Are Annuities less costly to younger individuals?

CFA Level III Portfolio Management
#1

How can that be? If younger individuals have, on average, more years of life and therefore will receive more payouts from the annuity?

Can anyone clarify that?

Schweser’s statement is as follows: "All other factors the same, mortality credits make annuities less costly to purchase at a younger age - think of it as the annuitants who live longer earn a mortality credit paid by those who do not live as long and collect fewer payouts).

Thanks

#2

Instead of thinking Annuity vs. Non-Annuity - think of life Insurance in general.

Who do you think pays a higher premium - a young 20 something guy with no disease (potentially longer TTL (time to live)) or someone who is 50 years old and has various known diseases (therefore potentially shorter TTL).

It does not matter whether the insurance payout is a lumpsum or an annuity - the basics behind the cost of the insurance does not change.

Yes the amount of payment would change if a higher payout is desired. (Higher payout = Higher premium paid).

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#3

Younger annuitants will of course pay more for the same amount of periodic income than older annuitants would: the young’uns will be around longer on average.

I think what Schweser is driving at is that within a group of annuitants, those that live longer than expected get more out of the system, while those who live shorter others will get less than expected. This is just risk pooling in action. Everybody pays in to the pool at a rate that reflects the chance of not being alive at time t: all those alive get their periodic payment, while all the deaths get 0. That’s why some people add guaranteed periods to their annuities: even if they die, the payments continue to the end of the guaranteed period to their beneficiaries.

#4

I have 2 questions with respect to Mortality credits:

1.mortality credits exist for fixed annuities only?

  1. To take advantage of the the mortality credits invest in annuities at an early age?
#5

  1. Mortality credit exists wherever a payment depends on being alive at time t. The annuity can be fixed or variable.

  2. The mortality credit effect depends more on expected future lifetime rather than early age. If you are relatively healthy (unhealthy) and expect to live a long (short) time, you have a better chance of getting positive (negative) mortality credits.

#6

Thank you!!