Living longer

AV: Aleks Vickovich, editor ifa (MODERATOR)

SM: Sean McCormack, general manager,insurance product and underwriting, MLC and NAB

VD: Vince Dore, director, Delphi Financial Management

KW: Katie Whiffen,portfolio manager, retirement solutions, MLC

GM: Geoff Munday, director Endevour Planning Services

MR: Miguel Rodrigues, managing director, Macaplan

AV:In partnership with MLC today we are examining a topic very dear to their heart – saving the retirement of Australians – and we will dive deeply into the related issues of longevity risk and wealth protection.

First, though, I want to share some new research released today by MLC and Investment Trends off the back of a wide-ranging survey of Australians over 40. Among a number of findings, the 2014 Retirement Income Report concluded that the average retirement savings gap is as much as $150,000 with people underestimating the length of time they will be in retirement by up to seven years. In addition, only 10 per cent of people have a plan to address longevity risk.Katie, do these figures surprise you?

KW: No, they don’t and that’s for a couple of reasons. Number one is that people don’t understand how long they’re going to be living for in Australia. The oldest Australian right now is 112 years old and the issue is not so much that our lifespans are increasing but that the number of people living up to that maximum age is increasing.

That’s the issue for longevity – people are underestimating how long they will live for.

If you’re a 65-year-old couple right now, there’s a 50 per cent chance that at least one of you will be alive at 95, so they should have a thirty-year planning horizon. But on the other side of that, people intend to retire at 64 but the reality is that many are retiring at 59.

And that’s because they have been retrenched or they are sick or need to care for someone and have to leave the workforce involuntarily and lose that income they would have otherwise been earning.

AV:To the advisers in the room, are your clients underestimating how long they will be in retirement?

GM:I don’t know that they are underestimating how long they will be in retirement, it’s just that they’ve never done the calculation and have no means of doing the calculation.

But when you do the calculation that’s when you realise that most have a problem.

VD:I think they just have no concept [of it] and they don’t want to think about death. So they just hope that everything will fall into place. But my experience is that they have an idea that they will live for about 20 years.

And when I explain to them that they might actually live another 10 or 20 years beyond that, many are quite shocked.

AV:Mark Bouris famously said that you need a million dollars in investible assets to retire. Do you agree with him? Is it helpful to put a figure on it?

MR:I think it was good that it got people talking about it. Immediately after [Mark Bouris’ comments] there was an encouraging amount of phone calls and queries, with people asking about where they were sitting and what they need to do to get to that goal.

But if he and the media wanted to flesh out that comment and back up why they came to that number then that might be more helpful than focusing on the one headline grab.

SM:Surely anything that gets Australians talking about ‘Do I have enough? Am I adequately protected?’ is the sort of dialogue we want to be promoting, regardless of whether what Mark said what right or wrong. At least it started a conversation.

And the same goes for [MLC’s] ‘Save retirement’ campaign – it was all about starting a dialogue on whether Australians are really aware of the risks they face in the lead-up to retirement and how they protect their income in retirement.

VD:I do think that putting a figure on it – whether it is a million dollars or some other figure – does get people talking. I use very simple rule of thumb when I’m talking to people.

The first question they often ask is ‘How much do I need to retire?’ and my answer is ‘Provided you leave the workforce after you’re 65 and you own your own property, then you need at least 10 times what you are likely to want to live on’.

So if you are used to living on $100,000 then you will need 10 times that. It is a good way of focusing their minds because most people have nothing near that.

KW:It is great to have those sorts of discussions but my only suggestion when Mark talks about those issues is that we need to start thinking about it as an income, not as a lump sum.

Realistically the purpose of our superannuation is to fund our retirement which means trying to generate an income for it.

The ‘10 times’ rule is a good one. The other one we are promoting is the ‘10-2’ rule, so if you think about your superannuation balance, divide it by 10 and then halve it.

If you were relying on your super balance that’s what you could reasonably expect you would have in retirement. If you are young enough and have time enough you can ask whether you can do something about it. And the answer is ‘Yes, you can’.

AV:Vince mentioned the psychological aspect – is it the case that many consumers see retirement as a one-off event, rather than a transition or time horizon. Have you noticed that?

GM:It’s classic baby boomer behaviour. We have been through all of the life stages and it is almost like a shock when you get to another life stage.

I for one, and most of the baby boomers I know, still think of ourselves as teenagers and there is a part of us that still thinks that way, so it can be a real shock.

There is almost never a single day when you retire – there is almost always a transition.

