What is the mortality credit in an annuity and why does it matter?

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AcadiFi · Accepted Answer

Mortality credit is the extra yield an annuity pays above the risk-free rate because annuitants who die early subsidize those who live long. The insurer pools thousands of contracts; premiums plus investment returns plus forfeitures from deceased annuitants fund the payments to survivors. The longer the annuitant lives, the larger the implicit benefit from the pool. Example: a 65-year-old buys a $100K immediate annuity paying $6,500 per year for life. With 10-year Treasury yields at 3.5%, a pure bond portfolio would fund only about $4,800 per year indefinitely. The extra $1,700 is the mortality credit — roughly 1.7 percentage points of yield. Mortality credits grow with age because survival probabilities drop faster; a 75-year-old buying the same annuity gets a larger credit than a 65-year-old, and an 85-year-old's credit can exceed 5%. This is why deferring annuity purchase to later ages (deferred income annuities) amplifies mortality credits. The tradeoff: annuitization is largely irrevocable, transfers longevity risk to the insurer in exchange for credit risk and inflation risk, and forfeits bequest value. CFA L3 integrates mortality credit analysis with Merton's 'ruin' framework: households with long horizons and low bequest motives benefit most from annuitization. Partial annuitization (pairing an annuity that covers essential spending with a liquid portfolio for discretionary needs) captures mortality credits while preserving flexibility.

What is the mortality credit in an annuity and why does it matter?

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