Universal Life Insurance as an Alternative to the Joint and Survivor Annuity

Abstract

This paper examines whether it is better for a married employee to take a pension as a joint and survivor annuity or to choose a single life annuity and provide separate protection for the spouse through life insurance. A model is developed to describe the problem, and sensitivity analysis is performed using data from 50 state university retirement systems. The feasibility of purchasing the necessary life insurance is tested using a no-load universal life policy. The results indicate that a single life annuity plus life insurance is a viable alternative retirement plan in many states. This approach is especially feasible for female retirees. Universal Life Insurance As An Alternative to the Joint and Survivor Annuity When a married employee retires and begins receiving retirement benefits from his or her employer, the worker often chooses to collect the benefits under a joint and survivor annuity option. In exchange for the benefit to the survivor, the retiree must accept an income, while both people are alive, that is less than that which would be received under the single life annuity option. In the present study, the authors examine the question of whether it is better for a married employee (a) to accept a joint and survivor annuity or (b) to choose the single life option and provide separate protection for the spouse through a life insurance mechanism. The latter choice is economically attractive only if the life insurance death benefit provides an income stream at least equal to what the survivor would have received under the first arrangement, at a premium that is no more than the after-tax difference Sandra G. Gustavson is Associate Professor and Department Head of the Faculty of Risk Management and Insurance at The University of Georgia. James S. Trieschmann is Dudley L. Moore, Jr. Professor of Insurance and Associate Dean of the College of Business Administration at The University of Georgia. The authors acknowledge and thank Cannon Financial Strategists in Athens, Georgia for their assistance and cooperation in connection with this study. The authors also thank Jungkon Suh for his assistance with some of the computer analysis. This content downloaded from 40.77.167.32 on Sun, 04 Sep 2016 04:16:59 UTC All use subject to http://about.jstor.org/terms 530 The Journal of Risk and Insurance between the single life and joint and survivor payments.1 If the difference between the two payment options can support the necessary life insurance premiums, the insurance alternative can be used to protect the spouse while providing income for the retiree who outlives his or her spouse. This extra income results because the retiree who selects the single life option can quit paying life insurance premiums when his or her spouse dies. Furthermore, any cash values that have accumulated may be used by the retiree upon the death of the spouse, since the insurance protection will no longer be needed. A life insurance equivalent to the joint and survivor annuity is being marketed successfully in many areas and is attracting considerable attention2 in spite of the fact that there are no inherent theoretical advantages that can be claimed for this arrangement. This paper illustrates that the viability of the life insurance alternative may be attributable to the excessively large benefit reductions within many retirement plans for retirees who select the joint and survivor option. Background for the Study The concept of an insurance alternative to the joint and survivor annuity option was described by Brainard and Lord [1] in 1980 and has been explained more recently by Corbett [2]. Corbett illustrated the feasibility of the insurance alternative for some levels of life insurance premiums, but the analysis did not consider potential inflation adjustments following retirement. In addition, Corbett's analysis ignored the effects of the 1983 U. S. Supreme Court ruling in the case of Arizona Governing Committee v. Norris.3 That decision stated that retirement benefits provided by an employer cannot differ on the basis of the employee's sex. Thus, joint and survivor reduction factors must be established on a unisex basis. If a male employee has a younger spouse, the joint and survivor reduction factor is now smaller than prior to the Norris decision, making the annuity option potentially more attractive and the insurance alternative less attractive. Life insurance used as an alternative to the joint and survivor annuity is usually not sold on a unisex basis. This fact may further lessen the attractiveness of the insurance alternative for male employees, while making it more attractive for female employees.