Financing Longevity – Challenges & Opportunities
Last week I participated on a panel looking at ways to finance longevity. The panel was part of a larger conference in Tampa that considered the effects of the aging of the baby boomer generation on businesses in southwest Florida. Each time I organize presentation materials, I realize how large are our challenges and how great our opportunities to be helpful. I ask myself, “What can I do to protect people against risks of needing to pay for long term care or major health care setbacks? And how do I assist people now that employers are limiting their responsibility for pension and health care programs?”
So while I can speak to the availability of products that are major tools in addressing these needs, I also know that we have to improve the rate at which things like long term care insurance and longevity insurance, such as immediate annuities, are utilized. As this mix of products and solutions gets stirred, another interesting perspective appeared in Sunday’s edition of the Washington Post. This article calls for change to strengthen the reliability of 401k plans in meeting the very real concern of a person outliving his or her savings. It also recognizes the reality that most people don’t save based on formulas that tell them how much they’ll need to retire with full confidence in maintaining their desired lifestyle.
“Our nation’s system of retirement security is imperiled, headed for a serious train wreck. That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system.” - John Bogle (Vanguard), Feb. 24
The severe recession is likely to cause a comeback to the concept of saving, and that outcome is a good thing. The big challenge is for people who are in their upper 50’s and 60’s who need to both save more and recover from huge declines in values of investments and home equity. Many of them are also confronting lower wages as unemployment looks like it will move upward for a while longer.
The choices facing people may not be ideal, but they exist.
Great post Steve and interesting bit from the Washington Post. The quote from Bogle was especially intriguing given his position with a large 401k provider. Looking forward to more content from you.
Steve, this is a fascinating topic. The financing of longevity risk is a complicated behavioral issue. The lay consumer/investor/plan participant falsely believes that they are likely to die at the age of average life expectancy. They misunderstand two things: (1) there’s a 50% chance of outliving your life expectancy; (2) your life expectancy is not a static number … it’s a moving target that increases as you age … i.e. the longer you live, the more likely you are to live even longer. It’s a vicious and insidious risk.
Notwithstanding this huge misperception regarding longevity risk exposure, it is quite possible to work with investors to create retirement plans that play to or leverage off of the misperception, but to address the real risk as an add-on “sale”.
For example, if a 65-year-old investor assumes that they will die by say age 85 (approx life expectancy for 65-year-old in great health), then clearly they have a clear need to develop a retirement plan that at least gets them to age 85. If the programs used to address this part of the solution are efficient in terms of costs relative to the universe of available solutions, and are also tax efficient, then this 65-to-85 solution will consume the least amount of retirement assets relative to other approaches. In addition, if the application of the assets to the solution, does not result in a perceived loss of the assets to the insurance company, the solution is likely to be embraced by the lay consumer.
However, this still leaves open the exposure to longevity (and other catastrophic) risks. However, it is my hpyothesis, that once the consumer is satisfied that their primary survival needs would be met by the solution, it is then a much easier step to then address longevity, LTC and other catastrophic risks as a pure risk management add-on to be financed out of the funds that were not used to secure the basic 65-to-85 (in this example) needs. Because, these are pure risk exposures, the cost of financing them is cheap if pure insurance products are used, e.g. longevity insurance. Since the discussion does not have to wait until the actual point of retirement (e.g. age 65 in this example), these pure insurance vehicles can be purchased earlier at even greater cost savings, e.g. prior to age 65 in this example. But the key is that the first “sale” that must be made is financing the first likely half of retirement.
Given all of the behavioral research that proves that consumers compartmentalize their finances, my hypothesis is that this methodology of executing the wholistic solution is likely to be most effective in terms of widespread acceptance among consumers. The real question is how do you teach an advisor to make the cultural shift to come at the problem/solution from this angle rather than the historical single-product push that proved so successful for accumulating assets or dealing with individual/specific financial risks.
Garth Bernard, President
Thrive Income Distribution System
I’m the researcher on a study for the Society of Actuaries on the “Implications of the Perceptions of Post Retirement Risk for the Life Insurance Industry” at http://www.soa.org/research/other-research-projects/proposal-requests/research-imp-post-retire.aspx
My findings to date are that the train wreck will be more like a shock to the perhaps too high standards of living we have become accustom to. Many will be severe and very unhappy ones, and my guess is that is what it might take, together with downturns such as we are now experiencing, for future generations to steer more thoughtful courses.