Here’s why and for whom it could be particularly useful
You’ll remember that earlier this year I said that QSuper, a major Australian superannuation (i.e. pension) fund, launched a lifetime income product that pools longevity risk without annuity-type guarantees. (It has since been given several industry awards, recognizing its leadership.) I’m delighted that it hasn’t taken long for Canada to follow suit. On May 28, 2021 the Longevity Pension Fund was launched. It’s organized and managed by Purpose Investments Inc.
I’ll start with a reminder of why this sort of product is an important development, anywhere in the world.
In the decumulation phase of our lives (after we retire), we suddenly lose the regular paycheck we were used to. Converting (at least a part of) our assets into a regular income that is guaranteed to last for the rest of our life is a difficult task, because we don’t know how long we will live. Research by David Blanchett and Michael Finke suggests that, as a result of that uncertainty, and in a desire to stretch out how long our assets will last, we tend to draw spending money from our assets at a slower rate than we would if we had that lifelong guarantee. In turn, this suggests that we spend less than we otherwise would. Specifically, the research suggests that we tend to spend half as much from drawdowns as we would if we annuitized that same amount of capital. Wow, quite a difference to a lifestyle!
That doesn’t mean we should automatically annuitize all our assets, of course. Many countries around the world already give us limited amounts in the form of lifetime income: for example, the Canada and Quebec Pension Plans and Old Age Security in Canada, Social Security in the USA and the State Pension in the UK. So, even though we don’t think of these as being assets, they really are, and they are actually pre-annuitized assets. Further research suggests that the need for a paycheck-like income stream is most beneficial for those in a particular set of circumstances.
This group consists of people who want some minimum level of income to generate peace of mind regarding spending. For example, enough income that, combined with pre-annuitized government benefits, enables you to cover all the things that you consider your “needs” (things you simply must have) as opposed to your “wants” (things you desire but, in a pinch, could live without).
The more certain you desire to be about the level of the income, the more desirable it becomes to lock in the level with an insured annuity. The more flexible you are about the possible variations in the income level, the more a longevity pool will appeal over an insured annuity. Either way, though, it’s clearly not an all-or-nothing issue, as far as it goes, regarding how much of your assets you annuitize or place in a longevity pool. For most, it’ll make sense to devote part of your assets to this purpose, and the rest to the more traditional drawing down as required for spending. All you’re doing, with the annuity or the longevity pool, is doing away with the financial effects of your longevity uncertainty on that portion of your assets.
Are there people who shouldn’t think of a longevity pool at all? Yes.
The important characteristic is if you have so much in the way of assets that you can maintain your desired standard of living to age 110 or 120 (or whatever is the final age in the longevity table that’s used in your country) and still not exhaust your assets. If so, longevity is simply not a financial risk for you. For anyone else, longevity is indeed a financial risk. In most ways longevity is something we seek, of course – but from a cold financial perspective, it’s a risk, because we have to pay for it.
It’s a risk that becomes particularly important for men of at least average health after age 75, and for women of at least average health after age 80. Why? This was something I had to think of for myself, as I’m even older than Baby Boomers – I’m a WW2 baby, and so there certainly wasn’t anyone to advise me on these issues when I graduated from full-time work. But as an actuary, I was familiar with both investment return uncertainty and longevity uncertainty, and it seemed to me that nobody had ever compared them. So I did. Some years later my friend Bob Collie re-did the work much better than I ever did.
What I found, in essence, is that at younger years, investment return uncertainty has a greater financial impact than longevity uncertainty. But after those ages 75 and 80, longevity uncertainty has a greater financial impact than being 100% invested in equities. If, therefore, you’re approaching or at or over that age and are scared of being 100% invested in equities, you ought to be even more scared of not doing something about your longevity risk – like putting money into a deferred annuity (not available in most countries) or an immediate annuity or (now) a longevity pool.
