Caveat: I am not an agent for LIC. No, I am not on the payroll of the LIC. Actually I do not even know whether LIC knows that I exist.

Having said that let me accept that the press (including some of us fringe players) have written a lot of bad things about LIC – they are also true. However, LiC has one policy which I recommend to all people hoping to get old and live long.

THE ANNUITY.

The annuity is a ‘risk protection’ product, NOT, a ‘return enhancing’ product like mutual funds, direct stocks, etc. So understand the context first. A life annuity is a contract sold by a life insurance company (no clue why a mutual fund cannot do it, but the NPS will have to do it soon) to an “annuitant” (mostly a retiree, and has to be at least 45 years of age) guaranteeing periodic payments for as long as the annuitant lives. In retirement planning, we SHOULD use annuities to combat longevity risk, the risk of outliving our retirement savings. It is also a very simple product to remember so even a patient aged 90 years can be expected to remember that he gets ‘Rs. 5456 a month’ in his bank account. There is no product simpler than that.

The payout for a single male aged 60 today is about Rs. 9350 per annum,  for a Rs. 100,000 annuity. That’s about 9.3% annually. That is not equivalent to a 9.3% investment return because part of this payout is a non-taxed return of your own capital. The  investment return will depend on how long you live!  It will begin with a negative return and, should you live long enough, it will eventually exceed the payout rate. In other words it is a terrible investment if you died at the age of 65, but will turn out to be a great asset if you lived till the age of 95. Since we do not know how long we live, let us call this product as an ‘Insurance against running out of cash – the longevity risk’.

The insurance company invests the money you give them mostly in debt instruments with longish duration. It also uses premiums paid by annuitants who died early on in the journey to pay annuitants who live a long time using “mortality credits.” The payouts you receive come from income (bond interest, dividends and capital gains), from a partial return of your own capital and, if you live longer than average, from mortality credits.

Another objection to life annuities, is the fact that a life annuity typically has no RESIDUAL value i.e. it goes to zero when the annuitant dies. I am not getting into some variants where the principal is returned – we will do that later. However, exactly the reverse of insurance – you get better returns the more you delay in buying the annuity. So for Rs. 100,000 where we saw that a 60 year old was getting 9350, a 70 year old will get about 12000 and a 80 year old will get about Rs. 18000 per annum. This is obvious, is it not? REMEMBER THESE FIGURES ARE INDICATIVE AND I HAVE TAKEN FROM AN OLD TABLE – now the rates will be lower as interest rates have softened.

Many people fear that the retiree will buy an annuity and die so soon that it is not worth buying an annuity!  You need to remember that life annuities are insurance – not investments! It is an amazingly simple way – that reduces the risk of living a long, expensive retirement!  If the annuitant does not live a long life (there is obviously a break even calculation too!), then he or she would clearly have been better off not purchasing the annuity. So if you know when you are going to die, you do not need term insurance, nor do you need an annuity, but I have no clue when I am going to die.

All insurance have value whether or not we make a claim! They give us peace of mind. The retiree who purchases an annuity at age 65 but only lives to age 70 REDUCED the risk of a long life even though THE RISK of living long did not happen. People who purchase car insurance, term insurance, medical insurance or critical illness do not crib about not making a claim, right? Are those premiums wasted? NO. It gives us ‘peace of mind’.  Many retirees considering annuities MAY NOT see longevity insurance in the same way as they view other policies but purchasing life annuities provide a transfer-of-risk insurance benefit. So if your grandfather is fine at the age of 90, better arm yourself with an annuity. Makes sense? Yes, yes, yes.

Liquidity is another thing that people worry about. The money once paid is GONE. You cannot get even a rupee out of that contract. No penalties for withdrawing – IT JUST CANNOT BE WITHDRAWN. Many people are worried about this too!  The annuitant takes a big sum of his assets that could be spent and purchases a life annuity whose value can only be spent as periodic payments. Let’s assume a retiree decides to spend Rs. 100,000 of cash on a life annuity that pays Rs. 6,000 a year. She will now not see the Rs. 100,000 for the rest of her life.

The alternative to purchasing a life annuity is to self manage your investment portfolio. I am worried about a person’s investing skills, alertness levels, who he listens to, etc. I would not recommend that – unless your son / daughter or their spouses are handling it.  The same risks / difficulties crop up even when when you are handling it yourself without an annuity!