SPIA Purchasing: Are you sure you want to wait for higher interest rates?

 

gm-bioRegarding SPIAs, I know the normal emphasis is on interest rates but, when SPIAs are “mortality based”, paid on the stipulation you remain alive, mortality and mortality discounts become much more important factors in the decision of when to purchase vs. the speculation of an interest rate increase from these ultra-low levels down the road.

Take the following example of 100 males all age 65 who purchase a lifetime only SPIA for a $1,000 annual income and let’s only concentrate on the income due after five years at age 70. At the purchase date, the insurance company estimates there is a 73%1 chance of making it to age 70 and the insurance company will have to disburse $73,000 to these 73 survivor annuitants. Therefore, the insurance company, for this year, has to stand ready to have on hand $73,000. This is the expected outcome of company’s promise to all 100 age 65 male annuitants at the time of purchase attributable to each survivor because 27% or 27 annuitants will have died, we don’t have to worry about them! If the insurance company can credit a 2.00% annual interest rate, the premium cost to each of the 100 age 65 year-old annuitants is $6612 because it takes five years at 2.00% per year to grow the collective $66,100 premium cost to the $73,000 required sum for this age and class of annuitants. In reality, this dynamic is played out over all the years from age 65 (purchase age) to about age 120 but, we are only going to look at one point of time at age 70 to make things easier.

But let’s say a year has gone by and interest rates increased by 10% so that the new available interest rate the insurance company can credit is 2.20%! Sounds good right? At this time, another group of 65 year-olds step up to the plate to purchase their $1,000 annual lifetime annuity. But the insurance company says; “hold on a minute, I know we said last year we thought these individuals had a 73% chance or 73 of them making it to age 70 but now we think it’s more like 75% or 75 of them making it because people are living longer and we changed our estimates.” This is a 2.74% improvement (73% to 75%) in the survivorship estimate. And again, all the others years’ survivorship estimates to age 120 improve as well.

What does this look like for this new set of age 65 individuals, at their age 70? In this case, the insurance company has to stand ready to have on hand $75,000 because they now think that only 25% or 25 annuitants will have died instead of the previous years’ estimate of 27% or 27 annuitants. But now that interest rates have gone up by a whopping 10%, this premium cost should be a lot cheaper right? Absolutely not! If the insurance company now thinks it has to have $75,000 in five years and they can credit 2.20% interest the required premium cost is $67,200! It takes five years at 2.20% per year to grow $67,200 to $75,000. Therefore, the premium cost for each annuitant is $672 and this is higher than the premium cost of $661 for this same age group and class just last year! And, if interest rates didn’t improve at all and remained at 2.00% for this new group then, the premium cost would be even still higher at $679 each.

Of course, if there is no survivorship improvement and it remains at 73% or a $73,000 requirement then the premium cost, in this example, reduces to $65,400 or $654 each because the interest rate increased to 2.20% vs. the $661 cost at the 2.00% interest rate.   You never know when insurance companies may increase their survivorship estimates. Hint: carriers will not tell you when this happens. And, for new potential SPIA purchasers each year, when they don’t purchase a SPIA, they are subject to insurance companies’ changing survivorship estimates. This is why it’s advisable, regardless of interest rates, to make some SPIA purchase at younger retirement ages to lock in your survivorship rates because survivorship estimates can’t be changed once the contract is issued.

In this example; a mere 2.74% improvement in survivorship rates was more than enough to counter act the effects of a 10% rise in interest rates. In fact, for this example, when survivorship increases to 75 individuals, interest rates would have to increase about 30% from 2.00% to 2.60% to retain the original $661 individual premium cost for the next group of 100 age 65 male annuitants, because it takes $66,100 to grow to the new required sum of $75,000.

 


1. Not actual mortality table, only math example for illustration purposes
2. Not counting other factors like; home office expenses, agent commission, premium taxes, etc.

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