Annuity Payouts Are Poised to Decline, but the Pain May Be Curbed

Annuity payout rates are on the cusp of declining in 2016. That’s because insurance companies are adopting new mortality tables showing that people are living longer and so, predictably, insurers must make lifetime payments for a longer period. Something had to give.

There could be some good  news, however – a decent  chance that some or all of these cuts will be reversed later this year if Federal Reserve-engineered increases in short-term interest rates translate into increases in long-term interest rates. Historically, things have typically played out this way. If it happens again, insurance companies would increase payouts in a bid to reverse sagging sales.

The new mortality tables show that 65-year-old men, as an example, are living three years longer than they did in 2000 and 65-year-old women more than two years longer. Insurance companies must adjust to this to make profits.

Annuity payouts have already been declining for years, largely because of a sharp drop in interest rates. But this year’s cuts will be the deepest in eight years.

The mortality table-induced cuts, while painful, are fortuitously coming at a good time. Insurance companies had no intention of boosting annuity payouts until it became clear that the Federal Reserve was ready to increase interest rates. Heretofore, they weren’t in a position to earn more on bond investments, which provide the wherewithal to increase annuity payouts. The odds of rising bond market interest rates are good, albeit with a lag, market observers tell me.

Insurance companies do want to increase annuity payouts if they can make it work financially. Dwindling payouts has hurt sales. In the first nine months of 2015, total annuity sales totaled $169.6 billion, down 2 percent from the same period in 2014, according to the Insured Retirement Institute.

In contrast, in some healthy years in the past, such as 2006, annuity sales rose as much as 10 percent. And that was before Baby Boomers, the most affluent generation ever, was retiring in mass and, at least theoretically, interested in buying annuities for guaranteed lifetime income.

by Andrew Murdoch, Somerset Wealth Strategies

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