As the retirement world continues to shift from defined benefit to defined contribution plans, the investment risk is being moved from the plan sponsor to the employee. That’s a fact most people understand, says Bob Collie, chief research strategist, Americas Institutional at Russell Investments. Outliving savings is another risk individuals must face — and it’s less predictable than investment risk.
“As part of the shift from DB to DC, we have this unfortunate side effect that the individual longevity risk got passed on to everyone who is in the system,” Collie says. “You don’t know whether you’re going to be living for one year or 40 years.”
Outliving retirement savings isn’t as much of a concern in DB plans, he says. “Longevity risk gets pooled,” Collie says. “With everybody together, defined benefit arrangement takes care of the uncertainty around longevity risk.”
Pooling doesn’t work to mitigate investment risk. “If the investment returns are good you, they are probably good for me,” Collie says. “If they are bad for you, they are bad for me.”
Most in the industry have a decent grasp of investment risk and understand that the equity market has a certain amount of volatility, Collie says. “We don’t like that, but we have a sense of how big that is,” he says.
However, ask someone if the risk of outliving their money is bigger, smaller or the same as investment risk: “You don’t intuitively have an answer necessarily to that question,” Collie says.
As a person ages, outliving their money becomes a greater concern than investment risk. Longevity risk “starts to become a real issue in the later retirement years,” Collie says. “Once you pass 70, it starts to become a bigger consideration.”
Living longer
A significant portion of the population is projected to live well past their 70s. About one in four of today’s 65 year olds will live past 90 — and one in 10 will live past 95 — according to the U.S. Social Security Administration.
Starting to save for retirement early in a career is part of the solution, Collie says. Creating pools also helps alleviate some of the risk of outliving savings. “It doesn’t go away completely, but it definitely reduces it,” he says.
Annuities have been one way participants can pool longevity risk with others, Collie says, but Americans haven’t shown a big interest in them. “Annuities are not that popular,” he says. “There are certain things about them that people don’t like. In particular, you’re putting all of your money into this one product. It’s a very big commitment.”
More recently, individuals have been gravitating toward qualified longevity annuity contracts, Collie says. A QLAC, an investment that starts making payments later in life, requires less of a down payment than an immediate annuity, but still protects against living longer than expected, he says.
“This is a relatively new development,” Collie says, but a lot of people are talking about deferred annuities. “That’s a product which we might find gaining greater acceptance in the marketplace.”
