings for your wants (travel, eating out, etc.). Thus, you would not need to buy insurance for all your expenses, just the necessities (to reduce costs). However, as you age, your fixed expenses grow (e.g., prescription drugs and home health care costs) while other expenses decline (e.g., vacations). Thus, what fixed expenses do you cover, the expenses you have now or the expenses you may have later? You may find that most of your expenses later in life are fixed.

In addition, if you have long-term care insurance, longevity insurance may add some overlap that you end up paying twice. Do you really need an annuity payment if you are in a nursing home that is covered for? It is not like you are going on vacations or eating out, if you can not even feed yourself or go to the bathroom without assistance that the long-term care facility is providing.

I bring this all up to put some questions in people’s mind before rushing out to buy a longevity policy. At first, I thought this was a brilliant idea, which it may still be under certain situations that you should review with an independent financial adviser (one not selling you the policy). However, I started to have second thoughts about the cost of the insurance when I saw a policy illustration showing the benefits of longevity insurance. In the example, a $100,000 policy to a 40 year old showed a $4,960 benefit at age 85 that would accumulate to $892,800 if the policy holder lives to age 100. However, $100,000 invested at 6% from age 40 to age 85, would grow to $1,375,000 at age 85, which can covers 23 years of a $4,960 monthly benefit even if it is not invested after age 85. Where did the extra $½ million go ($1,375,000 - $892,800)? Note, the insurance policy may have other aspects to it that the illustration is not reflecting (e.g., having the ability to invest in more aggressive assets which could increase the monthly annuity significantly, dependent on market performance).

Before considering or not considering a longevity insurance policy, please do your own review (or have an independent financial planner perform one). This analysis is based on information posted on the web provided by a major insurance carrier which can change over time as more competition hopefully reduces some of the expenses that are now being charged. The purpose of this article is to raise questions you may want to consider and should not be construed that all longevity policies are similar to the one I used for parts of this analysis.

Not to stir a controversy here or anything. Yet, I like to hear from you on what is your definition of a need and a want is.

Typically, I like to think of a need as what we need to sustain life: basic food, clothing, shelter, etc. I do this to show people that we have a lot more choices in life and budgeting than we realize. I look at the issue as what does a person need to eat to sustain life? Basically, it is beans, rice and some fruits and vegetables. What is it for housing? For many, this may mean an apartment or house. For others, it may be a tent or a car. As a society, we debate the minimal standard of living that we should help others with to maintain a minimal standard for quality of life. So we set the bar between what is a need and what is a want that may be a little higher than basic need to sustain life based on our definition of quality of life.

Quality of life is interesting to define because every one has a different definition. Thus, I write this for people to think about their quality of life. For some, the first words that come up may be based on having a space to live in a safe neighborhood. For others, it may be having enough to eat so people do not go hungry at night. Others may say it is to be happy and to be able to enjoy life.

So I thought that it may be easier to define if it from a life and death perspective (medical care). However, as I thought about it, hoping to find a clear answer to blog about, the gray area became even grayer. Recently, my grandfather in-law passed away after a stroke. He had been having health problems for the last few years, so it was probably his time to go. However, after the stroke, he was maintained by life support systems and his daughters had to decide whether to continue life support. Years ago, there would not be a decision if life support was a need or a want because there would not be any an option. Now, with all our technological improvements, the level of health care that is a need versus a want has become grayer.

There is the argument that if we have the technology to help the patient and if the patient may be able to have some quality to life after the procedure, that we should employ it, no matter the cost. There is a debate on what is quality of life that I do not want to get into here. So let’s assume, their quality of life is considered “normal” life with no health problems for the reason that brought the patient to the hospitals (yet there could be pre-existing conditions). This argument is probably an easier one to make to use the life-saving medical procedure for a 5 year old patient than it is for a 95 year old patient that probably only had a few months or years to live at most due to his pre-existing conditions. It also probably makes a difference if the procedure is a simple on or a complicated one that will take many medical professionals to take care of the patient and thus raising its costs.

Hold it. I know that some readers are questioning what does cost have to do with saving a life? Money should not be an object when we are talking about a human being with a soul. Yet, if we assume that every one in health care (pharmacies, hospitals and companies making health care equipment) are not in it for the money (no profit motives), then the cost of health care is equivalent how many hours a doctor and nurse have to work and how much the medical supplies and use of the equipment costs. Now, it may seem reasonable to save a life no matter what the cost, especially if we have the time and money to do it. However, there comes a point where “no matter what the cost” means that the medical staff can not go home because they need to take care of the overload of patients on life support measures for months and years at a time. The question is should we factor in how this affects the quality of life for the medical professionals who are working 80 hours weeks, years at a time, and can not see their family? Is it worth them giving up their quality of life (time with children and family) to support someone who may or may not live and with no certainty, if they live, for how long (maybe 1 day, 2 years or 5 years)? And, what if that patient would probably be in a coma the entire time?

