By Keith Whitcomb
Evidently, getting older is risky because there are insurance products that cover aging exposures (e.g. long-term care). And unlike other risks that are specifically tied to assets, family circumstances, or chronic medical conditions, everyone experiences aging.
So, should aging be managed like other insurable health and property risks, or should it continue to be handled by using a more traditional retirement investing approach?
One way to answer this question is to examine how retirement planning has evolved over the past few years. Within the industry, there is a trend to move beyond the classic two-stage work/retire planning framework. Now, multi-phase Retirement Workscape and Lifestage models are more in vogue. The result is an expansion of retirement planning to encompass individualized circumstances over a lifetime.
A 2018 Marsh and McLennan report takes this trend to a logical conclusion by creating a "Lifemap for Money" that looks at an individual's lifespan as a series of uniquely personalized financial events. How does this impact the way you should handle your financial plans? Let's take a look.
Sources of Funds vs. Income
The process of generating cash to pay for your personal expenses has traditionally focused on income. During working years, it is generated by so-called human capital. After leaving the workforce, classic retirement portfolios were built to generate interest payments from bonds to provide income. In addition, employer/union defined-benefit plans and Social Security created a three-legged stool of income sources in retirement. Throw on top of that post-retirement healthcare benefits and, voila, paying for retirement is done.
Well, those were the days. Now, it is a little more complicated. However, within the retirement package of yesteryear are foundational concepts that need to be mapped to our current financial product landscape. The first step is to move beyond an "income" mindset to a viewpoint of "source of funds."
It entails looking at all of your options, given the plethora of risk management and funding products in today's financial marketplace. Here's what that means:
- Low-cost laddered portfolios that incorporate harvesting capital gains and the maturation of bonds (e.g. equity index funds and defined maturity bond ETFs)
- Access to credit, like a home equity conversion mortgage (HECM)
- Insured income annuities that provide a stable floor of income to avoid market and longevity risks, and supplement Social Security (e.g. deferred income annuity/DIA, single premium immediate annuity/SPIA, qualified life annuity contract/QLAC)
Catastrophic Cost Containment
A second step is to have a plan in place to help you avoid what's known in baseball as "the big inning." It's an inning where poor pitching, inept fielding, and maybe a little bad luck, results in the opposing team scoring a lot of runs. Examples of personal finance "big innings" are common. A Kaiser Family Foundation
found that, of those who had difficulty paying medical bills, 66% were the result of a single short-term medical expense.
The strategic utilization of products designed to avoid this and other types of financial disasters needs to start during your working years and continue throughout retirement. By limiting losses and moderating out of pocket expenses, insurance (e.g. short- and long-term disability) and credit products (e.g. home equity line of credit, or HELOC) can supplement emergency fund cash reserves so you can pay your bills.
Balancing your Risk Profile
Here you need to look at how to optimize the "system" of coverage, and not sub-optimize the components. What does that mean? Well, back in high school, a brother of a friend of mine had a car he liked to race. He put wide rear tires on it and modified the engine to make it more powerful. When he brought the car up to the starting line and floored it, the engine roared and the drive shaft broke. The car never moved. Unfortunately, by not including the connection between the more powerful engine and the higher traction tires, the system failed. The key here is to take a global perspective on which products, features, and limits make sense for you. You need to consider:
Deductibles: Is the downside dollar exposure manageable given your financial resources, and are deductibles consistent across your home, auto, and healthcare policies?
Overlapping coverage: Are you paying twice to cover the same exposure? A classic case here is rental car insurance.
Gaps in coverage: Does it make sense for you to ignore or decline coverage of a particular insurable risk? It may if you have adequate funding to cover the loss.
Over/under insured: Is your coverage of various exposures balanced across all of your policies?
For example, if you choose a low premium health plan and supplement it with voluntary benefit offerings like hospital indemnity and accident insurance, is there a duplication of coverage in those multiple policies? Does your health plan deductible make sense when compared to your auto policy deductible and/or homeowner's deductible?
To Buy or Not to Buy
Beyond the base emotional responses triggered by the usual fear mongering and payback enticements of the classic insurance sales pitch, insurance forces you to evaluate life choices. This adds an element to the decision process that cannot be captured in an algorithm. Your core beliefs are key in deciding how you use your limited resources. For example, is it more important for you to send your child to college or fund a resort lifestyle in retirement? These beliefs and priorities ultimately shape your retirement income needs, timing, and safeguards. The task is to balance them with a reality that maximizes the multiple constraints on your finances.
In addition, insurance seems now to be offered everywhere for just about everything. Recently, I bought some outdoor decorative lights and was asked at the checkout if I wanted to purchase a warranty for them. Product warranties for Christmas lights? Really?
Safeguarding against the big stuff that happens is what you need to do. Consider your budget and capacity to self-insure unexpected financial events to help determine what insurance policies and limits make sense for you.
Employer Health Plan Open Enrollment
If you are one of the 156 million Americans with employer-sponsored health insurance, it is likely you have recently gone through open enrollment. Sometimes derisively described as "the annual pay cut announcement," open enrollment can actually be a great time to shop for insurance. Products can be competitively priced based on a group rating and also be "guaranteed issue" (i.e. no health exams).
While open enrollment principally focuses on short-term, annually renewable insurance products, those policies can form an essential foundation on which to safely build retirement assets.
Also, options to make deferrals for long-term investments in Health Savings Accounts (HSAs) and 401(k)s are starting to appear within open enrollment apps. However, while enrollment systems have made the shopping experience easier, they don't necessarily help you understand what products to buy within the context of the rest of your financial life.
So, the next time open enrollment approaches, take an inventory of your short- and long-term assets, insurable risks, and coverages to be prepared to purchase, defer, and invest based on your financial circumstances.
Melding the Methods
Is aging risky? Yes. Should we abandon the traditional asset-based retirement funding method to meet aging's financial challenges? Not completely.
In addition to accumulating assets, risk containment that uses financial products to safeguard against catastrophic outcomes is important. Doing so by avoiding a sub-optimized buying decision is also critical. In addition, you will need to find financial professionals who are more than just product jockeys intent on closing commission-driven transactions with you.
There are quality advisers out there, but it may be difficult to find well rounded guidance on the full range of insurance, credit, and investing products with a single professional. As a result, the process of weaving these pieces together may still largely fall on you, so be prepared to manage the managers.
The key to handling aging risk is to truly coordinate insurance, credit, and investments over your entire lifetime.
About the author: Keith Whitcomb MBA, RMA is the director of analytics at Perspective Partners and has more than 20 years of institutional investment experience.