By Mark Shemtob
I’ve covered the advantages to securing lifetime income using retiree longevity risk sharing pools (Pools), most recently in my article “Time to Take the Plunge?” (Contingencies; September/October 2022). For those not very familiar with the topic, Pools provide increased lifetime income with no additional investment risk through the use of mortality credits (discussed below)—the trade-off being lack of liquidity and potential for bequests. The actual value of using a Pool will vary from individual to individual based upon specific goals and needs.
Here are some key issues for individual consideration:
- Health
- Additional benefits available through pooling
- Importance of legacy needs
- Liquidity needs
This article will not address the question of whether one should participate in a Pool, assuming one is available.[1] We will assume that an individual has already decided to do so. The less-debated question is when the best time is to participate in a Pool. The conventional wisdom is to take advantage of participating in a Pool at actual retirement; the rationale is that this strategy allows for the most mortality credits—the additional benefits that are earned as a result of Pool participants passing away and having their accounts redistributed to survivors. Delaying may result in fewer mortality credits but has advantages that are often overlooked. This article will attempt to shed some light on this subject.
Analysis
Let’s consider a 60-year-old new retiree with $100,000 to be invested in a Pool. Let’s further assume that said retiree expects to live to age 90 (a conservative outlook) and the annual investment rate of return that will be achieved will be 5%. We assume mortality rates of the Pool participants based upon a male/female blended table.[2] Our retiree has the option to join the Pool at either age 60, 65, 70, 75 or 80.[3] If the retiree does not join at age 60, there will be a reconsideration at age 65. This occurs again at age 70 and 75. The last optional entry age is 80.
We will start with a comparative analysis of the relative advantages of participating in a Pool compared to a non-pooled withdrawal approach at the five ages under consideration. Table 1 illustrates these values in dollars and percentages.
As demonstrated in the last column, there is a distinct relative advantage to joining a Pool (as opposed to not joining) as one ages. This should be somewhat intuitive because the probability of death increases with age and thus the mortality credits are larger. (The increase in the advantages does tail off at older ages based upon our assumption of death at age 90.[4])
However, as previously noted, delaying entering a Pool will negatively impact the amount of overall mortality credits to be earned. Table 2 provides an estimate of the mortality credits and applicable benefits lost by delaying entering the Pool for the ages under consideration.
Delaying entering the Pool results in reduced mortality credits which is a function of both actual and relative ages. Delaying from age 60 to 65 or 70 to 75 both represent five-year delays, but with significantly different mortality credit losses—2.5% loss vs 7.5% loss.
Though delaying entering the Pool will negatively impact mortality credits, it does provide several non-retirement income level advantages:
- Liquidity during the delay period
- Potential for a legacy during the delay period
- Allows one to consider changes in health
Discussion
Table 1 supports the argument for delaying based on the increasing relative advantage of joining a Pool (over no longevity pooling) as one ages. However, as Table 2 illustrates there is value in earlier Pool entry due to the additional mortality credits that will be earned. Let’s consider the following five-year delay intervals:
- 60 to 65: A 3.4% relative additional pooling value but a loss in mortality credits of 2.5%
- 65 to 70: A 3.3% relative additional pooling value but a loss in mortality credits of 4.5%
- 70 to 75: A 3.0% relative additional pooling value but a loss in mortality credits of 7.5%
- 75 to 80: A 0.6% relative additional pooling value but a loss in mortality credits of 12.9%
Note that the two measures being used are quite different and should not simply be combined. The overall takeaway based on this example is that delaying Pool entry is a good strategy. But at some point, the value of delaying loses its advantage. The sweet spot is somewhere between 70 and 75; individuals will want to consider the importance of liquidity and legacy.
Some key points:
- Above is based on an assumed age of death of 90. Changing this assumption will impact the results. A later assumption will increase the advantages of delaying Pool entry.
- These are based upon pure longevity risk sharing pools with no death benefits payable to beneficiaries.
- The above is based upon actuarially fair assumptions. There are no provisions for hedging or adverse selection that would be found in an insurance annuity contract.[5]
Conclusion
The goal of this article is not to debate Pool advantages but to bring attention to consideration of the value of delaying entering a Pool. Longevity risk-sharing pooling is the most effective way to deliver retirement income and is the cornerstone in the creation of traditional pensions, Social Security, and insured income annuities. Pools as analyzed in this article are essentially based on the same principles. The use of Pools allowing delayed entry ages may offer an alternative that will be well received by retirees for both economic and non-economic reasons. Should legislators eventually allow for widespread use of these types of programs,[6] they will have the potential to significantly improve retirement income security.
MARK SHEMTOB, MAAA, FSA, FCA, EA, provides consulting on retirement income security at both the individual and the institutional levels.
Endnotes
[1] In the U.S., there are very limited opportunities to join Pools. One can purchase fixed-income annuities from an insurer that uses pooling, but the risk is underwritten by the insurer—not the retirees. The use of longevity risk pooling is popular and enjoys widespread use with growing interest in most developed countries, though not yet in the U.S.
[2] Based on assumptions used for measuring liabilities under an ERISA-covered defined benefit plan
[3] Whether one would ever enter a Pool at advanced ages such as 80 (if available) is a fair question. An individual in very good health, with no needs for liquidity or inheritance but in need of greater income, would find this option attractive.
[4] Using a greater life expectancy would improve the relative advantages to joining a Pool at older ages.
[5] Pricing under insurance company fixed income annuity contracts makes them unattractive when considering analyzing delay options.
[6] Only currently permitted in U.S. under church plans, state plans, and TIAA-CREF.
