vineviz wrote: ↑Sun Nov 20, 2022 12:01 pm
Prokofiev wrote: ↑Sun Nov 20, 2022 11:38 am
I don't think this is correct. Getting a graded 2, 3 or 5% SPIA will mean the break-even age MUST be higher than a 0% SPIA. You are effectively
moving payments from the present into the fu}ture and your starting point is much lower with the 5% annuity. They cannot both give you the same
dollars up to "average lifespan" since the 5% annuity would then be so much more valuable for the 50% of the pool that lives beyond that age.
It is correct that the amount of fixed increase ( whether 0% or more) is actuarially neutral.
It’s true that IF you could be SURE when you bought the annuity that’s you’d live longer than the insurance company expects you to, the 5% annuity would be very valuable to you.
But none of us know that, and the insurance companies know that none of us know that.
Well, I hate to press the point. but I believe it depends on what you think "actuarially neutral" means. Let me start by saying I have no deep knowledge of the insurance or annuity business. I did risk analysis for a major oil firm, and we did not need to use mortality functions. This is more of a math/statistics approach.
Consider two groups of annuitants. All are exactly 70yo, male and want to buy a SPIA. To make matters easier, we live in a zero-discount rate world where $1 today equals $1 30 years from now. No time value of money. Group A wants a simple 0% SPIA, while Group B prefers a 5% graded
life annuity. The insurance company needs to make a profit. Say 2% to the salesman, 2% to write checks for 30+ years and 6% net profit. So, lets
say 10% (I have no idea of the correct number). Each group buys $100 million in contracts and the insurance company wants to pay-out exactly
$90 million to each group over the next 50 years at which time everyone is gone.
There is a mortality distribution function known to the company and assume it is perfect. Given this function and the 10% profitability goal, can we calculate exactly how much each person in Group A should receive each year or month? Sure. Easy. Let's say everyone gets 6.67% a year of their initial premium (completely made-up number). They all can expect to break-even in exactly 15 years. For Group B using the same mortality function (more on this later) can they calculate what each member should receive to make their break-even exactly 15 years? Yup. 4.63%. But the problem now is that the insurance company will NOT pay-out exactly $90 million for their 10% profitability. It will probably be more. So can they
calculate what the initial pay-out should be to make 10% profit? Sure. But in general, these numbers are not the same. For a given mortality distribution function and 2 different pay-out structures, you cannot match BOTH the total payout (profitability) and the break-even age with a single initial pay-out number.
So here is my question. Does being actuarially fair or neutral mean both groups get the same total pay-out or the same break-even age? I would vote for the insurance company making exactly the same profit for both groups. That is their perspective. But many reading this thread think it
means "if I live exactly my expected lifespan, then all SPIA annuities will be exactly the same, be it 0%,1%,2%,5% or even true CPI". I don't believe that is the case. I haven't checked in quite a while, but I believe that adding a larger increase will also increase your break-even age. Now it may be a rather small increase, but that has more to do with the mortality function shape than any need for them to be equal. The difference between an age 85 or 86 break-even seems rather small, barely 1%. But the expected lifespan of an 85 yo is about 6 years. So that is a big % of your remaining life. A small increase of only a few months can mean a large difference in profitability to the policy writer. Maybe this is a very small point. Kind of like saying SS is actuarially neutral. For men or for women? For a single person or married? For a 60 yo or a 70 yo. It may be a small difference, but they cannot ALL be fair.
I would not be surprised that companies use a different mortality table for different pay-out escalators. Does a 70 yo with a 5% annuity live a little longer than those with 2%? And 2% live longer that 0% who surely will live longer than the general public. Is that slicing things too thin? If I ran the company, I would certainly look at that and I'm pretty sure they do. Perhaps there is someone doing this work who could chime it. I am too lazy to ask for different graded quotes and I don't want to send them my personal info. The calculators seem to only provide a simple 0% answer.
My other point is that it is more than semantics to say COLA doesn't equal CPI. We can agree that a SPIA with an escalator of x% has nothing directly to do with inflation or your personal cost of living. It just changes the pay-out structure of the annuity for the annuitant. The insurance company is accepting no risk nor changing their expected profit.