SM:That whole notion of having the final day before retirement, when you finish work and there’s a big afternoon tea, maybe you get a gold watch and then the next day you are off on your caravan…

GM:…There is often that day but often that day is when you are 45 or 54 and then you haven’t got enough money and you are trying to get consulting work or jobs on less pay because it is difficult to get back in.

That’s the other big issue when dealing with clients in their 40s or 50s. You can extrapolate what they might need based on their current income, but (a) there is always the risk of poor health and (b) will the economy and the employer allow them to keep working at that income right through when the numbers said they need to.

AV:So when a client comes in and asks that question – ‘How much am I going to need?’ – how soon after that do you bring up wealth protection and insurance? Are they inextricably linked?

VD:I think so. Part of the issue if someone is younger is that they are the asset. How many people willingly go and not insure their house and just hope for the best? But when it comes to the major asset, a more significant asset than the house [often there is a lack of protection].

So to explain it in simple terms, I ask ‘What have you done to protect this aspect?’
We don’t want to shock them unnecessarily but our role is to educate them about what they need to think about if they can no longer work and insurance is a huge part of that conversation.

MR:It’s also important in the planning part. Because you have to highlight to people that the overall plan is no good if something happens to you.

You can have a strategy, a retirement plan in place, but all of that is impacted if something happens to you or your partner. You need to ensure the plan has longevity.

SM:That’s a really good point because, in a way, it’s in the latter years leading up to retirement that the shock of injury or illness may mean you’re off work and need to dip into your retirement plan – the impact of that can be catastrophic.

If you are 25 and you have an injury or illness that takes you out of work for a year it’s not great, but at least you have time to recover up until the point you retire.

We see that all the time – there’s this transition between protecting your most important asset, which in accumulation phase is your ability to earn an income, and then there is this transition at retirement when it is no longer the ability to earn an income through physical exertion, it actually becomes the nest egg you have built up and the income stream you are drawing – that’s the most important part of protection when you retire.

GM:The big issue with insurance is that you have to get to people and get them insured before they are 40, due to risk stepped premiums.

So if anyone is going to keep their insurance into their late 50s and early 60s and be able to afford it, they need to be on level premiums much earlier. That’s what worries me about this whole risk commission debate.

If the issues in the media are keeping the kids away from getting advice then that’s going to be a massive disaster.

AV:Perhaps I should take some responsibility for that as the token media representative. But more broadly do you think debates about remuneration are a distraction?

GM:Absolutely, there’s a crisis of confidence.

The issue is a bit like mobile phones in that the cost with compliance of the upfront advice is so large that people won’t buy the product if you have to pay upfront, but it seems to be the only way you can do this is where – like mobile phones – you build it into the recurring cost and the life companies wear that initial cost.

The problem is we want to remove conflicts of interest, we want to remove product – well, can’t we just make everyone have the same commission on the product and make it more difficult to switch from one to the next.

We just need to get these people covered and we need to get fairly paid for doing the work.

SM:I think that’s the most important point here. It is in no-one’s interest for Australians not to be protected. The role of the adviser in having the sorts of conversations we just spoke about is absolutely critical, because if you’re not having those conversations then they’re not happening.

And that just leads to underinsurance and poor consequences for Australians.

MR:I haven’t seen, with both existing and new clients coming in, that commissions on insurance is [a major issue]. The fraud issues that make the commercial newspapers sometimes get raised but most [clients] have no idea. Often people don’t care what we are being paid; they care about the end benefit to themselves.

AV:So what we are saying is that insurance needs to be sold.

MR:Yeah. I mean looking overseas, they can’t believe Australia has this ‘She’ll be right’ attitude. This belief that ‘If anything happens to me, my parents have money, my wife’s parents have money so I won’t worry about it’.

Irrespective of the cost issue, I think the attitude needs to change. And we need more stories of claims and what it meant to people, rather than so much focus on the front-end.

SM:Do you think there’s the same sort of apathy affecting injury, sickness and accident insurance among accumulators?

GM:I think the accumulators have not thought through to retirement.

They have a house, they have kids, they have expenses, their budgets are barely breaking even – I think they’re just trying to hang in and get through and pay their enormous private school fees and pay their house off.

It’s not until they get to their 50th birthday, and realise they need to start thinking about this. Sometimes it’s quite alarming.

VD:Geoff’s right. Sometimes it doesn’t come onto people’s time horizon until they are well into their 50s.

When they are 10 years out, that’s when they start to look at the statement and say ‘Have I got enough?’ And most of the time they don’t.

