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By Christine Benz and David Blanchett | 09-13-2012 02:00 PM

Managing the Risk of Outliving Your Assets

Morningstar retirement expert David Blanchett covers the pros and cons associated with the key longevity insurance products.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

The average American who retires at age 65 can be expected to live 20 more years, and many people will live much longer than that.

Joining me to discuss some of the key products to help hedge against longevity risk is David Blanchett. He is head of retirement research for Morningstar.

David, thank you so much for being here.

David Blanchett: Thank you for having me.

Benz: So, David, one of the key products to hedge against longevity risk is the whole suite of annuities, but first let's discuss exactly what is longevity risk. On the surface it seems like a really good thing to be able to live as long as you possibly can, but there are certainly some financial risks there?

Blanchett: So, longevity risk is a good thing in some ways; it's the risk of living too long. We all want to live long lives, but people don't plan for 30 or 40 years in retirement. If we go back 30 or 40 years ago, people had defined benefit plans. You had investment types that provided income for life.

Well, today's generation of savers, they have 401(k)s and IRAs, and there is no guarantee component of lifetime income. So, the risk for them, the longevity risk, is the risk that they're going to not have enough money to live or pay for their retiree expenses for their lifetimes.

Benz: You have noted that there is research out there showing that this is a hugely pressing concern for today's crop of retirees.

Blanchett: There was a study done by Allianz Life, and they asked retirees, which are you more afraid of: death or outliving your resources. And 61% said outliving their resources. So, clearly the idea of outliving your available spending is significant for many retirees.

Benz: Certainly the volatile financial markets have contributed to that sense of uncertainty.

So, let's outline some of the key products that are out there. Annuities in general do provide some hedge against longevity risk. Let's start with the most vanilla, oldest product out there: the single premium immediate annuity, whereby you fork over your money and you get a stream of income through the rest of your life. What is the key advantage to such a product?

Blanchett: So, immediate annuities have been around for, I think, thousands of years. They are the simplest, and like you said, you're just trading $100,000 for income for life. So, there is no worry about monitoring the money. Once you've done it, you receive this paycheck, so to speak, for the rest of your life. So, it makes it very easy to transfer these funds, and there is no worry about can I outlive it. So I think that's the simplest and easiest way to kind of create income for life.

Benz: Also generally speaking the cheapest type of [annuity].

Blanchett: It is. There are all different kinds of insurance now to hedge against longevity risk, and this tends to be the cheapest because it is the most plain-vanilla. There are underlying sub-account fees, and there is going to be a commission probably when the insurance agent sells the product, but there are not that ongoing kind of fees involved to other types of products.

Benz: A lot of transparency there for the consumer...

Blanchett: Yes. It's really easy to compare. It's the easiest product to compare. It's like life insurance, because you know what you're going to get for a given price. There are no underlying hidden fees that would affect the benefit at all.

 

Benz: So let's talk about the disadvantages to SPIA...

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