Some Thoughts on the "Longevity Pension" from Purpose Investment

In the 1966 British comedy “The Wrong Box”, a group of comedic actors (including Peter Sellers, Dudley Moore and Michael Caine) have great fun trying to collect the proceeds of a tontine that had been set up many years earlier. Described as a “delicious hysterical black comedy,” it is well worth a watch. On the other hand, a similar “black comedy” called the “Longevity Pension” – also based on the concept of a tontine - is not quite so amusing. This new product, launched by Purpose Investments in June, 2021 deals with the retirement monies of real people and how they plan to receive income in their retirement. It presents itself as a solution for those looking for lifetime income, and as an alternative to a traditional insurance company annuity.
Unlike a traditional annuity, the Longevity Pension is not an insurance product and the payments from it are in no way guaranteed – either for the lifetime of the individual or in the amount of the monthly payment that will be received. In fact, payments are expected to vary over time – one hopes upward, but possibly down as well.

When is a Tontine not a Tontine?

Because the “Longevity Pension” is NOT an insurance product, the annual payment made and the duration of those payments are not guaranteed. Payments are expected to vary over time depending on investment and mortality experience. Should mortality be better than anticipated (ie fewer people pass away each year), future payments will likely be reduced. On the other hand, if mortality is worse than anticipated (more people die each year), not only will future payments likely increase (depending on investment experience), but there will be unintended windfall payouts to the survivors in each cohort (the plan is structured into three year tranches). Ultimately, any funds remaining will go to the final survivor since there is no reversion to the fund sponsor. The Wrong Box indeed! Provisions in the 2021 Canadian budget to permit Variable Payment Life Annuities (VPLA) will permit such a product to exist – whether or not it is in the best interest of the participants.

When is a Pension not a Pension?

In my opinion, calling this product a “Longevity Pension” is somewhat misleading. While it is a bona fide investment product, subject to oversight by securities regulators, it is not a “pension” in the sense that it is subject to pension legislation across the country. In particular, there is no need to provide a Joint and Survivor option as required under pension law. While the intent of the product is clearly to provide lifetime income, that may not be the result.

Registered pension plans are required to offer persons who retire the option of taking some form of joint and survivor pension, with the percent continuation to the surviving spouse varying from jurisdiction to jurisdiction – with two-thirds continuations being common. This is intended to provide ongoing income to the survivor on the death of the annuitant. Since the 1980’s, pension legislation across the country has required that surviving spouses be protected under pension plans. With there being greater than 50% likelihood that one member of a retired couple will now live into his/her 90s, such a provision is important and provides security and peace of mind. The “Longevity Pension” does not provide for such a payout; the payments will cease on the death of the annuitant. If more has been paid out that was paid in, nothing further can or will be paid to any surviving spouse.

Are Men and Women Created Equally?

Years of actuarial statistics have documented that men and women experience different rates of mortality – with women generally living about three – four years longer than men of the same age. This difference in mortality is widely recognized in both life insurance premiums (women pay less for the same insurance) and in annuities (women receive less income for the same lump sum.) “Longevity Pension” does not recognize this difference - the anticipated payout for each age-banded cohort is the same for men and women. This results in men subsidizing the payout to women.

What other Options are Available?

For many years, the purchasing of an annuity from an insurance company was the only choice a person had to receive income in retirement. Over the years, other options have been created so now retirees have some additional options available. Only the insured annuity can provide certainly as to both the annual amount of income and the lifetime guarantee. The risks that the retiree must face relate primarily to mortality (the “probability of dying”) and the rate of investment return. The insured annuity transfers both of those risks – for a price – to an insurance company. While other risks may also be present, these two are the ones most often considered. The willingness of an individual (or couple) to accept either of these risks – in whole or part – must be considered when choosing another retirement option.

The “Longevity Pension” provides an option, without any guarantee as to amount of lifetime income that a person will receive, and has limited flexibility in terms of letting the annuitant adjust – up or down – the amount of income received each year. Furthermore, on the death of the principal annuitant, there may be no residual amount left to continue payments to a surviving spouse. All of the investment income that might have been earned while receiving income, which could be considerable, is forfeited.

To address these shortcomings, another option would be for the retiree to invest in a fund created to optimize the income that can be generated (albeit, without the certainly of an insured annuity), but with the added benefits that i) payments can be adjusted – up or down (subject to applicable CRA limits) from time to time and ii) whatever amount remains in the fund at the death of the annuitant is payable to his/her surviving spouse or estate. Such funds – generally known as “Income Funds”- have existed for some time and would be a viable alternative. The common characteristic of Income Funds is that they tend to invest in a combination of high quality dividend paying equities, fixed income and possibly preferred shares. Historically, these funds have generated an annual income of about 4% per annum, with an average annual rate of return of about 6.5% (net of fees).

Managing Risk in an Income Fund

As mentioned earlier, the two main risks that must be considered are interest and mortality. If we consider four scenarios, we will see how an income fund can be used to meet the needs of a retiree. High Mortality – with high or low interest rates: Under this scenario, the individual passes away before his life expectancy. At age 65, this would be about 17 years for a male, and about 21 years for a female. In this instance, even if the fund earned only 2% a year, the fund would not be exhausted at the time of death. Residual amounts would be payable to a surviving spouse. High Earnings – with high or low mortality: Similarly, if the fund were to earn a rate of return of 6% per annum (or higher), and an annual payment of 7% of the initial lump sum were made, the fund would last until the annuitant were about 110.

Alternative Solution

Using such an income fund, a person could arrange to withdraw funds on an annual basis based on his/her life expectation at each age. This would result in a gradually increasing stream of payments – from age 65 to about age 80, then the annual payment would gradually decrease. This option also has the added advantages that:

i) Payments could be increased or decreased by the recipient as they wish (always subject to limitations imposed by CRA). We must caution that removing additional funds in the earlier years will reduce payments in all subsequent years. Conversely, taking less in early years will increase the payout in future years.

ii) There will always be a residual amount left in the fund to be provided to the surviving spouse or the estate. Depending on the interest assumption that is used, the return of the initial capital will likely occur (assuming commencement at age 65) around age 79-80. Such capital will not be forfeited for the benefit of other persons.

iii) There will be no windfall profit at the end of the day because there is no sharing of risks with others. Each account is managed for a specific individual. While no solution is “perfect” there are other options available to retirees which warrant consideration.