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Mortality Credits – Get ‘Em While They’re Hot!


Retirement today is much different than it was for your clients’ parents and grandparents. Gone are the days of the shiny gold watch and the guaranteed corporate pension. Today, not only are retirees living longer, they must also secure guaranteed sources of lifetime income to cover their basic expenses. As wizards of the financial industry, you must educate your clients on the various types of annuities and share how lifetime income annuities should be a key part of any retirement plan, serving as a pension-like stream of income.

Even in the 21st Century, when it comes to annuities, there are still many misconceptions that your clients may have about them. Some people love annuities. Some hate them. And, some just simply do not understand them. In today’s low interest rate economy, retirees may appear wary when discussing annuities as a result of market uncertainty.
Today’s low interest rates are a result of deflationary pressures, which are currently affecting our nation’s economy. Deflationary? But wait, aren’t news stations and other media outlets saying otherwise? The government has printed trillions of dollars, which usually leads to a spike in inflationary pressure as well as interest rates. However, rather than these trillions of dollars flooding the economy, the money is just sitting on bank balance sheets. There is no money velocity, which is keeping those inflationary pressures at bay.
I believe that we are currently living in a “new,” rather than low, interest rate environment.
As I discuss in my 2015 Economic Commentary, I believe that we are currently living in a “new,” rather than low, interest rate environment. Despite what many are saying about a possible spike in interest rates occurring sometime this year, I disagree and believe that we will see these low interest rates continue for as far out as I can see. I also discuss the three “Big D’s” that are currently affecting this country: Debt, Deleveraging, and Demographics. As our nation’s massive debt continues to rise along with an increase in longevity in our population, we are seeing more spending and less saving. So, exactly how do these deflationary pressures affect today’s interest rates and more importantly, your clients’ retirement income?

Your clients may feel that they should wait until interest rates rise before they purchase income annuities. In my opinion, this is wrong. Since we will likely not be seeing any significant increase in interest rates for possibly decades to come, now is the time to educate your clients on the importance of securing lifetime income annuities.
Lifetime income annuities are not an interest rate play. In 2011, The Financial Research Corporation of Boston published a whitepaper entitled, “Income Annuities Improve Portfolio Outcomes in Retirement.” Retirees must take the key retirement risks off the table, especially longevity risk, which isn’t just a risk in and of itself; it is a multiplier of all of the other retirement risks! It has the potential to stretch out all of the other risks like inflation, long-term care, withdrawing too much, and market risk. The study discusses how retirees can improve portfolio outcomes in retirement by combining income annuities with mutual funds in an overall asset allocation. “Income annuities generate more income per dollar of capital invested than any other income generating asset class, are non-correlated with equity and bond markets, and perfectly hedge longevity risk—a powerful combination of features to address a significant set of challenges.”

Retirees must take the key retirement risks off the table, especially longevity risk, which isn’t just a risk in and of itself; it is a multiplier of all of the other retirement risks! It has the potential to stretch out all of the other risks like inflation, long-term care, withdrawing too much, and market risk. Since the longer you live, the more likely these risks will occur. Careful planning, education, and securing guaranteed income will hedge this risk.

Most people do not realize how income annuities are able to offer such high cash flows given that they are an insurance product. The whitepaper goes on to say, “The older the investor, the higher these cash flows will be. For example, income annuities recently paid out 6.8 percent of the initial premium, for life, for a 65-year-old male investor, compared to an 8.9 percent payout for a 75-year-old male investor.”

These products provide investors with a type of alpha that traditional investments simply cannot match: longevity credits, also known as mortality credits. These credits are what separate income annuities from other investment options within the fixed income market. The whitepaper mentions this, “Mortality credits increase significantly with age because as people grow older, their future lifespan decreases. Older investors are more likely to return their capital to the mortality pool quickly, generating more cash flow for the remaining investors. That is why income annuity payout rates increase with age.”

Morality credits are derived from the mortality pool that is built into income annuities and the payout provided by the insurance company is guaranteed regardless of the performance of that pool. The whitepaper continues, “Only life insurance companies can manufacture mortality credits. There is no such thing as a ‘synthetic’ mortality credit. As importantly, the life insurance industry has a finite capacity. Therefore, there is a limit to how many income annuities the entire industry can produce.”

I was surprised to learn that life insurance companies have a limited amount of mortality credits. But when you think about it, it makes sense. An insurance company basically sells two products that are based on risk pooling and utilized mortality credits – (1) Life insurance, which protects you if you die too soon, and (2) annuities, which protect you if you live too long.

A company would be perfectly hedged against longevity risk if they had equal weightings in life insurance and annuity sales. Right now, most companies have much more life insurance on the books than annuities. But, over time, annuity sales could very well surpass life sales, and mortality credits could become very limited. Pricing could be very different from today. Additionally, since people are living longer, these credits will be reduced in the future. Today’s credits are likely the highest credits your clients will receive for the rest of their lives!

I recently presented at a meeting for an AAA rated mutual life insurance company. The company has already applied the updated mortality tables to their SPIA’s and DIA’s, and as a result, payout rates went from 14 percent to nine percent and from nine percent to seven percent. These are not minor changes! Keep your eyes peeled as many other companies will most likely be making this same change in the next 18 months.

Like I said earlier, your clients’ retirement planning is very different from how their parents’ or grandparents’ planned for retirement. Retirees face many more obstacles and risks today, especially longevity risk. People are simply living longer. Income today must last for a longer length of time. Despite the low interest rate environment, your clients might be pausing their decisions when it comes to securing guaranteed income with annuities. The time to act is now. Utilizing lifetime income annuities is a must when securing guaranteed income. There are only so many mortality credits to go around so get ‘em while they’re hot!

Access Tom’s 2015 Economic Commentary HERE »

Tom Hegna Tom Hegna, CLU, ChFC, CASL, is an author, speaker and economist and host of a popular public television show. As a former Fortune 100 senior executive, Tom has dedicated his entire career to helping retirees obtain a “happily ever after” retirement. He has been featured on FoxBusiness, American College Wealth Channel Magazine, Round the Table, Advisor Today and GAMA Magazine. Tom is also a retired U.S. Army Reserves Lieutenant Colonel. He currently lives in Arizona with his wife and children.

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