Macchia – Just by way of background for my readers, would you be kind enough to talk about your position and title at Northwestern Mutual, and specifically, what your role there involves?
Robinson – Sure. I am responsible for developing the strategic initiatives for what’s called our Investment Products and Services Division. My primary focus right now is developing our retirement planning philosophy and strategy. However, I also have responsibility for strategic initiatives that include our wealth management company, our broker/dealer, the development of our annuity products and our mutual fund products, specifically the integration of Frank Russell Mutual Funds into the Northwestern Mutual Financial Network.
Macchia – Chuck, I know that you’ve been a very active road warrior, you’ve been a speaker at many industry conferences and among the things that you’ve talked about, and I’ve certainly heard your presentation at least a couple of times, is what I would categorize as a very innovative solution for long-term retirement security, albeit one with a different approach and focus than perhaps anything that we’ve seen anywhere else. I know you know what I’m talking about. I’d like to explore this in some depth because I thought that it was a rather fascinating solution when I first saw it. Cleary the creator of that solution, which I take to be yourself, has seen some insights that perhaps others are missing. I’d like you to take me through, if you would, what was going through your mind when you first thought of this solution.
Robinson – It’s really interesting. This whole idea that you refer to, that we call the Lifestyle Income Approach (LIA) or a phased income approach, is something that I’ve been thinking about for a long time. I began working on pieces of it 25 years ago when I was helping non-profit employees plan for retirement. I have spent most of my career focused on retirement planning and retirement income development. For about 20 years I was with a company called VALIC (Variable Annuity Life Insurance Company) which used to be a subsidiary of American General and is now wholly owned by AIG. Their whole focus was on developing retirement programs primarily for public employees, school teachers, university employees, health care workers, state, county municipal government employees, and eventually they got into the 401K market. The real genesis of the LIA concept lies in a group of ideas that are neither unique nor revolutionary, nor were they invented by me. They are ideas that have been around for a long time. Some of the ideas that are key components of the lifestyle income approach are things like the old split annuity concept, which was a pretty common part of any retirement planners arsenal when I came into the business 25 years ago.
I should point out that there was a time in my career when I actually worked as a retirement planning advisor. I started out as a financial planner in the field and spent a lot of time with people who were planning their retirement. There was no question in my mind that when I talked to retirees about their dreams, their hopes, and how they expected to live out their lives in retirement, they had a vision of how they would be living that was at odds with a lot of conventional thinking.
The conventional thinking was that you started out with a set withdrawal amount roughly equal to 60%-80% of your pre-retirement income and you increased it by inflation every year for the rest of retirement. However, the more I talked with people, the better I understood that they did not intend to spend less in retirement than they spent when they were working. In fact, they were actually planning to spend as much or even more money in the early years of retirement than they did when they were working. In those early years, they perceived they would still be relatively healthy, vital and active and they intended to live out their dreams of travel, recreation and leisure while they were still young enough to enjoy them.
Subsequently, McKinsey Consultants and others have conducted some fascinating research that has validated the tendency for affluent retirees to spend as much or more in retirement. McKinsey discovered that, on average, 40% of people spent as much in the first few years as when they were working. Among affluent retirees (those with more than $1 Million in investable assets), 60% spent as much money in the first few years of retirement as they spent when they were working. Those findings are certainly consistent with what I observed when I was in the field working face-to-face with both pre and post retirees.
The other thing that impacted my thinking was the fact that I began to pay a lot more attention to observing the way that elderly people live their lives. As I watched grandparents, aunts, uncles, acquaintances in my community live beyond 85 or 95, it seemed transparent to me that the nature of their lifestyle changed dramatically. As I began to talk with my clients about these observations, they confirmed that they did not see their lives unfolding in a linear fashion. Most believed that they would eventually slow down dramatically as the infirmities of old age began to restrict their activities. (Parenthetically, I might note that this was not a unique observation on my part. Michael Stein wrote a book called “The Prosperous Retirement” in the late nineties that articulated three stages in retirement: The Go-Go from 65-75; The Slow-Go from 75-85 and No-Go” phase beyond 85.)
However, I’ll never forget one experience when I was talking with a client about this issue and I was sharing my perception that people don’t spend the same amount of money all the way through retirement. I think they spend more in the early years of retirement and it starts to decline as they get older. Sometime in their eighties it starts to decline pretty dramatically. Certainly by the time that somebody gets into their nineties or even one hundred they are just not as active and they are not as vital.
My client suddenly looked at me and he said, “You’re describing my mother.” I said, “Well, tell me about mom.” He said, “My father was an executive for a small company that was bought out by a Fortune 100 hundred firm. Mom was left in pretty good shape. She inherited about $5 million in company stock and it is now worth about $15 million.” He said, “She’s eighty-six years old.” And I said, “Well tell me about how mom lives.” He said, “Well, three things are really important to mom. Number one is menthol Kool cigarettes (hard to believe that she lived to be eighty-six). Number two is the rock candy that she used to eat when she was a little girl. Number three is Vernor’s ginger ale.” I looked at him, I smiled and I said, “Well, tell me how much of those mom can eat or smoke in a year. He kind of laughed and I said, “Obviously what I’m asking you is, how much money do you think your mom is spending?” He said, “Well, she’s no longer living in the big house. She moved to a small condominium. She doesn’t travel the way she used to. I’d be really surprised if mom is spending more than $50,000 per year.” Now this is somebody who, when her husband was alive and they were young and they were healthy, was probably spending several hundred thousand per year.
