Moshe Milevsky, professor of Finance at York University Canada, is a widely recognized innovator in the field of retirement-income planning, insurance and pensions. Milevsky has been instrumental in developing the personal “longevity insurance” market, and coined the advanced life-delayed annuity (ALDA) concept as well as “sequence of returns” insurance. (Sequence of returns risk refers to the fact that bad returns in the early years of a retirement portfolio are much more damaging than a downturn later on.) In addition to his academic research, he has worked with Fidelity, and most major insurance companies, including MetLife, Pacific Life, John Hancock, SunLife, AIG/SunAmerica, AXA/Equitable, Prudential and ING. Milevsky is the founding co-editor of the Journal of Pension Economics and Finance, published by Cambridge University Press in the U.K. His next book, titled, Are You a Stock or a Bond? How to Risk-manage Your Financial and Human Capital to Create a Sustainable Retirement Income, is due to be published in mid-2008.
Here Milevsky shares his thoughts with Registered Rep. on what's next in the retirement-income market.
Registered Rep.: How real is the retirement-savings crisis in the United States? And what about all that wealth sitting in people's homes?
Moshe Milevsky: The word “crisis” might sound extreme, but I heard Alan Greenspan use similar words to describe the situation at a recent Million Dollar Round Table conference at which I was also a speaker, and I certainly won't argue with him. Basically, I think that for a large group of Americans, there is a growing retirement fear across a number of dimensions. First of all, there is a basic primordial fear of the question, “Do I have enough?” which truly starts to resonate with you as you get closer to retirement, and the end of your most productive economic years. There is also growing concern around corporate defined- benefit (DB) pensions. The vast majority of the most respected private sector employers in the U.S. no longer offer DB pensions to their new and existing employees. And, workers that are part of a DB plan can't help but wonder if it will be frozen. There is concern around longevity risk, and there is especially a concern around health care in retirement — as it pertains to the cost and complexity, not just the concern of poor health. So, if a crisis leads to fear, stress and reaction, perhaps we skipped the crisis, and jumped straight to into the anxiety part.
RR: If people haven't saved enough, they are screwed, right? How you put together a retirement-income plan takes a backseat to the fact that they don't have enough.
MM: I don't think this is a second-order issue. I actually think that the exact strategy for your nest egg is more important than the sum in your nest egg. Basically, you might have a million dollars in your IRA, and I might only have $750,000 in mine, but if I'm smarter or more strategic about how I allocate my nest egg amongst the various retirement-income products, then my money can last longer than yours. The closest analogy I can think of in the financial arena is how we academics describe the concept of stock market risk. We all know that risk and reward are intertwined, and that higher-expected returns are associated with greater risk, but some risk can be diversified away via portfolio management. Your investment return, therefore, depends on the amount of “smart” — read: non-diversifiable — risk, and not the total amount of risk. In plain English, you might be taking a hell of a big chance, but you might not get much reward for the extra risk. Apply this same idea to retirement-income yields. You can't just compare numbers. What are you doing with your number? Lee Eisenberg's book, The Number, raised public awareness about the sum of money needed to retire comfortably. I think the next step for him is to raise awareness again, perhaps even writing a book titled, Allocating Your Number. So, the response to your question is that we should be focused on the optimal structuring of retirement income, especially for those who approach retirement with a nest egg that is on the edge of sustainability. It cannot be dismissed as a second-order concern.
RR: Let's discuss income solutions. Which do you think will come to dominate this market, insurers or investment companies?
MM: Right now I think insurance companies are dominating in this space, but the asset managers are very rapidly catching up. In fact, I am seeing more traditional investment companies, such as Vanguard and Fidelity, designing and distributing products that attempt to mimic products that are being offered by insurance companies, perhaps more cheaply. Also, a third player in this space will be the derivative boutiques who offer to hedge your retirement risks using financial-engineering techniques that neither the insurers nor investment companies are currently best at. I also think technology software companies have a role to play in that they will help retirees be “smart” about their number's allocation, which increases sustainability.
RR: How much money is at stake here?
