Why advisors need to factor longevity risk into their clients' plans

Canadian clients may still be underestimating how long they’ll live. Life expectancy keeps rising. At birth, the average Canadian is expected to live to be 81.55 years old. If they make it to 65, they’re life expectancy will be 85.77. At age 80, the average life expectancy is 89.98 and at age 90 the average life expectancy is 94.98. The trouble with longevity, at least statistically, is that the longer someone lives the longer they’re expected to keep living.

A long life is obviously something we all desire to some extent or another. However, longer lifespans pose significant challenges from a financial planning standpoint. The older we get, the more likely we will encounter chronic health conditions or require long-term care. That longevity risk is a key focus for Theo Kocken, professor of risk management at VU University Amsterdam and the founder of Anglo-Dutch pension investment & risk management firm Cardano. Kocken was in Toronto speaking at RTOERO’s inaugural Future of Aging Summit and he spoke with WP about how advisors can help manage longevity risks.

“Longevity risk is a big issue for many people because they only have a lump sum, so they will underspend in case they live longer and they become very conservative,” Kocken says. “That’s not the case if you have a defined benefit pension plan. In defined benefit your longevity risk is shared with other people. That risk sharing is now more and more absent, so we need a solution for that longevity risk.”

Kocken notes that the highly individualized way we now prepare for retirement in North America and much of Europe is perfectly adequate for the accumulation stage. Whether through an advisor or an employer-sponsored defined contribution pension plan, individuals can accumulate and invest assets easily and while investment has its challenges, the core decisions of the accumulation stage are relatively straightforward.

It's the decumulation stage where Kocken sees fewer solutions. Annuities, he says, can help manage that longevity risk, but today’s interest rate environment has made them less popular. He highlights the Longevity Pension Fund by Purpose Investments as another novel solution which can help individuals share that longevity risk. On a global scale, however, he notes that these solutions ‘barely exist.’

As financial advisors work to manage their clients’ longevity risk, he says they can always bring in the client’s core asset – their own human capital. By introducing the idea of some income-generating work later in life, an advisor can go a long way to securing their client’s financial assets and wellbeing through a longer period. In addition to the income earned in work, Kocken notes that through work many of us have key social interactions which can help stave off issues like dementia. Work can also be good for physical health in the long-term.

As they do that, advisors may have to run up against some of the industry’s own marketing. The promise of ‘freedom 55’ might not align with the management of longevity risk and the idea that working longer can actually be healthier. However, plans that open up a range of possibilities, from retiring at the earliest date possible, to staying in a job, to making a career change, can all help inform a decision that best manages that longevity risk.

For all the ways advisors can help their clients manage longevity risk, Kocken agrees that there needs to be a greater emphasis on collective solutions. Longevity risk is best managed when it is shared, and finding a route to that could go a long way to helping clients.

“In the accumulation stage, when you’re saving and investing, you can do that individually, but you have to share longevity risk,” Kocken says. “Just like how you’re never going to bet your entire portfolio on one security, you can’t bet on your individual day of death, you can’t bet on your mortality. You have to share that risk with others that’s just simple mathematics.”