The more I thought about that I really began to look around at people that I knew – relatives, neighbors, people who lived in my community – and when I speak to advisors I frequently ask them, “I want you to think of someone that you know, or knew, who was more than ninety-five years old. I want you to get a picture of that person in your mind. Tell me about the kind of lifestyle they live.” And obviously at ninety-five the issue isn’t “Am I going to travel around the world?” The issue is “Can I keep my driver’s license to be able to travel around the corner to go to the local grocery store.” Almost without exception, the level of income expenditure for consumable income needs beyond the age of 95 is significantly reduced, other than potential health care. Health care is always a major wild card and should be addressed separately with a different set of metrics and assumptions regarding inflation, costs and investment solutions.
There’s no question that running out of money is one of the worst things that can happen to retirees. However, for many retirees, the next worst thing to running out of money in retirement is discovering that they cheated themselves out of opportunities to enjoy their retirement by spending too little money when they were young, healthy and active. It became clear to me as I talked with people and sat down to plan with them that you had a lot of elderly people who had skimped and saved and had done without during their working years and in the early years of their retirement, only to discover in their late eighties or nineties that they have all this money left over. Some of that was a factor that we were going through the great markets of the 1980s. You had people like this woman, whose original $5 million had now grown to $15 million. The sad thing was, at 90 or 95 there was almost no marginal utility to that additional money. What difference did it make whether her income was $50,000 or $500,000? She couldn’t enjoy the additional income and she couldn’t use it.
On the other hand there is a tremendous marginal utility to every dollar that can be used on the front end of retirement. Although most retirees really want and can use more money on the front end, they are absolutely frightened to death to spend money on the front end of retirement because, “We’ve got to save for a rainy day.” There may be a time when we require hospitalization, long term care and/or home health care. Of course, this is precisely why I advocate addressing these issues first; then, dealing with the issue of generating consumable retirement income.
The next part of the LIA concept was trying to figure out the role of annutities. Most 65 year olds are reluctant to trade access to their assets for a slightly higher income payout. As a result, most immediate lifetime annuities are not purchased until 10 years after retirement when retirees begin to realize they may not have saved enough to cover the increasing costs of retirement. Considering all of these factors, the thought occurred to me that perhaps it made more sense to delay the annuitization decision until Age 85 when the mortality premium was so high, and was so large, that you literally could generate twice as much income as the traditional method for the same amount of assets; or, you could generate the same income for half the assets. At Age 85, the consumer has an enormous incentive to trade liquidity for a significantly higher income and by Age 85 most retirees will have a much better idea of whether they will need a larger income.
Of course, half of them will be deceased and will never have to deal with the issue. Deferring to 85 also gives the retiree liquidity and access to assets from 65-85 and aligns with the advisor’s interest in continuing to receive an asset based fee. Combining this concept of delaying the annuitization decision with an understanding of the phased nature of how people spend money in retirement and a desire to create a program that advisors would embrace really got me thinking about how you put all of these ideas together.
And then the next piece of the LIA concept was stimulated by an article Bill Bengen published in the Journal of Financial Planning in 1994. I think that everybody who works in the retirement income space owes an enormous debt of gratitude to Bill Bengen. His research caused all of us, for the first time, to think more realistically about the magnitude of a safe and sustainable withdrawal percentage. Almost all retirement planning approaches today are based on his conclusion that 4% is the Rule of Thumb for an initial withdrawal amount. However, his real impact on my thinking was to make it crystal clear, for the first time, that the real threat was a potential down draft in equity markets during the first ten years of retirement, even the first 4 or 5 years. In short, the major focus of retirement planning was on “Worst Case Scenarios” and how to insulate retirees from the shock of another period like 1965-l975 or another Great Depression.
The more I started thinking about all of this it struck me that there were three major objectives: number one is the goal to create multiple levels of phased retirement income spending that gradually decrease instead of increase; number two is to insulate investments in the first ten years of retirement from market declines; and, number three, is that all retirement planning is focused on worst case scenarios, yet worst case scenarios only take place about 15% of the time.
It was at that point that I started to put together this concept that you use potential annuitization at age 85 as a hedge or an option like a put, as a way to allow yourself to recover from bad markets in the first ten years of retirement. I believed advisors would buy into this since the odds were pretty low they would ever have to commit “annuicide”, as Garth Bernard calls it. The reason the odds are so low is that half of those who started at 65 will be deceased by 85 and there is only a 15% chance the survivors will have lived through a Worst-Case Economic Scenario. As a result, the odds are only about 7.5% a retiree will ever have to consider annuitization. Moreover, half of those who survive to 85 are likely to be so ill that it wouldn’t make any sense to annuitize so that the odds are potentially 3-4% a retiree will ever actually have to annuitize. Yet, 100% of retirees can benefit from planning to use annuitization as a hedge since they will be able to draw out, on average, twice as much money at the beginning of retirement as the conventional method. In order to verify these concepts, I started to play around with all of those things and I started to run some historical scenarios so I could look at what would happen if you implemented these ideas.
