Hedging Longevity

The importance of QLACs in the discussion about living longer.
Roberta Rafaloff

Last year’s Treasury Department regulation set the stage for qualifying longevity annuity contracts (QLACs) being made available in defined contribution (DC) plans. This new rule impacts the options plan sponsors can offer participants and sparked many questions about longevity risk and longevity insurance. Roberta Rafaloff, vice president of Institutional Income Annuities at Metropolitan Life Insurance Company and Jack VanDerhei, Ph.D., research director at the Employee Benefit Research Institute (EBRI), provided PLANSPONSOR with more insights in a recent conversation.

PS: How does longevity insurance work?

Rafaloff: Longevity insurance is a fixed deferred income annuity that protects individuals against outliving their income. For those nearing or even already in retirement, it provides a set amount of guaranteed income that begins later in life—say, when they’re 80 or 85—and may be set up to coincide with the depletion of other income sources. Longevity insurance makes it easier for individuals to plan for retirement rather than self-insuring their retirement. And, of course, the longer they wait to start their income payments, the larger those payments will be.

PS: When was it first introduced in the qualified plan arena?

Rafaloff: In 2004, Metropolitan Life Insurance Company was the first company to introduce longevity insurance, which evolved into a product category for the industry. And, to the best of our knowledge, we are first to market again as the first insurance company to introduce a group QLAC this month. Americans buy life insurance, health insurance, insurance for cars, our homes, etc. We insure just about everything except our retirement income.

Yet during people’s working lives, most make nearly all of their spending decisions based on their paycheck, so they’ll likely make similar decisions later in life based on their retirement paycheck—whatever sources of lifetime income they have then.

PS: So what particular issues or challenges does longevity insurance solve for participants?

Rafaloff: Longevity insurance solves for longevity risk—somebody outliving the average life expectancy, which is the greatest risk a retiree faces. Think of it this way: An individual will need to figure out how to ensure his or her retirement income lasts 20, 30 years, maybe even longer if he surpasses the average life expectancy. In fact, a 65-year-old male has a 50% chance of living beyond age 85 and a 25% chance of reaching 92.

Unfortunately, we often see the “wealth effect.” At retirement, people take a lump sum from their defined contribution plan because it’s typically the most money they’ve ever saved and they want to hold onto it.

PS: A lot of attention has been focused on raising awareness about longevity risk. Do you think those messages are resonating with defined contribution plan participants and that they understand the need to hedge that risk?

VanDerhei: At EBRI, we just conducted our 25th annual Retirement Confidence Survey and wanted to get at exactly that issue. We asked 1,000 workers whether or not they would be interested in using a portion of their savings to purchase an insurance product that begins providing guaranteed monthly income in their future, such as at age 80 or 85. We said this monthly income would continue throughout their or their spouse’s life, and this product is sometimes called longevity insurance. Among the workers we asked, the overall findings were that nearly four in 10 were interested, including 8% of workers who were very interested and 30% who were somewhat interested.

I went back and did some breakouts on those, and what I found is that a person’s expectation of how long she’s going to live affects how she answers the question. After combining some groupings because of the sample size, of those individuals who believe they are not at all or not too likely to reach 85, only 25% were interested in buying, in essence, a QLAC. Of those who believed they were somewhat likely to reach age 85, 41% were interested in a QLAC; and of those who felt they were very likely to reach age 85, the number jumps to 47%.

One other quick break down: Among those with some form of retirement plan, 39% said they’d be interested in a QLAC, and 47% with no plan at all would be interested, regardless of age.

Rafaloff: We think this data is really encouraging and shows that workers are really starting to think about not just retirement savings, but how they turn that savings into guaranteed retirement income they can’t outlive.