Some things in life are brand new. Some things fall out of favour and disappear. A few can pass through a high period, fade into the background, and then make a comeback. It is rare, however, for a concept that has fallen out of favour to make a comeback based on a new product. Until now. I think it would be good to explore combining the new Purpose Longevity Pension Fund with universal life insurance.
By now, you’ve likely seen the slick ad campaign that Purpose Investments Inc. has been running. The idea behind the fund is actuarially sound and based on the centuries-old concept of tontines. People of similar age get together and pool their risk of premature death in a way that is not too punitive to those who have the bad fortune of dying early while simultaneously solving the problem of outliving your capital – the latter of which is a problem that has become an important, if underappreciated, issue these days.
Now that there’s a reliable product that addresses the modern-day problem of getting sufficient cash flow, an old school high-net-worth solution has reappeared.
For many years throughout the 1970s, ‘80s and ‘90s, the concept of an insured annuity was a relatively simple and elegant way to ensure that HNW individuals would be able to pass on a sizable estate to their heirs. They would simply free up a small portion of their current cash flow to guarantee a large, tax free payment to their named beneficiaries upon their demise.
An insured annuity was essentially a prescribed life annuity and a permanent life insurance policy, purchased together. The annuity provided a guaranteed and regular income stream, while a “term to 100” or universal life insurance policy provided a cash payout upon death.
The problem, as you might imagine, is that when interest rates hit rock bottom, there wasn’t much of a reliable income stream being thrown off by annuities. The age-old concept was perfectly fine, but today’s environment made it untenable. That development is one of the downsides of interest rates that dropped precipitously and stayed down for decades. Rates have been modest since the turn of the millennium, but the new Purpose product steps into the breach.
While the underlying basket of Purpose exchange-traded funds (ETFs) that make up the Longevity Fund is designed to generate a long-term, after-costs return of no more than 3.75%, the age credits one might garner as a result of staying in the fund while your cohorts pass away has allowed the brainiacs behind the fund to offer an audited assurance that an annual payout of 6.15% for a 65-year-old (before advisory fees) can be sustained for as long as you live.
That’s a huge step forward for anyone who is either afraid of outliving their capital or in need of funding a back-to-back setup.
Let’s say you want to leave a largish sum to your kids and you have $500,000 available today that you know for certain will not be needed to sustain your lifestyle. If that money were to be placed into the Longevity fund at age 65, it would generate an annual cash flow of $30,750. Let’s call it $30,000. How much T-100 coverage could a healthy 65-year-old get for premiums that cost $30,000 a year?
We went to BMO to run some numbers on a T-100 policy. The answer depends on gender. If you’re a male, the number is $972,500; if you’re a female, it’s $1,080,965. From there, we can look at the internal rate of return (IRR) you would have effectively earned at various ages at death. For the males, the IRR was 9.15% at age 80, 4.4% at age 85, and 1.95% at age 90. For the females, the IRR was 10.34% at age 80, 5.32% at age 85, and 2.71% at age 90.
Back to the Purpose fund. It could make the payments throughout and it would return the untapped principal (but not the growth on that principal) to named beneficiaries. If you die after $150,000 of the $500,000 has been paid out, your beneficiaries get $350,000 – even if the underlying fund might have grown to $450,000. The extra $100,000 gets added to the pool to make up the difference between the 6.15% payout and the lower amount that is earned.
After 15 years at $30,000 paid out annually, your beneficiaries would get an additional $50,000 or so. That’s in addition to the million dollars (give or take, male or female) those beneficiaries would get when you pass.
It might even work if you have health issues and are rated (i.e. if you have to pay higher premiums than a healthy person would to offset the risk the insurance company is taking by offering you a policy). The bad news is the premiums are higher. The good news is that you cannot outlive the fund. If you die early, your heirs get the insurance money sooner. If you unexpectedly live a long time, however, the payments are still covered.
The opposite works, too, and it employs a concept known as “adverse selection.” Used in economics, insurance and risk management, this term denotes a market situation where buyers and sellers have different information. As a result of the asymmetry, participants with key information might participate selectively in trades at the expense of other parties who do not have the same information. If everyone in your family lives to be 100, for instance, the Longevity Fund is a good “hack” because the odds of you winning the game of “last person alive gets the money” compared to the other participants… er… investors, are pretty good.
Likes Keynes once said, “in the long run, we’re all dead.” The context was totally different, but the sad truth is that everyone dies, so we might as well deal with it. For some of us, that run is longer than others. Whether your time is up sooner or later, however, using life insurance to put an effective estate plan in place is a great idea for those who have the means to do so.