That’s the general story. Here are some of the characteristics of the Longevity Pension Fund: necessarily a brief description, and certainly not a substitute for your own research and getting professional advice.
- It’s available for people born in 1945 through 1956. I understand that the intention is to extend the availability in the near future to those born in 1942-44, and each year, as people turn 65, to extend availability to them. Meanwhile, additional amounts can be invested by participants until they reach age 80.
- A lifetime income stream is paid once a month, guaranteed to last for the lifetime of the purchaser.
- If your death causes that lifetime income stream to end before the purchase price has been returned in income payments, a lump sum death benefit equal to the rest of the purchase price is paid to a named beneficiary.
- Meanwhile the purchase price is invested in a balanced fund run by Purpose Investments. The intention (it’s too early to establish a pattern) is for it to be invested 47% in equities, 38% in fixed income and 15% in alternative investments, with a geographical spread intended to be 25% in Canada, 60% in the US, 9% in international developed markets and 6% in emerging markets. The further intention is to use derivative collars for additional downside protection, at the cost of some upside potential.
- The initial amounts of the payments each year are specified in advance, and range from 6.15% of the purchase price for the youngest investors to 7.40% for the oldest investors. These are based on assumed investment returns of 3.75% a year after investment expenses and an annual management fee of 0.60% a year. That’s if you buy through a discount broker or a fee-based dealer. If instead you buy through an authorized dealer, subtract 0.50% from the payment levels (so, they range from 5.65% to 6.90%) because there will be a “trailing commission” of 0.50% a year paid to the authorized dealer.
- Once a year the payment levels will be reviewed and possibly adjusted (up or down – both directions are possible) to reflect any difference between the actual earned return and the assumed 3.75%, as well as longevity credits reflecting deaths beyond the period when the second bullet above operates. The numbers (payouts and assumed returns) have been designed to make payment level increases far more likely than decreases; I’m told that Purpose worked with Morneau Shepell (now called LifeWorks) on the economic modelling and sensitivity.*
- If at any time you change your mind and want to terminate your contract, you can do so. Except in extraordinary trading circumstances, you will be repaid any balance of your purchase price over your receipts (unless markets have declined, in which case you may get less than the balance of your purchase price). My observation: be aware that this is not a “can’t lose” situation, because in effect you’re sacrificing all returns earned to date as well as longevity credits.
- I’ve described the Decumulation Units in the mutual fund. There are also Accumulation Units for investors younger than 65, but they’re not what I’m writing about.
I noticed that some Reddit comments confused the 6.15% (to 7.40%) lifetime income stream with the assumed investment return of 3.75%, wondering how it’s possible to pay so much more than the investment return, asking suspiciously: where does the rest of the money come from? The answer is simple: the rest of the money is a return of the purchase price, and the longevity credits generated as others leave the fund (voluntarily or at death).
In other words, the intent is to help you to draw down capital as well as the investment return, and the excess (for example, 6.15% – 3.75% = 2.40%) comes from drawing down the capital. The idea of living off your assets is not to live solely off the investment returns (because then your main goal is evidently to leave the capital as a bequest!); it’s to draw down your capital too, just not so fast that it runs out before your life runs out. The longevity pool is a way to arrange that you can’t outlive your capital, because it’s pooled with the capital of the other purchasers, and the whole thing is gradually spread over the years at a pace that reflects the actual mortality experience of the group: hence potential longevity credits for those who live longer than average and longevity losses for those who live shorter – that’s what pooling the risk means. You can’t tell in advance how long you’ll live, but it’s the pooling mechanism that guarantees that the pool won’t run out before the last purchaser does.
The website says that Longevity’s decisions will be guided by an external Advisory Committee. Under Canadian law, the Fund itself will also have a 3-person Independent Review Committee.
* I’m a board member of a LifeWorks subsidiary. I had no knowledge of or connection with this work.
Products of this sort are very useful to help get around the financial risk caused by longevity uncertainty, and I hope to see them proliferate.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.