Doesn’t this bring up an interesting medical debate?

If you think that the current medical staff can not get stretched so thin that they are working all the time, consider the debate over residents working a standard 80 hour work week a few years ago. Part of the reason they worked so long was done to help them learn everything that they needed to know in their few years as a resident which is hard to do if they just work 9 to 5 without seeing a critical patient from start to finish. Yet, the long hours from residents also helped a hospital to be able to keep its doors open to patients that the staff could not do without an extra set of hands. Think about how the waiting lists of patients waiting for surgeries in other countries who decide to come to the U.S. or other countries like India because they do not want to remain on a waiting list for several months before it is their turn. Also, many of our hospitals are running at 95% to 100% capacity already with the growing needs of baby boomers waiting to hit our medical facilities in just a few years.

I do not mean this to be a question on whether we should have universal health care in the U.S. or if the price of health care is too high. We can save that for later. Rather, I ask to raise a question for readers on what is quality of life and where the minimal line should be drawn. In particular, if you could to make a decision today to work 2 additional years (60+ hours a week) to afford to live an additional 2 years beyond where your life would currently end via the assistance of advanced medical care, would you do it?

It may be an easier question to ask if you made it at the end of your life, if you had to decide to have a surgery to extend your life because it is a life or death decision. It is easier if you did not have to pay for it and harder if you when you need to pay for it and work harder and longer to do it ahead of time.

No matter what health system we have (government pay, company pay or patient pay), it ends up costing us as a tax payer, consumer or directly as a patient, one way or another. Thus, in a sense we are paying for it now.

For myself, I would want to live a balanced life today rather than work extra on a consistent basis, giving up time with my family, to afford to pay the few extra years at the end of my life. However, I do enjoy the benefits that our health care systems provide. Thus, my wife and I work to afford basic health insurance to have the opportunity to have a normal life after a car crash. However, there is a line we have talked about on where to cut off life support based on the prognosis of quality of life.

This is going to become an important issue for our politicians and voters to decide on as our baby boomers reach their 70’s and 80’s. Before, we automatically paid for health care because we had many people working to support Medicare for a few elderly. Thus, costs did not really factor into the decision, too much. In the future, we will have to pay for their health care with a few workers supporting each elderly patient on Medicare. It may seem easy to say pay for health care no matter what the cost. Yet, even if we did use money to pay for health care, there may be a point where the health care needed strains the resources we have available.

Thus, for me, the current political discussion on health care should not only be if we keep the system we have or go to a universal health care system but also should be how to clarify our expectations on what is quality of life. It is one thing to discuss how to extend our quality of life if cost was not a factor. However, it is another decision when we are the ones paying for it whether it as taxpayers or directly as the patient or whether we consider the doctors and nurses who may be the ones expected to do more for less (which has already been going on with Medicare cost cutting measures).

This also raises other questions as consumers on how we make purchases to help our quality of life especially if it means working longer in a job we do not enjoy. Where do we draw the line on working harder (especially if it is in a job we do not like) or making by with less?

Again, I do not mean to raise an argument on whether insurance companies, drug companies or hospitals are greedy or not. I meant it for a philosophical debate on if your quality of life is measured more on quantity (length of life) or quality (doing more of what we want in the time we have, even if it means a shorter life).

I know most people would like to have quality of life mean sitting on a beach sipping a margarita (instead of working), yet who would be at the hospital taking care of the sun burns and skin cancer?

I have been hearing this more and more about how a retiree should not sign up for the joint & survivor benefit option (if married) and go with the life annuity option. The premise is that the life annuity will give them a bigger benefit that they can invest the difference in the two benefits and have more money to pay to their spouse when they die. Unfortunately, this is an old myth created by life insurance agents to sell more life insurance policies that has continued because people do not understand the math behind the issue. They just see a bigger benefit and focus on that.

To understand this better, when a person selects a monthly annuity from a company, the factors used to adjust the life annuity to a different benefit form (e.g., joint and survivor annuity) are based on what is called actuarial equivalence factors. The factors convert a benefit in a way that the “normal” person would receive an equivalent benefit no matter what option he/she choices. For example, if a retiree has the options of choosing between a $1,000 per month life annuity versus $850 100% Joint and Survivor option (where $850 is paid to the retiree and spouse when either one is alive), the joint and survivor benefit is smaller because it is expected to be paid out over a longer period instead of a shorter life annuity paid only when the retiree is alive. Based on actuarial tables, both options would pay out the same amount benefits on a present value basis.

Second thing to understand is to get a similar benefit from the life annuity option as a from the Joint & Survivor option, the retiree will need to buy a term life insurance benefit to pay for an annuity for the spouse when retiree dies. By doing this the retiree is paying two commissions (one commission on the life insurance and another on the annuity). Thus, instead of making money, the retiree is usually paying it out any profit to pay for commissions instead, thus actually losing money. Sure, people can show examples of where a person can win by selecting a life annuity option, yet they tend not to show where people (actually their spouse) can lose if the retiree dies to soon.

