What do you get when you splice together a life insurance policy and an immediate annuity?
A reversionary annuity. Yes, that's a mouthful, but it carries some of the advantages of each and is ideal for certain kinds of clients.
The niche insurance product combines an insurance policy with an immediate annuity to provide for a surviving spouse. Much like a permanent life insurance policy, the policy owner of a reversionary annuity pays a premium to guarantee a benefit to the survivor. The life insurance has no cash value. With a reversionary annuity, upon the insured's death, the beneficiary receives a guaranteed lifetime income instead of a lump sum payment.
The income payments will cease upon the death of the beneficiary, and if the beneficiary dies before the insured, the policy is terminated. As a result, premiums are typically about 50 percent lower than those on a life insurance policy.
“The product provides a well-targeted benefit in the form of a fixed lifetime income for the beneficiary,” says Noel Abkemeier, consulting actuary with Milliman. “This contrasts with level term or whole life insurance in which the level death benefit may become too large over time. The reversionary annuity allows you to buy just as much death benefit as you need.”
Other benefits include return of premium rider, an inflation option so that the income maintains its purchasing power over the years. And since the product provides a decreasing death benefit, the premiums are lower than for level benefit insurance.
“The pay-as-you-go nature of the funding is attractive when compared with most annuity purchases,” he says. “Tax treatment is favorable — just like life insurance. The value of the death benefit is tax-free. Subsequent interest is taxed under an exclusion ratio approach.”
He adds that if there is a concern that the beneficiary will die soon after the insured dies, it can be possible to have the annuity payout in the form of a life annuity over a certain period. Of course, this is more costly since some of the mortality leverage is removed.
Assurity Life, Lincoln Neb., is currently the only insurer underwriting a reversionary annuity, according to Dean Potter, president of Potter & Associates, Edmonton, Okla., who holds a U.S. patent for a “method of providing streams of monetary payments solely to beneficiaries who survive respective insured.” Assurity Life's A.M. Best financial strength rating is A- with a stable outlook.
Insurance research by the Society of Actuaries and Boston College's Center for Retirement suggests the demand for longevity insurance could increase due to a reduction in Social Security benefits and the disappearance of defined benefit plans.
“Reversionary annuities are most often used for pension maximization for people with defined benefit pension plans,” says Potter.
“A prospective retiree can choose a single life payout option from the pension plan rather than the joint and survivor option and use the portion of the income to fund a reversionary annuity. The result can be more income for the retiree and spouse while they are both living and more income for the spouse following the death of the retiree.”
Potter has also used a reversionary annuity with clients that have poor performing universal life insurance policies. The premiums they used to fund the life insurance will buy more monthly income coverage from the reversionary annuity. Plus, the cash value in the old universal policy can fund another paid-up annuity.
The product can also be used in prenuptial or buy-sell agreements, and for fulfilling alimony payments.
“Assured Income Protector” comes with a return of premium rider, a 3 percent and 5 percent increasing monthly benefit option on the anniversary date of the policy, premium options, a simultaneous death benefit or accelerated first-year benefit rider.
“The marketplace is huge,” says Potter. “For seniors there is one critical need that has gone unresolved — to save enough money to sustain the clients' and spouses' lifestyles for two lifetimes.”
Potter says that agents often recommend life insurance or single premium immediate annuities as a way to protect the surviving spouse.
But term insurance renew rates are higher and only cover people to age 70 to 75 years of age, he says. Meanwhile, single premium immediate annuities pay income to the policyholder for a lifetime. Payouts to a beneficiary lower the monthly income payments.
For example, Potter says a single premium immediate annuity for a female age 50 supporting $2,000 a month in income requires a single premium of $479,800. By contrast, a universal life insurance policy would have to have a death benefit of $479,800 to provide the surviving spouse with the same $2,000 monthly income. The policyholder's monthly premium would be $396.
The reversionary annuity insuring a male age 50 would provide his survivor, also age 50, the same income benefit of $2,000 per month for a monthly premium of $207, including the return of premium rider.
Despite the benefits, there is, of course, no free lunch with a reversionary annuity.
“The value of the benefit relates to the health of the beneficiary,” says Abkemeier of Milliman, “Consequently, it may not be a good buy if the beneficiary is in poor health. Since the beneficiary cannot be changed, a purchaser occasionally can find the benefit to no longer fit because of a changed family situation, e.g., a divorce.”
He also says there is no cash value, but this is a trade-off for lowering premiums through leveraging mortality. In addition, premiums might change because the value of the death benefit varies inversely with interest rates. If interest rates fall, the value of the annuity death benefit rises.
Actuary Garth Bernard, CEO of Sharper Financial Group, Boston, says 95 percent of people take systematic withdrawals from their investments. That is unlikely to change unless interest rates rise dramatically.
“Traditional income annuities are barely sold today; even fewer exotic income annuities are sold,” he says. “While everyone talks about the importance of lifetime income, the reality is that investors, regardless of age, hoard money. This is unlikely to change in our lifetimes unless interest rates rise to 10 percent. Buying an income annuity of any kind [today] would be akin to pouring water into your gas tank.”
Alan Lavine is a contributing writer to Registered Rep., and author of some 15 books on investments and insurance. He writes a column for Dow Jones MarketWatch's “Retirement Weekly,” and is a contributing editor to Financial Advisor magazine.