Premature Death vs Unexpected Longevity

Life Insurance

This week we’ll discuss the first risk categories mentioned in last week’s general introduction to personal risk. The risk of premature death and longevity risk are distinctly different uncertainties but both can be addressed with insurance products. We transfer (or share) some of these risks with the insurer by purchasing an insurance product specifically designed for the particular issue.

Life insurance has been in existence for hundreds of years. The earliest forms of life insurance in the U.S. can be traced back to the 1760’s. The Presbyterian Synods of Philadelphia and New York created The Corporation for Relief of Poor and Distressed Widows and Children of Presbyterian Ministers in 1759. Episcopalian ministers started a similar fund in 1769. As the name implies, the concept was to protect the wives and children who depended on the ministers for their financial support. 

This need is the same today as children and stay-at-home spouses are usually dependent on the income earned by a working spouse(s). In the event that this breadwinner(s) was to meet an untimely and premature death, the surviving family members would be left with no means of support. Thus, life insurance policies can mitigate this risk by the payment of a regular and smaller premium in return for a much larger death benefit. Clearly, the negative event (premature death) must have a relatively low probability of occurrence in order for this “insurance mechanism” to function. If the probability of occurrence of the negative event was too high, the insurance premiums would be so excessive that no one would be willing to purchase the insurance policy. This is why it’s generally a good idea to acquire life insurance while one is young and healthy as the insurer will more readily offer an affordable policy.

Excess longevity is merely the inverse situation when compared to the risk of a premature death. Living a long life is not necessarily a bad thing but it creates the possibility that one may outlive their financial resources. The insurance industry offers annuities to deal with this situation. There are many forms of annuities but they all seek to address an unexpectedly long life. In its simplest form, the purchaser of a commercial single premium immediate annuity (SPIA) exchanges a lump sum of money with the insurance company in return for the insurer’s promise to make regular payments (usually monthly) for the remainder of the life of the insured. Because the insurer will issue many of these policies, they have some purchasers who do live exceedingly long lives, but they also issue polices to people who die shortly after purchasing the annuity.  In essence, those who die early “subsidize” the payments to those who live much longer than their projected life expectancy. These “longevity credits” allow the insurer to offer higher monthly annuity payments than any individual might be able to safely extract from the same lump sum.  

The following euphemism is an easy way to comprehend these two insurance products.  “Purchase life insurance to protect against dying too soon and purchase annuities to protect against living too long.”

Well said!

If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240.  This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Certified Financial Planner