Longevity insurance

Longevity insurance, insuring longevity, also known as a longevity annuity or deferred income annuity, is an annuity contract designed to provide to the policyholder payments for life starting at a pre-established future age, e.g., 85, and purchased many years before reaching that age.

Longevity annuities are like "reverse life insurance", meaning premium dollars are collected by the life insurance company by its policy holders to pay income when a policy holder lives a long life, instead of collecting premium dollars and paying a death claim on a policy holder's short life in ordinary life insurance. Longevity annuities use mortality credits to pool money and pay out the remaining policy holders' claims, this being living a long life.

The term "longevity insurance" comes from this type of annuity being insurance against unusually long life. It may seem odd to insure against an event that most people would welcome. However, living a very long time would strain many people's financial resources, just as a fire which destroys their house would strain many people's finances if they didn't have fire insurance. The logic that makes fire insurance a prevalent means for coping with the financial risk of house fires would seem to argue for greater use of longevity insurance for retirement planning: Few people will live to a very old age, so it doesn't make sense for everyone to try to cover that possibility with savings and investments. (The same type of reasoning applies to house insurance: because few people will experience house fires, therefore it is not realistic to expect everyone to save and invest specifically for purposes of house replacement.) Longevity insurance is not designed for the early retirement years, so it is not intended as a complete retirement plan by itself.

For example, a person might pay $20,000 from his or her retirement savings at age 60 to purchase longevity insurance that would pay $11,000 per year starting at age 85 and continuing until death. These numbers are made up, but are based on actual terms offered by at least one major insurance company in November 2011. Thus, in this example, if the person lived to 95, they would receive $110,000 on their $20,000 investment (10 years at $11,000/year). This is a rate of return that far exceeds that available at prevailing interest rates on government bonds. The economic reason for the high return at low risk is that one is giving up any claim on that initial $20,000 investment on behalf of one's heirs. If you die the day after buying the policy, or at any age before 85, the insurance company pays nothing to you or your estate. (Some companies offer optional features that would modify this, so there would be a death benefit or so you would have the option of starting payments sooner, but taking these options would substantially reduce the annual income the policy would pay at age 85.)

...
Wikipedia