Retirement Income Redesigned: Master Plans for Distribution: An Adviser's Guide for Funding Boomers' Best Years

Chapter 19. Immediate Annuities: Structure, Mechanics, and Value

r. h. "rick" carey and jeffrey k. dellinger

Having passed the hurdle of accumulating assets during working years, the next risk faced by retirees is living longer than their assets can sustain them and becoming financially dependent on others—children, relatives, friends, or the government. If we knew how long we would survive, we could invest our assets appropriately to support ourselves for this known period. In reality, length of life is a random variable, producing longevity risk.

Income annuities provide a sound solution to that risk. The annuity contract owner pays a premium and the annuitant receives regular, periodic annuity benefits regardless of how long he lives. Some annuitants may survive only a short time, whereas others will live well beyond age 100. Although the length of life for a single individual is unknown, the length of life for a large collection of annuitants is more predictable. For example, the survival curve for 1,000 females age 65 resembles the pattern in FIGURE 19.1.

The law of large numbers enhances predictability and permits individuals— who cannot safely absorb longevity risk—to transfer that risk to companies that can, by using a mortality pooling function. A state regulatory framework ensures that reserves held for annuity benefits not yet paid are sufficient to support these contractual obligations.

Working separately from Social Security and corporate defined-benefit pension plans, ...