Longevity Risk

A retiree elects a fixed period payout from her annuity contract instead of any life contingent option. The principal consequence is that she

1. A.converts whatever remains in the contract into a lump sum after the final scheduled payment.Wrong. The payments are calculated to exhaust the contract, so nothing is left standing at the end of the term.
2. B.may outlive the payments, because the contract pays over a stated term rather than for life.Correct. Removing the life contingency leaves the annuitant, not the insurer, holding the risk of a long life.
3. C.transfers longevity risk to the insurer more completely than any life contingent option would.Wrong. It transfers less, because the promise ends on a date rather than on the death of the annuitant.
4. D.guarantees payments to her beneficiary for her full life expectancy whatever term she elects.Wrong. Any continuation runs to the elected term, and life expectancy plays no part in a fixed period option.

Why: A fixed period option pays a stated amount over a stated number of payment intervals and stops, whether or not the annuitant is still alive. Because the insurer makes no lifetime promise, the contract does no mortality pooling and the annuitant keeps the longevity risk herself. That is the opposite of what a life contingent option does, which is precisely to transfer the risk of a long life to the insurer in exchange for forfeiting any remaining value at an early death. The election makes sense only where the income need is genuinely time-limited, such as bridging to a pension or Social Security start date.

A healthy client entering retirement with a very long expected horizon wants guaranteed lifetime income but fears a level payment will lose ground to rising prices. Comparing a fixed immediate annuity with a variable immediate annuity written at a low assumed interest rate, the variable contract

1. A.removes longevity risk and inflation risk at once, because the payments follow the market.Wrong. Following a portfolio is not the same as tracking prices, and payments can fall as easily as rise.
2. B.addresses purchasing-power risk by letting payments rise, at the cost of a smaller and less certain start.Correct. It states both sides of the trade, the chance of growth and the loss of certainty in the payment.
3. C.guarantees an increase in the payment each year equal to the assumed interest rate elected.Wrong. That rate is the hurdle payments must clear, not an escalator the insurer undertakes to deliver.
4. D.eliminates the mortality pooling that makes any lifetime payout possible in the first place.Wrong. A variable payout is annuitized and pools mortality exactly as the fixed alternative does.

Why: Both contracts annuitize and both pool mortality, so both transfer longevity risk to the insurer; the difference lies entirely in what happens to the purchasing power of the payment. A low assumed interest rate sets a low hurdle, so the payment starts smaller than the fixed alternative but rises whenever separate account performance exceeds that hurdle, which is how the contract addresses purchasing-power risk. What it does not do is guarantee that outcome, because a period of weak performance sends the payment down instead. The choice therefore trades a certain but eroding payment for an uncertain one that has a chance of keeping pace.