Bill Bernstein wrote: ↑Sun Dec 04, 2022 12:29 pm
self-insuring against longevity is perhaps more costly than some tend to acknowledge.
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This is undoubtedly true to the extent that the issuing company isn't pocketing the lion's share of the true actuarial mortality credit.
But you get what you pay for: self-insured TIPS-based longevity insurance pays off in real dollars, a SPIA's sure doesn't.
Bill
What is TIPS-based longevity insurance? Is it funding out to age 105? Suppose a couple starts collecting SS at age 70, and suppose SS covers 1/2 of their expenses. They can fund 35 years of that with TIPS or about 15 years of it with a SPIA. As these numbers are estimates, let's say the TIPS portfolio/ladder costs about 2x the cost of the SPIA because the TIPS must fund more years and the SPIA has no COLA.
Instead of funding the TIPS portfolio, the retiree could hold something like:
50% nominal SPIA
50% stock or 30% stock + 20% TIPS
The retiree who puts everything in TIPS has covered liabilities and inflation, but is seriously exposed to unpredictable expenses such as uninsured long-term care as one possible example.
The retiree with SPIA, stocks, and TIPS has wrapped inflation for the expenses not covered by SS (half of liabilities in the example) in with other unpredictable expenses to be covered by stock or stock and TIPS.
The all-TIPS solution is a kind of financial Maginot Line. Inflation is addressed at all cost, but there is no mechanism to address expenses turning out to be significantly higher than projected for reasons other than inflation. It also is exposed to the retiree's inflation rate differing from the corrections for TIPS (CPI-U) and SS (CPI-W). For instance, we have seen health care and long-term care costs grow much faster than CPI-U/W at times.
A hybrid approach is also possible: hold the asset to be annuitized as TIPS, and annuitize at a later date to reduce the number years the asset is exposed to inflation.
A portfolio of rolling commodities futures like VCMDX also can cover inflation risk for more than just itself.
But any analysis needs to look at all the full picture, and not just compare two asset classes (TIPS and SPIA) in a vacuum.