The Advanced Life Deferred Annuity – Cost-Effective Insurance Against the Risk of Outliving One’s Wealth
The study by Scott proposes a simple metric for measuring the financial benefit of longevity insurance, the Spending Improvement Coefficient. This is the increase in spending an individual would enjoy if, instead of setting aside money to pay for late life spending, they purchased a hypothetical longevity insurance contract under which the insurer pays the individual a lump sum conditional on the individuals survival to a specified age, zero otherwise. The key insight is that the largest Spending Improvement Coefficient is for contracts paying out at very advanced ages.
Consider an individual aged 65 who faces the task of financing spending during a single year 20 years in the future. They could self-insure by investing in a financial asset. At an assumed 2.5 percent interest rate, $1 would grow to $1.64 over 20 years. Assuming population mortality, the insurance company could offer a lump sum benefit of $3.18 because it knows some purchasers will not live to collect the benefit. The Spending Improvement Coefficient is 1.94: the $3.18 they receive from the ALDA divided by the $1.64 they would receive if they invested the money themselves.