Do Private Insurers Out-Compete The Federal Government?
A recent article of mine posed the question: If you want the largest possible HECM credit line in the years ahead do you take it now or wait until you are older?
I suggested that it was advantageous for borrowers to wait because the line grows over time, and it will grow more rapidly if interest rates rise during the period.
A reader took me to task because I did not consider what the borrower did with the line. The best possible use, according to the reader, would be to purchase a HECM tenure payment, which is a fixed dollar amount for as long as the borrower lives in the house. As I will show, however, using a HECM to buy a private annuity is a better option.
The charts illustrating the comparison are for a male of 65 with financial assets of $300,000 earning 4.0%, and house equity of $500,000. The upper chart shows spendable funds over the client’s life while the lower chart shows estate values.
The chart of spendable funds compares two plans that employ the retiree’s financial assets and a HECM based on his house value. In one plan, a HECM credit line is integrated with a private annuity carrying a payment deferred 10 years. The credit line and the financial assets cover the cost of the annuity (which is paid for upfront), and to the monthly draws during the deferment period. In the case illustrated, both the draws and the annuity payments are set to rise by 2% a year. This is the steadily rising line at the top of the spendable funds chart.
In the second plan, the retiree’s financial assets are used to draw spendable funds monthly at an initial rate of 4% (the “4% rule”) to which a tenure payment is added. Three versions are shown for tenure purchases at the outset, after 5 years, and after 10 years.
The spendable funds comparison shows that the private annuity option is significantly better than the tenure payment option. The major reason is that HUD, which developed and manages the HECM program, calculates tenure payments on the assumption that the borrower will live to 100 whereas insurance companies calculate annuity amounts based on mortality distributions – most retirees die before they reach 100.
The second chart shows that estate values are a different story. They are substantially lower on the annuity option, except for those with exceptional longevity, where the differences are small. My informal inquiries suggest that the major concern of retirees with limited means, such as the one illustrated here, is the adequacy of spendable funds.
A Caution: While tenure payments are set by the Government, annuities are provided by a large number of private companies, and prices can vary widely on identical transactions. The annuity prices used in the charts below are the best of those with high quality ratings who I surveyed. Retirees interested in pursuing the annuity approach can be sure of getting the best competitive prices by clicking the link below.