Abstract
Building on the May 2011 EBRI Issue Brief, this paper analyzes how changes in longevity annuity prices and longevity risk affect retirement income adequacy of retirees facing three different types of risk-investment income, longevity, and long-term care risk. Longevity annuities are similar to immediate annuities in that they provide a stream of fixed benefits over time (usually until death). Unlike an immediate annuity, which (as the name implies) begins to provide a benefit immediately upon purchase, a longevity annuity starts to distribute its payments only when the retiree reaches an advanced age, such as 80 or 85. The price of a longevity annuity is lower than that of an immediate annuity because it is mainly determined by conditional survival, which declines with age. In other words, a longevity annuity distributes higher payments per premium dollar compared with an immediate annuity because the payments are deferred until a commencement age at which the chance of survival declines. Since retirement income adequacy depends, in part, on different annuity prices (how much the annuity costs) and mortality (how long the individual lives), this paper analyzes how those factors would affect the retirement income adequacy of retirees targeting a desired level of adequacy (e.g., a 90 percent probability of adequacy). As the price of a longevity annuity increases, and as longevity risk grows, more initial retirement wealth is needed and the degree of annuitization needs to be increased - especially to achieve a 90 percent chance of adequacy (the inverse is true as well). The optimal degree of annuitization with a longevity annuity, however, depends on how much an individual’s retirement portfolio is invested in equities. The analysis also shows how changes in longevity annuity price and longevity risk affect retirement income adequacy in terms of a multiple of final earnings. Note: The simulation results presented here were based on certain assumptions for a male retiring at age 65, with specific long-term capital market and investment expenses, and long-term general and health-care cost inflation rates. Additional research is needed to analyze retirement income adequacy for a female or a household with alternative assumptions.