Guest Spot: The death benefit distraction

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  • Author : Just
  • Date : 21 Jan 2021

For Adviser use only

It could be argued that the art of distraction, the practice of moving someone’s attention away from what they should really be focused on, has become more prevalent in some areas of our lives recently. The tactic can obviously be deployed consciously, sometimes with the intent to manipulate, but it can also be a completely subconscious and innocent action, but which can still lead to someone being focused on something other than what they should be.

One example of such an innocent and subconscious distraction could be the importance and focus sometimes placed on maximising death benefits early within a retirement plan when death is statistically less likely to occur.

If we look at the survival probabilities for a 65 year old male in the longevity risk chart below, we can see that up until age 91, they are statistically more likely to be alive than dead. The likelihood of dying increases quickly after that age, to the point where there would only be a one-in-10 chance of still being alive at age 99.

Chart 1: longevity risk

Source: Just data, based on an individual who is married, height 183cm, weight 94kg, 31 units of alcohol a week, never smoked, taking medication for high blood pressure with most recent reading 140/90 mmHg and taking medication for raised cholesterol, most recent reading 6.0mmol/L  

For the retiree who wants to maximise death benefits, an obvious solution is to invest in assets that are readily accessible, so that funds not used to support retirement income are available to beneficiaries at death.

Another way is to swap out some of the retiree’s fixed income allocation within their retirement plan and replace it with a longevity insurance solution such as Secure Lifetime Income (SLI), an option within the Novia SIPP.

Let’s compare these two different approaches by looking at a hypothetical scenario.

Our retiree has a portfolio of £300,000 and is 65 years old. An initial income of £12,000 is required, of which £5,000 is to cover a shortfall in essential expenditure, and they also want to increase their income by 2% pa.

We’ve used a stochastic model to generate 1,000 economic scenarios and selected both the median and lower quartile market conditions as the basis for our comparison. The outcomes are shown in charts 2 and 3 below.

In our investment only approach we’ve used a portfolio with a 60% equity 40% bond asset allocation. This ensures that all assets used within the plan are readily available in the event of death.

In our investment and SLI approach we’re going to purchase an SLI plan for £99,367 to cover our retirees essential expenditure*. The asset allocation of the remaining portfolio will be adjusted from 60% equity 40% bond to 90% equity 10% bond. We’ve made this adjustment as SLI should be thought of as a low risk asset. This is because:

  • It’s guaranteed for life;
  • backed primarily with bonds; and
  • not correlated to other asset classes.

 

Treating the SLI purchase price as part of our retiree’s bond allocation ensures the same monetary allocation to equities within the plan, maintaining alignment to the their risk appetite. Taking this approach has a really interesting effect on long term portfolio values and the amount potentially available at death.

Chart 2: portfolio value – median market conditions

Chart 3: portfolio value – lower quartile market conditions

*scenario’s assume 1% AMC/ongoing adviser charge, escalation in both scenarios is provided from non SLI assets

The charts above illustrate that:

  • Longer term portfolio [and death benefit] can be improved compared to an investment only approach.
  • Alignment to the retirees risk appetite is maintained.
  • In our median market conditions, from age 81 onwards the investment and SLI approach provides higher death benefits.
  • In the lower quartile market conditions, higher death benefits are achieved from age 84.

For retirees who wish to maximise death benefits, including an element of longevity insurance within the retirement plan rather than holding that proportion in fixed income can actually improve the level of death benefits available later in retirement, when statistically there’s a greater chance of death.

Find out much more about the valuable features SLI offers you and your clients that might surprise you at novia-financial.co.uk under Guaranteed Income

*Quote produced using rates from 25.02.2021

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