MM: If you consider the issue more broadly to include home equity — and the potential of a reverse mortgage to create an income stream for life — and you include the long-term care and health market, then we're talking tens of trillions of dollars. If you focus exclusively and more narrowly on the 401(k)/IRA roll over market, then it is in the single trillions. Either way, the sum is vast and the stakes are enormous.
RR: What sort of products do you think we will see on offer when the boomers actually retire?
MM: Boomers will be able to allocate their nest eggs across various product classes that help them manage their risk and protect retirement income. I think these products will be broken down into three distinct silos. The first are longevity-insured, insurance-created immediate annuities, SPIAs and the like; the second will be the new generation of lifetime- income riders; the third will be traditional instruments, such as a systematic withdrawal plan from a diversified portfolio of stocks and bonds. Each one of these product categories has its own benefits and features.
RR: Will the financial advisor fit into all of this?
MM: For the millions of people who do not have the time, inclination or patience to do it themselves, the financial advisor will play the role of a college guidance counselor who helps new students select from a bewildering array of courses. Based on personality, background, risk tolerance, financial means, etc., the advisor will guide the typical boomer to the right mix of courses. I think financial advisors will be better described as “retirement risk-managers” for their clients, which is a much broader role than just investment manager.
RR: What retirement-income innovations excite you?
MM: Careful. As a financial professor with a PhD, I get excited by some pretty perverse innovations. What excites me from a social welfare perspective is products that can find a careful balance between simplicity and effectiveness. In fact, this “future of financial innovations” point was recently made by a number of economic luminaries such as Robert Shiller from Yale University, and Robert Merton from Harvard. Right now, since you asked, I'm actually excited about a concept I have been calling a ruin-contingent life annuity (RCLA), which allows you to combine a basic long-term equity put option to protect against investment risk together with a deferred life annuity to protect against personal longevity risk.
RR: What about the risk of failure by the industry? Is the industry pursuing short-term gain, high margins, at the risk of long-term pain, such as re-regulation?
MM: I don't want to second-guess insurance regulators, credit rating agencies or corporate actuaries and risk managers. I don't have enough information to judge whether they are exposing themselves to undue risk — which I doubt. The one thing that I believe I have a slight comparative advantage in thinking about is that via teaching and lecturing, I have the opportunity to interact and meet with both financial advisors and their clients, perhaps thousands of them on an ongoing basis. What I am finding is that people are becoming much better at optimizing the value of products that they are holding. The best analogy I can think of is the equivalent of Hewlett-Packard offering a $25 mail-in rebate on a printer to help increase sales, knowing full well that over half the buyers never come around to mailing in the coupon. Then, people smarten up and, perhaps, all start to send in their coupons for a refund, which can lead to some very unprofitable business.
RR: You are often described as the father of many insurance innovations. But often retirement products are inappropriately distributed through overly aggressive sales techniques. Even though this is hardly your fault, do you ever feel like Dr. Frankenstein as you watch these innovations go haywire?
MM: Having just turned 40 — and with hopefully an average of 40 more years of research writing ahead of me — I think it is premature to describe me as the father of anything, other than perhaps my four daughters. What I am more comfortable acknowledging is that I am the son of a parent who died at an age — cancer at 50 — that was two standard deviations under the mortality mean, and the grandson of someone who passed away at an advanced age that was almost two standard deviations above the mean. To add to all of this, my mother is a social worker with an advanced degree in gerontology who counsels seniors on the non-financial aspects of aging. I have therefore come to appreciate the important role of longevity, mortality, morbidity and heath risk in shaping our personal life.
To be brutally honest though, when you mention Frankenstein, what worries me sometimes is that my message of a “balanced income diet” gets lost in the individual product pitches. If I like a particular income product, or a given insurance rider, I would hope that it is viewed as just one component of a properly functioning risk-management system. Also, in the last few years, I really have learned to “keep it simple, stupid” and that retirees and their prudent nest-egg advisors will simply not buy something if it cannot be explained in simple terms — without equations.
One thing is for sure: I'm having a really fun time working in the field.