The Sum Total Of Ageing

Source : The Straits Times, Fri, Sep 21, 2007

Tan Kin Lian, For The Straits Times

THE Government has announced its plan to introduce an annuity scheme - dubbed longevity insurance - in five years' time.

On reaching age 55, a Central Provident Fund member will be required to use a part of the Minimum Sum to buy a longevity annuity that will pay him $300 a month after he reaches 85.

Many people think their chances of reaching 85 are slim. But they are mistaken. I estimate more than 50 per cent of the population will live to age 85 and beyond.

You do not believe me?

The Department of Statistics' publication Population Trends has data for the death rates of each age group over a period of 25 years from 1980 to 2005. Death rates have been falling over this period by about 3 per cent yearly.

I did some projections based on that data, assuming the decline will continue. This is likely to be the case, at least for the next 10 to 20 years. It has been falling at this rate for the past 25 years. Why should it stop now?

Based on my projections, a male at age 55 today has a 57 per cent chance of surviving to age 85, and 32 per cent chance of hitting 95. The probability for a female is higher, at 70 per cent and 42 per cent, respectively.

If you still do not believe me, remember I am referring to people who are 55 years and less today. This group will have a longer life expectancy compared to that of the older people living today.

What will be the cost of the longevity annuity?

I assume the annuity provider (i.e. the CPF Board or an insurance company) is able to earn an investment yield of 4 per cent and there is no loading to cover operating expenses or profit margin.

I calculated the cost of the annuity to be $6,818 for a male and $8,759 for a female. This is to be paid at age 55, for a monthly payout of $300, from the age of 85 onwards till death.

The cost to females is higher, as they have a longer life expectancy and thus likely to receive the monthly payouts for more years than males.

If the annuitant lives for 10 years, from 85 to 95, the total payout will be $36,000 (i.e $300 x 12 x 10 years) - several times the original sum paid to buy the annuity.

The annuity can pay out much more for these reasons:

* Some annuitants will not live to age 85. Their money will be used to pay out to the annuitants who live longer.

* The provider is able to invest the money for the next 30 years.
Many people dislike the idea of losing their money, in case they do not live to 85.

It is possible to design a 'full refund' annuity that will return the original sum on the death of the annuitant. But the cost will be higher. My estimate is $9,824 for a male and $11,594 for a female.

Under this annuity, a male pays $9,824 at age 55. On the death of the annuitant, whether before or after age 85, the original sum of $9,824 will be refunded, without any interest. If the annuitant dies at 95, he would have received $300 a month for 10 years and his estate would still get the refund of $9,824.

Compared with the 'no refund' annuity, the cost of this 'full refund' annuity is 44 per cent more for a male and 32 per cent more for a female.

Another criticism pertains to the monthly payout of $300. This, it is argued, is not only inadequate, but will also be further eroded by inflation: $300 a month in 30 years' time will be worth much less than $300 today.

This criticism can be addressed by designing an 'increasing payout' annuity. The payout will be revised upwards by 2 per cent yearly to cover inflation. In 30 years' time, the payout will be $543 a month, instead of $300 (i.e. $300 increased by 2 per cent yearly for 30 years). The payout will continue to rise by 2 per cent each year.

To be sure, a 2 per cent rise yearly may not match actual inflation over the years. But it does offer some protection, against a 'flat' annuity.

What is the cost of an 'increasing payout' annuity that also provides a 'full refund' on death?

I estimate it to be $15,137 for a male and $19,548 for a female. Obviously it can get quite costly, if you wish to have a full refund and also a monthly payout that keeps up with inflation.

What do I recommend?

Go for the 'increasing payout, no refund' annuity if you are in fairly good health and unaware of any serious medical problem. Stay healthy and live a long life. Enjoy your golden years to 95 or longer.

If you are in poor health, you can buy the 'increasing payout, full refund' annuity.

What should the Government do?

Encourage people to buy a life annuity that pays from age 65 - yes, age 65, not 85 - and for a lifetime. The life annuity will give them a steady income payable for a lifetime.

Then they do not have to worry about managing their retirement account for 20 years and be subject to a fluctuating interest rate that is pegged to the yield on Government bonds. They will also not suffer a drop in their income when they reach 85.

If the life annuity scheme is administered by the CPF and the annuity payout is calculated using an interest rate of 4 per cent, the payout can be quite attractive. These life annuitants should then be exempted from the longevity insurance scheme.

The writer is a qualified actuary and was CEO of NTUC Income for 30 years until his retirement in February. His blog is at www.tankinlian.blogspot.com.

The above calculations are for educational purposes and do not reflect commercial terms that may be offered by any specific annuity provider.