Longevity Risk and Portfolio Protection Without a Variable Annuity

Two of the most daunting risks faced by the majority of retirees are:

  1. The risk of outliving one’s money (longevity risk).
  2. The risk of experiencing a bear market near or at the beginning of retirement when one’s portfolio is most vulnerable (sequence of returns risk).

Various types of annuities—particularly longevity annuities—can effectively address the longevity risk issue.  Guaranteed living benefit features that come with variable annuities can mitigate both sequence of returns and longevity risk.

The variable annuity, however, requires that the investments (portfolio management) and insurance coverage are bundled into the same product.

What if there is a product that separates the investment process from the insurance piece?  What would the pricing look like and how would this work?

A couple of years ago Moshe Milevsky introduced the notion of a ruin-contingent life annuity (RCLA).  Conceptually similar to living benefit riders and the standalone living benefit, a ruin-contingent life annuity is basically an option that is triggered or pays a lifetime stream of income once an investment portfolio has been depleted.

The RCLA is similar to a longevity annuity except that:

  • The date at which payments begin is uncertain since it is contingent on adverse capital market conditions and depletion of the investment portfolio.
  • The RCLA is triggered by two conditions: a) the annuitant and/or their spouse being alive, and; b) financial ruin.
  • The RCLA not only hedges longevity risk but also sequence of returns risk.

Let’s take a look at what a RCLA would cost and how it works through the following hypothetical scenario:

  • Bob is 65, is in relatively good health and plans to retire at age 68.
  • Bob has $1 million in investable assets and plans to withdraw $60,000 per year from this portfolio.
  • Bob wants to insure that he is able to withdraw the same $60,000 per year for the rest of his life in the event that he depletes his $1 million portfolio during his lifetime.
  • Let’s assume that the average annual return on Bob’s portfolio is 7% and that equity market volatility is 20%.  We will use the current 10 year treasury rate (3.4%) as our discount rate.

Given the assumptions above, the following table shows the amount Bob would have to pay now—as a single lump sum—to insure that he has some level of annual income that is guaranteed for life in the event that his portfolio is depleted at a future date.  The table also shows how changes in some of the assumption will affect the amount of the RCLA:


The other factors and their impact on the value of the ruin contingent life annuity are as follows:

Current Age: Higher age will make the RCLA less expensive.

Age of Retirement: Delaying retirement will make the RCLA less expensive.

Investable Assets: Higher assets result in less expensive RCLA.

Systematic Withdrawal Rate: Lower withdrawal rate results in less expensive RCLA.

Portfolio Value: Higher portfolio value results in less expensive RCLA.

Investment Return: Higher investment return results in cheaper RCLA.

Volatility: Lower volatility results in less expensive RCLA.

Discount Rate: Higher discount rate results in less expensive RCLA.