A captivating speaker, Moshe Milevsky was invited to present at this year’s ASFA conference in Melbourne. Moshe is a Professor of Finance at York University, Canada and was named as one of the most influential authorities in the U.S. financial advice sector. He specializes in the intersection of insurance and financial products – with an emphasis on retirement income.
I attended Moshe’s presentation to the ASFA Leadership Symposium and his Plenary Session on Biological versus Chronological Age so was very fortunate to have the opportunity, with Stephen Huppert, to have breakfast with Moshe before his flight back to Toronto. Here is what we learned.
The need to insure against living too long
In financial planning, when we budget our various spending needs we include items that we know we are going to occur such as rent, groceries and travel. But there are also events that can happen to us but might not. These are much more difficult to budget for. For example, a car crash, or a flood in the basement. Do we include these items in our annual budget? No, we insure against them.
It makes much more sense to use insurance for events that are low probability and high impact. At its core, insurance is a mechanism for groups of people to pool risks in a way that’s more manageable for each person’s financial planning.
The applies to the possibility of living into your 90s and beyond. Demographics show that most of us face this possibility. But only a third of retired households will indeed have one spouse still alive at age 95. It therefore doesn’t make sense for ALL of us to budget for living all the way to age 100. We can use insurance (or pooling). We can all put a much lower amount into the pool knowing that if we happen to be one of the ones who does live that long then the pool can provide income.
Internationally and historically, annuities and defined benefit pensions fulfil that need. Australia’s age pension is another good example – it pools retirees together in order to pay a lifetime income stream to those who need it.
There is much evidence that Australians with account-based pensions tend to underspend – driven by concerns that their money will run out while they are still alive. Lifetime income products give us ‘permission to spend’ as we don’t have the worry that our income can run out. With a lifetime income we cannot outlive our savings. It removes that anxiety which comes from spending down our own balance as we age.
People are generally not good at decisions which impact our future selves. It’s only when we get there that we fully understand what we need. The only people who proactively search out and buy annuities are economists!
We know people need to save for their retirement – that is why Australia introduced compulsory superannuation.
The behavioral issues don’t end at retirement. People still need to look after their future selves if and when they reach advanced ages. U.S. studies show that people who have lifetime incomes such as annuities and defined benefit pensions say they’ve had more satisfying retirements than those who didn’t, particularly for cohorts whose total wealth was under US$500,000.
Despite this real-life experience of older retires, to get people entering retirement to make good decisions for their future selves global retirement systems seem to need either:
- Compulsion (like the SG system, Age Pension and many overseas pension schemes); or
- High incentives for planners to educate retirees to focus on their future selves
Providing good and timely education may help some people but not others. Nudge theory (soft compulsion) may also help. All this made me wonder if Australia’s model of fee-for-advice and best interest duty will really be sufficient to overcome consumers inertia to take care of their future selves.
The need to make it real
Climate change is a global issue that requires current action to help mitigate future outcomes. Part of the current momentum for addressing this is it’s all starting to seem real – with extreme weather events being linked to climate change.
Risk issues suddenly become real when we see other people experiencing the consequences. It makes us want to prevent that happening to others and to ourselves.
Perhaps we need to help people visualise the consequences of outliving their savings. What does life look like to someone who has been relatively comfortable while working but now depends solely on the Age Pension because their savings have run out? How does it feel to be too scared to spend your capital as you’d feel vulnerable without it?
The use of case studies and gamification techniques may help people better understand these low-probability, high impact events and the solutions that are available to them. Then they might see the merits of insuring their longevity risk.
 University of Michigan Health and Retirement Study of approximately 26,000 Americans over age 50. Article by Towers Watson Insider, September 2012.