GMI think pretty much everyone under 40 doesn’t think of super as real money, because they can’t touch it until they’re at least 60 or beyond, and often in the early days, there are quite small balances and they are in different places.

AV:Katie, do your insurance needs change over time from a retirement solutions perspective?

KW:There comes a point when it’s important to change that portfolio mix in terms of insurance.

One of the things that most planners would see is that when the client starts getting to 50 – and if they’ve been on stepped premiums, do they keep on insuring? No, they’ve still got bills to pay and the reason the cost of the premiums goes up is because the likelihood of a claim goes through the roof.

So they become less likely to take up income protection or trauma insurance because they just think they can
self-insure. They’ve got the half million dollars in superannuation; they’ve nearly paid off the house – ‘She’ll be right’.

They feel 10 feet tall and bulletproof, but they are actually mistaken in some of their assumptions.

One of them is their super balance. They’ve got $500,000 – they feel wealthy – but this would only reliably generate $25,000 at retirement for 30 years.

If they were to suffer an injury or sickness that could have a huge impact on drawing down on the balance. So we think it’s important to change the portfolio mix.

Your second biggest asset at that point is going to be your super, so you need to think about insuring that and by ‘insuring that’ I mean being able to go for growth in your super while making sure the balance is protected and won’t collapse when you need it most.

AV:We’ve spoken about the importance of insurance in mitigating longevity risk, what are some some of the other financial planning strategies you employ with your clients?

VD:The main option I use is income protection and for most of them it’s 20 years regardless of age. There’s a sweet point in the cost-benefit I find. Basically, worst case scenario, they get their money back.

And they say ‘Well that doesn’t seem like such a good deal’, to which I respond ‘What if we have another GFC?’ I’ve had a number of clients that have taken up that option.

SM:What are the challenges you face when you’re having that conversation with clients?

VD:The challenge is to justify the cost. But at 0.5 per cent with an option to cancel it’s justifiable.

I say to them I’m not one of those gurus who is going to predict what will happen in the market, but let’s say the worst scenario happens and there’s a 50 per cent decline in the market, I couldn’t look you in the face and tell you that’s what has happened to your money, when I had that option sitting on the shelf.

I wrote to all my clients when [Protected Income] became available because I actually saw it as a business risk if I didn’t.

KW:Just to explain that, it’s insurance – wealth insurance essentially. And like any insurance you never want the circumstances to occur where you are making a claim.

You can protect a portion of your portfolio, and on every policy anniversary if the investments have gone up we lock in the guarantee of five per cent income pa, at that higher balance.

So it means you can have a conversation at accumulation phase knowing exactly what your worst case scenario for income is going to be once you’re in pension phase without limiting your upside.

So it can be a very powerful for clients in that circumstance.

AV:That aspect of uncertainty that Vince mentioned – what other ways do you deal with that and provide clients peace of mind?

GM:The way I describe it is it’s a bit like the monster in the dark.

The lights are off if you’re afraid of the monster and then you turn the lights on and see what the monster is. The problem we have is that when we turn on the light there is a monster and we have to deal with that.

Part of it is turning the light on and facing it. For most people there is a monster, there is market timing risk, there’s longevity risk, there’s spending risk – I had two clients in their 70s spend $60,000 on their teeth in one year and that wasn’t planned.

The baby boomers are not going to put up with the stuff that the depression generation put up with and therefore they’re going to want to spend that money.

So we have to build contingency into the calculations. Inevitably you have a calculation around what you need, which is highly dependent on (a) what you spend and (b) how much risk you take with your investment.

And then there is this agonising risk-return trade-off conversation. So there is a monster.

KW:And the monster sticks around for a long time. Even in pension phase you are vulnerable for at least the first 10 years.

GM:Yeah, I often have 65-year-olds come into my office and – I need to be careful that my face doesn’t show it – but I think ‘Gosh I wish you’d come earlier, if you’d come earlier I could have fixed this’.

When you’ve got 10–15 years to work with a client you can at least alleviate the damage when they do fall over the waterfall.

AV:How important is the risk profiling element of building that retirement strategy?

MR:Massive, absolutely massive. Particularly with clients that don’t fully understand how the markets work and how things can go from bad to worse in an instant.

Risk profiling has a place, but it’s really about trying to understand what [a client’s] risk profile is.

Many of the profiling tools we are working with are simplistic because when you delve down and ask more questions you can see the divide getting wider and wider which rings alarm bells.

