Key Differences in Risk Sharing for Life Insurance vs. Annuity Products

by Ciaran John

Annuities and life insurance policies are two types of contracts that you can purchase from insurance companies. You and your policy issuer must shares certain types of risks when you buy an annuity or an insurance contract but the manner in which those risks are managed depends on the type of contract that you buy.


When you die your family members may suffer financial hardship particularly if you are the primary income provider in your household. If you buy an insurance contract, the insurer provides your loved ones with a lump sum payout upon your death. When you buy an annuity contract you are buying yourself insurance to protect you against the risk of outlasting your assets. If you live too long then you may deplete your savings and find yourself unable to cover your day-to-day costs. Annuities provide you with a lifetime income stream, which means that you will have some form of income for the duration of your life.


You pay for life insurance contracts and annuities with premium payments and the policy issuer pools together your premiums with the premiums from thousands of other policy holders. The insurer uses actuarial tables to predict average life expectancy and prices premiums so that the premiums being paid into the fund exceed the insurance or annuities payouts. The insurer loses money on life insurance contracts if large numbers of people die earlier than expected. The insurer loses money on annuity contracts if large numbers of annuitants live longer than anticipated. You lose on both types of contracts if your premium payments exceed your insurance or annuity payouts.


Term life insurance contracts only provide your beneficiaries with an insurance payout if you die within a certain period of time such as the next 10 or 20 years. The older you get, the more these policies cost. Young people statistically have less chance of dying within the next decade than older people so premiums for these contracts are low and you can cancel the contract at any time. State laws enable insurance companies to refuse to insure people past a certain age due to the high probability of the insurer having to make a payout. Annuity providers assume a greater degree of risk when issuing contracts for younger people rather than older people because the longer you live, the more the insurer has to payout in terms of income benefits. In many states, insurers do not issue annuities to people below the age of 40 due to the longevity risk.


While life insurers use your age to determine your life expectancy, other factors can also impact your longevity, such as serious health conditions or the fact that you smoke. Insurance companies can charge higher premiums or refuse to provide coverage to people in poor health or people who have an above average mortality risk. Annuity providers will happily insure people in poor health because the insurer stands to make money from the transaction if you die unexpectedly young. Therefore, you, rather than your insurer, have to consider health factors when you buy an annuity contract.


Some life insurance policies such as whole life contracts have a cash value that can include living benefits. This means that insurers have to consider the danger of longevity as well as your life expectancy when these policies are issued. Likewise, variable annuity contracts include a death benefit which amounts to a life insurance contract which protects your family in the event that you die before you at least get a return of premium in the form of income payments. Insurance providers must assess your health when issuing variable annuities since these contracts are basically hybrid contracts that expose your insurer to the danger that you will die too young and the danger that you will live longer than expected. However, the policies also cost more since you pay a price for transferring more risk to your insurer.

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