Insuring Defined-Benefit Plan Value: An Examination of the Survivor Benefit Plan (SBP) Decision

AbstractThe U.S. Military Survivor Benefit Plan (SBP) allows military retirees to protect a portion of their retirement income stream. Specifically, retirees can pay a pre-tax premium from their retirement income to insure up to 55% of the retirement income stream. Two recent changes have dramatically improved the value of the plan. In this study, we construct a Monte Carlo simulation model to describe the distributions and implied discount rate for SBP participants. Our model demonstrates that the program is quite lucrative for most male retirees. In contrast, the program is less rewarding for female retirees, especially when they are somewhat younger than their spouse. Retirees and their financial planners can use our results to make more informed retirement planning decisions. © 2012 Academy of Financial Services. All rights reserved.JEL classification: G23; H55; J38Keywords: Survivor Benefit Plan; Insurance; Valuation; Pensions; Retirement1. IntroductionThe focus of this article is on valuing the spousal insurance option of the U.S. military's defined-benefit retirement plan. The Survivor Benefit Plan (SBP) allows retirees to insure up to 55% of their retirement cash flow benefit to a spouse. More specifically, in valuing the benefit for the surviving spouse, we seek to inform the selection decision. We want to identify when insuring the retirement cash flow is worth the cost and under what circumstances. Recently, the program has experienced two important changes, generating a need for new research to reassess the retiree SBP decision. The first change allows retirees to stop paying insurance after 360 months; at that point the insurance remains in force without further payment. The second change was even more significant: the Social Security offset, which in some cases could reduce the insured spouse's SBP payout by more than 35% after age of 62, was removed.1Johnson, Uccello, and Goldwyn (2003) suggest that retiree survivor benefit decisions are generally rational. However, other studies suggest that retirees and their spouses would benefit from additional information concerning this important decision. For example, Aura (2001) finds that education level matters greatly; relative to annuitants with only a high school education, those with a college education are 13% to 20% more likely to opt for survivor benefits. In addition, Holden and Nicholson (1998) find that the survivor benefit decision is strongly affected by race. Holden and Zick (2000), using data from the early 1990s, find widow poverty rates can be reduced from 21% to 15.5% simply by increasing the election of survivor annuities.Limited research particular to the SBP program exists, and none that examines the SPB decision in light of the most recent changes. Higdon (2009) provides a detailed account of the program from a legal perspective, while Burrelli (2011) provides an overview of the program. Neither conducts an analysis of the costs and benefits at an individual level. Burrelli (2011) does highlight that in fiscal year 1973, costs to retirees totaled $36,145,000 while payment to families totaled only $5,700,000. In fiscal year 2005, payments into SBP were $1,099,363,000 with payouts increasing to $ 2,253,728,000.1.1. Military retirement and the SBPThe spectrum of retirement options continues to change. For example, the number of workers who are covered under defined-benefit plans falls every year. The Center for Retirement Research at Boston College reported that the percentage of workers covered by only defined-benefit plans fell to 8% in 2006 from 23% in 1993 (Munnell, Aubry, and Muldoon, 2008). However, various government employees, both state and federal, continue to earn excellent defined-benefit retirements. One standout in the defined-benefit arena is the U.S. military. Those serving in the U.S. military have the opportunity to retire, in most cases, after 20 years of service. Retirees then receive an immediate lifetime annuity. …