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Pensions are very popular financial products, and are quite strongly encouraged, both through favourable tax laws and employers contributions. In all cases I am aware of, neither the contributions nor benefits depend on personal circumstances, in particular life expectancy (LE) and marital status. For example, a well recognised predictor of LE if where you live. If we compare a single person living in Glasgow (LE = 74.8) to a couple living in Kensington and Chelsea (LE = 87.45, joint LE = 94.45) with a retirement age of 65 the London couple is likely to receive about two and a half times as much than the Scottish single. From an individual's point of view, this calculation could be refined using personal medical information, such that for many people the difference in expected return could be greater than this very coarse analysis.

A major reason why pensions are a popular investment is that if you do live a long time, you do not run out of money, effectively insuring yourself against not dying in the next few years. This can be contrasted to life insurance, where you are insuring yourself against dying in the next few years, and that frequently does take into account medical information, allowing personal circumstances to be priced into the deal.

My questions:

  • Is my general assessment correct? Am I missing something in how pensions work that means this is already priced in?
  • Are there any resources to help an individual calculate the likely value of a pension, taking into account things like medical history and marital status?
  • Are there any financial products that provide the "reverse life insurance" feature of pensions and the actuarial assessment of personal circumstances of "normal" life insurance, that would be suitable for an individual who is single and below average health? If any benefited from favourable tax treatment, or even allowed one to take advantage of employer contributions this would be a large bonus.

LE calculations for individual are mean of male and female here. Joint LE alteration is maximum from here, assuming the healthiest couple will have highest gain. I know that some pensions can pay out to a non-spouse on death of a single person, but without children I do not see this is much value to the individual. I also know that the calculations are wrong, as they do not take into account the shape of the distribution, but I hope they illustrate my point.

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Depends on the kind of pension you're talking about. Common UK pensions are

  • money purchase. You put money towards a pension and once you hit a certain age (usually 55) you can spend it as you wish, although you'll pay tax.
  • final salary. You're guaranteed a monthly payment till you die.
  • state. You pay into this via National Insurance and it pays out from around 65-68 years old again till you die. There's a maximum sum you can get for your state pension and the amount depends on how many qualifying years of payments you have.

If you have a money purchase pension you can (if you want) use it to buy an annuity and annuities can take your personal circumstances such as pre-existing health conditions into account. Annuities pay a monthly amount till you die. You'd need to make your own assessment as to whether an annuity is suitable for your specific circumstances.

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You should look for "impaired life" annuities.

However, don't expect to get anything like the same extra value as you might pay in extra life insurance. Health is very uncertain and there's an information asymmetry between the applicant and the insurer/pension company (in fact often annuities are ultimately provided by insurance companies). For an impaired life annuity you'll have an incentive to exaggerate your health problems, for life insurance you would want to minimise them. They'll need to price them to take that into account.

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The formula you're looking for is "present value of an annuity":

enter image description here

Where:

  • P = pension payment
  • r = stock market rate of return (this represents opportunity cost of not investing the lump sum). Note that it's represented as a rate per period.
  • n = number of payment periods

The number of periods would reflect the individual's life expectancy. If the pension grows over time, there's a similar equation which can account for that.

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There are some things you my be overlooking here.

  1. As any form of insurance, pensions are a form of pooling/sharing your risks with others. (call it the capitalists socialism if you will). This means, as with all insurances, you are likely to be financially better off without them but for the unlikely case you are not they really can save your ass. No if you segment the risk in your insurance too strongly, that benefit will go away and you get more towards being sure to be better off without the insurance.

  2. A insurance contract has legal limitations. If for example you grow up in Glasgow and get the cheap pension contract and then move to Chelsea and live a healthy lifestyle, would that cancel the contract? Would that warrant a smaller payout than agreed upon in the contract? You see where I am going with this.

  3. Life expectancy is a statistic value. On person in Glasgow may get 110 and the other only 50. Life expectancy for future pensions is also loaded with a lot of assumptions about the future, which, depending on the development of medical technology and or the next pandemic may be totally off. In either case, you are almost certainly not going to be the "average joe". Statistics tell you nothing about individual cases.

In the end, if the insurance had a crystal ball and could foresee the individual fate of every customer and adjust pricing accordingly, what you had to pay for your contract woudl be the exact sum you would get as settlement+overhead costs, making the product completely economically useless!

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