"If I knew when I was going to die, then planning would be easier."
By Nic Round/ 5 minute read
By Nic Round/ 5 minute read
The purpose of this article is to explore an opportunity for the insurance industry to develop a new product that can really help investors in their planning. Lets imagine you think you will live past the age of 85. Then from age 85, you benefit from a guaranteed income until you die. Would you buy such a policy? Many thousands of people buy life assurance. They are hoping they don’t die early, but recognize that its important to provide capital for family and others if they die too soon.
Over 30 years ago, insurance providers issued retirement annuities. They were very much like todays personal pensions and often issued using with profit funds. Some also offered guaranteed annuities payable from your nominated retirement date. However, if you died, they offered various death benefits. Some offered policies with a return of premiums paid. Others offered return of premiums with a fixed return, of say 6%. But some also offered no return. In other words, if you did not live until your nominated retirement age, the insurance company benefited from all your accumulated fund. With the onset of unit linked plans in the 1960s, the industry moved towards plans that were issued on the basis of a return of fund in the event of death. Most pension plans today offer return of fund. In other words, the value of your investment is paid out in the event of death. In fact, the industry has been moving away from being insurance based to where individuals are more responsible for their own financial future.
Imagine a person wants to insure living past the age of 85. They have calculated their annual expenditure, which has been inflation adjusted. The insurance provider can issue the policy either with a single premium or regular premiums. However, if you die before age 85, there is no death benefit payable.
The title is important here. So many people say, if only I knew when I would die then the planning would be easier.
You are recently retired. Aged 60. You hope to live to 100. If you die at age 80, you leave 20 years of unspent capital, which is now inherited. But if you knew at age 85, you would benefit from a guaranteed income for the rest of your life, you could have spent your capital by age 85. This offers more certainty than exists in any planning today. Whilst some want their family to inherit their capital after they die, often inheritance is based on what’s unspent. But if you knew when a replacement income would be payable, you could give more away whilst you were living. That means your family could benefit whilst you are alive. You can help them today and you see the benefits today. In other words, your wealth is enjoyed during your lifetime. If you are saving for your retirement, would you bet on living by allocating part of your wealth into a policy that pays out post 85? If you believe life assurance is important just in case you die, then why not invest part of your monthly income into a plan that pays out if you live? What about long term care needs? Thinking about how to fund for long term care is a very big issue for people. As such, a plan that could provide certainty maybe helpful in the planning process. Perhaps even a plan could be developed that paid a lump sum rather than income, but still with zero death benefits.
The insurance provider can assess the risks for death after 85. In fact policyholders could elect different ages. Some may elect from age 90. ( Age 85 in this article is simply an example.) Providers can take a view if you live past 85, how many people will do so. Some people may only benefit from a guaranteed income for a short time, others may live for many years. Is it time for the insurance providers and the regulators to take steps to explore a new way forward? Perhaps then plans could be offered and likely costs assessed.
As a planner, there are so many benefits in insuring against living too long.
Would people bet on living too long? Absolutely. It’s a matter of being clear about benefits We are seeing the decline of Final salary schemes but part of their design is an element of nil return on death. If you are single and die whilst taking benefits, any accumulated assets remain for the other members. The actuaries running these schemes understand the risks of death and use averages to ensure the schemes benefit all members. Such schemes have and still do provide significant peace of mind to members.It seems to me that the insurance industry could start to rethink products that bet on living. They have the experience. If such polices are explained, the benefits are very strong and will offer peace of mind that currently does not exist. Even for the wealthy, where the chances of running out of money are slim, there are still benefits of being able to distribute assets whilst they are living. That is a win win for everyone.
I hope insurance providers will take up the challenge to assess the benefits of developing plans that bet on you living.
On the question of costs, it is our presumption that by embracing a new way forward when investing, investors could allocate capital to policies that “bet on living” At present, there is much debate about the costs of investing. There is various research but for most investors the costs are greater than they appreciate. Mifid11 has started to highlight hidden costs. When investors add adviser fees, fund management, platform costs together, it is not unreasonable to approximate costs at 3% each year. (There are various studies that highlight the costs of investing.)
The equation becomes clearer with an example.
An Investor has £1m. They elect to withdraw £4,000 per month. The gross return on investments is 6%pa. The Net return after costs is 3%pa. After 25 years the fund is worth £330,988
If the ongoing costs fell to 0.75% pa. you could achieve a similar end result with a fund worth £342,683 but instead of investing £1m, the original capital invested is only £760,000. This clearly illustrates the impact of costs over time.
Our investor, could, in theory, allocate up to £260,000 into a plan that bet on living and would not be prejudiced in the next 25 years. Clearly, we have no idea of the costs of plans but if investors do adopt a new way forward when investing, the combined effect would offer significant peace of mind.