The answers they give you are often the answers they think you want to hear that will get them some unrealistic Melbourne Cup winner for retirement.

But if they are more honest and upfront they will end up with a plan that is more in line with their true expectations.

I constantly see in the news cases where people have entered into plans and I think there was a greed element there where people thought they were going to hit a home run off the one pitch, it didn’t work out and now someone else has to pay for it. There’s no self-accountability.

AV:How appropriate is the bucket approach? Is it too simplistic?

KW:It has been historically one of the most-used techniques that advisers have had in the belief that it helps address sequence risk. When we talk about the ‘bucket approach’, the mantra behind it is that you will never drawdown at a loss.

But academically there is no difference between the bucket strategy and drawing down from that same overall risk profile and doing a straight withdrawal program.

The great thing about the bucket strategy is that it gives the client comfort, and if you can give them comfort when going into growth assets then that’s a really great thing. What it doesn’t do is solve longevity risk.

GM:I don’t use it. One reason is because it’s actually an implementation inefficiency and it provides leakages of efficiency that actually cause you to be worse off if you do the calculations.

And secondly, depending on how many years you have in the bucket, it’ll get you through the mild storms – the every five years or so, the 20 or 30 per cent crash that you’ll have – but it won’t get you through the 30- or 40-year event storms like the GFC.

Because the three or four years you have in the bucket is not enough for the big storm. In other words, you will have to sell down growth assets to top up your bucket before the markets recover.

Therefore my strategy is to educate clients, spend more time with them upfront to say ‘This is what can happen and if it does you must not sell’.

VD:I find the [bucket strategy] simplistic.

It’s an easy and systemised way for advisers to sell a concept to their clients. But I think it’s incumbent upon us to educate our clients. It’s about getting that balance.

I had a client just this week and I sat down with her and had to say ‘You’ll be working until 70’. And she said ‘Yes I know because you’ve explained that I don’t have enough in my account and I need to work until then before I start drawing down’.

GM:I think there’s a thing in the human condition where we want to tell clients what they want to hear. The truth is we actually have to tell them what they need to hear.

Too often clients will say ‘You tell me where to invest’ and then they are all ‘shock and horror’ when the market performs badly.
I think it is far better saying ‘Here are the risks we are aware of and if that happens then we have to suck it up’.

AV:Another buzz term that journalists love – objectives – or outcomes-based advice. Do you think the idea of focusing on the goals and objectives rather than investment returns or pool of money required is helpful?

GM:It’s fundamental.

Most people come to me not having their money aligned to their purpose.

Clients then need you to do the calculations so they can make the trade-off choices and spend and invest and do things that align with their goals.

AV:In the FSI final report, David Murray concluded that the “retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees”.

We have spoken about some of the strategies available to those 2 in 10 Australians that actually receive professional advice – and I think everyone at this table would agree those people are in a better position to meet those challenges – but for those that don’t seek advice what are some of the solutions at their disposal and do we need government intervention?

MR:I was going to say we haven’t spoken about the government yet. For people under 40 they may say ‘Who knows what the government will change regulation-wise and are we going to get our super?’ There’s a level of distrust about what the government does and whether they really care.

They look at what politicians get in their retirement and they think well they’re well looked after.

SM:I wonder if this will evolve a bit over the next decade or so.

We have people that are around 40 now that have grown up with super, it has been on the edge of their consciousness and it’s a known thing, rather than the baby boomers who have had super brought to them at a time in their working careers.

I wonder whether the relevance of super will increase over time and whether those that have grown up with it will look at the age pension and say it’s just unsustainable.

KW:The best thing about superannuation is that it happens automatically if you’re working.

Realistically – even with the tax breaks – who would say we would have all been happily saving nearly 10 per cent of our income if we didn’t have to? Probably not many of us. The biggest part of the government’s change program was automating it.

But it also behoves all of us as companies and individuals to take responsibility now and recognise what’s in our account balance right now.

What am I likely to earn from this in retirement? How can I improve it? We don’t need to wait for government to create policy.

AV:And of course you can go and get some advice…

KW:…Absolutely. That’s the really interesting thing about the Investment Trends research is that those people who were really comfortable about superannuation and their understanding of retirement had seen an adviser.

That helped them see the monster. They felt more confident.

SM:I think that’s the answer. I defy anyone to navigate the retirement income system without seeking advice. I just don’t see how you can do it…

KW:…Let alone the aged care system.

SM:Well, that’s another minefield. At the moment the best thing anyone can do to save their retirement is to seek advice. 