Age/Pension Pot

Cherokeebluesome

Hi dunstonh, as a financial advisor you obviously know the way the system of providing pensions work. Not wishing to tell my Grandmother how to suck eggs, basically the pension provider invests the money in the pension pot and also pays out of that pot a sum of money to he recipient until he dies and then half of what he was getting until she dies. The return on the investment of the money in the pension pot even if it is 5% will make it profitable to the pension provider no matter when the recipients die. Do the maths.

atush

What a load of rubbish

grey_gym_sock

Cherokeebluesome wrote: »

Do the maths.

go on then, give us some figures (so we can have a proper laugh ).

kidmugsy

atush wrote: »

What a load of rubbish

Many months ago I started a thread with a topic of (approximately) "Stupid Beliefs About Investments". One of them was the belief that when you die your insurance company pockets all the money that your annuity hasn't paid out.

hugheskevi

Given the stated assumption "The return on the investment of the money in the pension pot even if it is 5%..." along with an assumed pot of £1,000,000 and a flat-rate annuity, it is quite clear that the annuity provider would be doing well out of the deal - the provider makes a payment of £50,180 every year, but gets £50,000 return from the money.

Doing the maths in a more rigorous fashion...

As the hypothetical couple have a £1m pension pot, they are likely to have longer than average life expectancy. Using the 2012-based cohort life expectancy high variant to allow for this bias from having a large pension pot, the male can expect to live to 88 and the female 91. Also assume that the female is 3 years younger than the male (consistent with common actuarial assumptions and the annuity rates stated, for example rates here).

Assume a rate of return consistent with current long-dated gilt yields of 3.55%. Also assume (for simplicity) that the pension income is taken at the start of each year as a lump sum.

The pension payments cease 34 years after commencing, with the death of the spouse. At that point, there is £226,500 left in the 'pot' in cash terms, or with inflation at 2%, £115,522 in real terms.

Another way to look at it is how much of the £1m pension pot does the annuity provider need to invest in gilts to meet the expected future payments, and how much can they set aside to meet running costs/profit and as a margin against longevity risk (or investment risk, if they choose investments other than gilts). The answer to that (using the assumptions above) is that £66,806 can be set aside for these other factors, or 6.7% of the pot. This is a bit lower than a rigorous example is likely to produce, which in 2009 was found to be about 10% (source here).

If the male should live to age 92 rather than the assumed age 88, the provider is making a loss even before taking into account administrative and capital reserving costs.