For example, let us assume retire and spouse are both age 65

- Life Annuity - $1,000 per month

- 100% J&S Annuity - $850 per month

- Difference is $150 per month

If the retiree dies immediately, the spouse would need approximately $135,000 (based on calculation done at Vanguard to get an equivalent $850 annuity per month. Now, the retiree can buy term life insurance for slightly less than $150 per Insurance.com yet it is for a 10-15 year term policy being assuming the retiree is in superior health. If the retiree is not in the best of health at 65, he would be paying a lot more money for the policy than $150. In addition, he is opening his spouse up to risks if he lives past the age 75 because he still needs to buy additional term life insurance. At age 75, he would have only accumulated $12,000 in savings ($75 per month at a 6% return) which will pay his spouse for only 90 to 100 months which is not enough if she lives into her mid-80s. However, buying life insurance at age 75 to have the additional benefit needed to guarantee annuity benefit to the spouse for her life will cost more than any savings (e.g. cost will be over $200 for a 10-year term policy in the best of health) that is if the retiree can qualify for life insurance at all.

Yes, the extra $150 per month does sound enticing. However, it does open up the retiree’s spouse do large risks:

• Cost of term insurance goes up significantly with age, so any perceived savings is reduced and eliminated in future years with additional costs

• Spouse may significantly outlive the retiree and any additional savings they may have accumulated

• Any short-term savings assume the retiree is in the best of health to qualify for term life insurance

• In future years, the retiree may not even qualify for term life insurance based on his future health condition (e.g., having a heart attack, cancer, etc.)

Thus, before selecting a life annuity instead of a joint and survivor annuity, understand the risks involved to the spouse if everything does not go as perfect as in the example from the insurance agent or financial planner. There may be times when the math does work due to age, sex and health of the retiree and spouse. However, with commissions paid to the agents, any profit can quickly erode any of the profit and there may still be risks involved.

Note, an insurance agent will say that there is a benefit because life insurance is paid out tax-free. This tax-free benefit will not change my example significantly. For example at a 33% tax bracket, the $150 extra a month for a life only benefit will be reduced to $100 after taxes are paid ($1,000 life only benefit is $667 after-taxes and $850 joint & survivor annuity is $567 after-taxes). Because the retiree only need $567 annuity for his spouse after his death, he will only need 2/3rd of the $135,000 life insurance benefit. Thus, instead of paying $75 for $135,000 of life insurance, he is paying $50 or so. As you are starting to see, the initial example without taxes is similar to an example with taxes factoring in the tax-free distribution of a life insurance benefit (just all results are reduced by 1/3 for taxes). Thus, because life insurance is paid for with after-tax money, reflecting the tax-free benefit of a life insurance payout does not materially affect the initial example.

When we hear of a variable annuity, we may think of them as

• Not a good investment due to the high fees

• A good way to defer taxes

• A way to protect against inflation

• A way to receive a higher investment return compared to fixed annuities by directing your investment (e.g., in equities)

There is confusion whether or not variable annuities are a good investment depending on who you talk to. So, let’s look at some of the logic behind the different viewpoints.

• Annuities can defer taxation on investment gains until you receive the payment

• Investment gains for annuities are taxed as ordinary income, thus forgoing lower capital gains taxes

• Annuities usually have a high commission paid to the broker/agent that the policy holder indirectly pays for in higher management and withdrawal feess

How does this work mathematically for investing in equities?

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CNN published an article from Associated Press on “Too high a price for life?” The article discusses the high prices for drugs and procedures that may extend life. It raises the question if extending life for a few months is worth the cost whether it is $50,000, $100,000, $250,000 or more.

Because I have been planning to write about the cost of health care in our society, I will take this opportunity to add my 2 cents to the discussion. The issues are too numerous to solve in one article. Thus, my intention is to raise awareness of some of the issues.

Is medical care worth the cost?

Whether or not to extend life at all costs is usually a hard decision. Some may say that you can not put a price on life, which is true. Yet, in our society, we commonly put a price on life. Think about how we

• Buy life insurance

• Use the legal system to create a financial settlement for lose of life or limb

• Desire to become a millionaire (to have a meaningful life)

With medical insurance, the question becomes easier. Many believe that because they (or their employer) paid the medical insurance premiums, they deserve the best care that money can buy. When you only need to pay $1,000 in co-payments to extend life a few months, the decision is easier than if you would be required to pay $100,000 for the full cost of treatment. And this desire to extend life is increasing. Per the article:

Faced with a lethal disease, more than a third of Americans now would want “everything possible” done to save their lives, up from just over a fifth in 1990.

Part of this may be due to medical care being better thus we expect miracles. Part of it may be due to families living farther apart where we want to have a few extra months to make up for the time apart. In other words, some people may not be ready to say goodbye.

Who is to Blame for High Cost of Health Care?

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