What Every Advisor Should Know about Longevity Risk
by Doug DubitskyMr. Dubitsky is Vice President of Product Management & Development for Retirement Solutions at The Guardian Life Insurance Company of America. Connect with him by e-mail: [email protected]
It’s no secret that Americans are living longer today than ever before. This is great news by any measure, but as people enjoy longer and longer lives, we also face greater and more prolonged financial risks. Coupled with Americans’ failure to save and overall lack of retirement confidence (not to mention historically low interest rates), longevity risk is a delicate financial issue that advisors must help clients confront head-on.
Longevity risk is simply a person’s risk of outliving their money, and it’s different for every individual. It’s also a risk multiplier; meaning that the longer someone lives the greater the likelihood of other risks occurring, including market losses, high inflation and health problems, all of which can wreak havoc on savings. It is incumbent upon every financial services professional to sit down with their clients for a frank conversation about longevity risk and to help them to start taking the steps necessary to make sure their money lasts throughout their lifetime.
The average life expectancy for an American is now nearly 79 years, according to the Centers for Disease Control and Prevention. In 1935, when Social Security payouts began, the average American life expectancy was almost 62. As fewer workers have access to pensions and more people realize that they cannot rely on Social Security to meet their retirement needs, a disturbing lack of retirement confidence has embedded itself in the American psyche.
The latest survey on the topic by the nonpartisan Employee Benefit Research Institute (EBRI) shows that 49 percent of workers are “not at all” or “not too” confident in their ability to retire comfortably. Workers also continue to lose confidence in their ability to pay for basic expenses in retirement – 29 percent lack confidence today compared to 18 percent in 2007 – and medical expenses – 52 percent today compared to 32 percent in 2007. (Full disclosure: The Guardian Life Insurance Company of American cosponsored the survey.)
The scare of volatility
We also know from our own conversations with advisors that equity market volatility and low interest rates are scaring clients so badly that they tend to sit on the sidelines. Fearfulness leads to mental paralysis, which results in inaction when it comes to retirement planning. Breaking this cycle by getting clients to focus on long-term financial health is one way advisors can play an invaluable role.
One of the biggest hurdles advisors face, however, is getting people to simply understand what their income needs are in retirement. Gathering this very basic information is the first step towards helping your clients build an optimal retirement income plan.
Some key questions to get this conversation started are:
- What do you want your retirement lifestyle to be beyond food, shelter and clothing?
- What are your resources to fund that lifestyle?
- Have you done an income gap analysis?
Nobody works their entire life just to squeak by in retirement. People want to travel, visit their grandkids, continue to care for their homes, maybe buy a new car or do some golfing. But in order to properly plan for these activities, it is vital that people first get a handle on their basic needs: housing expenses, insurance, healthcare, clothing and the rest of it.
The second step is to figure out what the client’s current sources of guaranteed income are. Is there a pension? What level of Social Security are they expecting? The next step is to calculate the gap between the basic expenses and the income they currently have to fund those expenses.
Filling the gap
The final, critical step is to look at ways to fund that gap.
At this point in the conversation, you may find that your client is hyper-focused on average returns and wants to achieve amazing returns into retirement. Advisors need to help clients understand that during retirement, as they take income from their investments, it’s the sequence of returns that may have a dramatic negative impact on their investment. With annuities you can enable your clients to receive stable income no matter how the market performs, with the potential to increase as their expenses go up, allowing them to keep pace with basic living costs, inflation and lifestyle changes after they have deposited their final employment paychecks.
A good way to approach a client about these issues is to explain a very basic scenario: A person has stopped working and they retire with $500,000 in a 401(k) plan and they have a mix of stocks and bonds. What happens when the market drops 25 percent? What do they do? They still have the same expenses, but a large percentage of their assets just took a big hit.
When they don’t have guaranteed income, clients are forced to draw upon equity accounts even in a down market. But when they cover basic expenses with guaranteed income it allows them to leave discretionary income in the markets until the time is right.
Guaranteed income solutions like fixed, variable, or income annuities can act as the foundation of a good retirement plan. They allow an advisor to be an advisor again, because once longevity risks are mitigated, financial paralysis is likely to dissolve from the client relationship. Also, once a client’s basic needs are covered, the advisor can work with his client’s remaining assets to address discretionary expenses.
The biggest problem most advisors have today is that their clients are too afraid to do anything. They’ve been burned by the markets and by low interest rates and advisors can lay out all sorts of different plans, but the response too often is something like: “This is great, I just don’t know if this is the right time. What about the debt crises? What’s going on in Cyprus? How close are we to the Fiscal Cliff today?” People will come up with any excuse they can, because they don’t want to do the wrong thing at the wrong time.
When advisors provide constant sources of income for clients – income that they can’t outlive – it’s easy to explain why these types of worries shouldn’t keep them up nights. They don’t have to watch the financial news shows every night and panic about every little thing.
Additionally, employing a laddering strategy using multiple annuities allows advisors to build a retirement income stream that is not only predictable, but also increases over time. During a person’s working life, they are used to regular pay checks, promotions and raises. Most people are not used to being at one income level for years at a time. By laddering fixed, variable, and income annuities, advisors can accommodate changes in their clients’ lifestyles, health status and a loss of other income sources (like no longer working in a part time job or as a consultant) throughout retirement.
Offering product solutions that mitigate longevity risk and other retirement risks as one part of a comprehensive retirement portfolio can increase client satisfaction and strengthen the advisor/client relationship. We have seen that when advisors follow this path, clients tend to bring other assets to the table for additional investments – and happy clients are a great source for referrals and additional business prospects.