Then, the next piece of it that fell in place for me was a better understanding of the dynamics of longevity for a retired couple, as opposed to a single individual. One day when I was working with one of our actuaries on life expectancy projections, we started talking about this issue of who’s going to live beyond age 95? Of course everybody has seen the statistic that says if you take all of the couples age 65, the odds are pretty high that one of them will live beyond the age of 95. In fact, for the whole population, about 25% of couples will have one member who lives to Age 95. If you take the healthy part of the population, it goes as high as 50%.
However, as we talked it struck me that it might be more interesting to look at the opposite side of that number. The question I wanted the actuary to answer was: If I take all of the couples starting at age 65 how many of them still have both people alive at 95? The actuary came back and said that it was a very small number; it’s less than 3/10ths of 1%. I asked how many at 85? He said that it was only 18%. I said that’s a huge, huge insight. We know with a fair degree of certainty that beyond 95 we’re only planning for one person.
In fact, in the majority of cases beyond 85 we’re only planning for one person. Even if I bought into the concept that you’re going to spend the same amount of money every year throughout your entire retirement, I know with a fair amount of certainty that beyond 95 you’re only going to be spending 75% of what you used to spend even if you’re spending at the same level, you’re traveling as much, you’re playing golf, you belong to the country club, and all of those things.
The combination of all of these ideas that had been germinating for several years caused me to start working on creating a hypothetical scenario so I could test how the math worked out historically. The final piece of the puzzle that finally came into focus was the issue of how you address the potential costs of health care. What if you need all of that extra money for health care? Some proponents of the conventional method said to me, “We agree with you. Consumable income will go down from 65 to 95, but people need all of that extra money because they will have to pay for long term care, out of pocket expenses, drug expenses, health care premiums and all of the things involved with aging.”
The more I thought about that, intuitively, it just didn’t make sense to me. Health care expenses are projected to increase 7 – 10% and inflation, historically, has increased at only about 3%. Consequently, you’ve got a huge mismatch between a revenue stream rising at a 3% CAGR to meet a liability stream growing at 7-10% CAGR. How can we be sure that the extra money that you’re not spending on consumption is enough to pay for health care premiums and health care costs?
It was about that time that I ran across an article sharing the research being done by the Employee Benefit Research Institute (EBRI) under the direction of Dallas Salisbury, CEO, and Paul Fronstin, who is their Health Care Expert. I’ve known Dallas most of my career and he and Paul were kind enough to sit down with me to talk about this health care issue. I thought these guys were just right on about calculating what it might be and about how it would look. Using their research, It didn’t take long to create a spreadsheet and a set of reasonable assumptions to demonstrate that, in fact, the conventional method is unlikely to generate in Worst-Case Scenarios enough to pay for healthcare expenses, even if we assume consumption declines by 50% beyond 85 and 60% beyond 95.
It was at that point that it suddenly began to strike me that when you do retirement planning you’ve got to break this apart. You can’t plan for both consumption and health care using the same set of metrics, the same investments, and the same strategy. They are so different, the inflation rates are so different, the potential costs are so different, that you’ve got to set up a different method or process for planning for health care. It was at that point that we started working on just exactly how much money will you need for health insurance premiums and out of pocket costs and long term care? How would you fund that? How much would you set aside? EBRI doesn’t really address LTC and uses an accurate, but conventional method of calculating funding that’s not designed to meet Worst-Case Scenarios. We elected to rely upon EBRI’s estimate of health care costs, but to develop our own funding approach that would incorporate Worst-Case Scenarios and would utilize both the leverage in the mortality premium of a lifetime annuity and the risk sharing features of LTC policies.
We did this because the estimated costs were potentially so high and so unpredictable. EBRI estimates that a couple at Age 65 who expect to live to 100 may need almost $800,000 just to cover health care costs. Once you add in the cost of LTC, vision, dental and hearing, the worst-case estimate can exceed $1 Million. Admittedly, it is not very likely both members of a couple will live to 100 and it is unlikely they will incur the max Out Of Pocket expenses each year. On the other hand, we have found that our affluent policyowners tend to be healthier than the general population and they like the concept of trying to protect themselves against worst case risks by covering all the bases. Obviously, these estimates need to be customized for each client.
We began doing a lot of work evaluating a wide range of assumptions and have concluded there is no simple, absolute or single correct answer. Depending on a retiree’s assumptions, wealth and tolerance for risk, the number that needs to be set aside to fund healthcare and LTC could potentially fall anywhere between $1 million to as low as $160,000, per couple. Given the wide disparity in estimates, It became clear to us that the calculation has to take place apart from and before you deal with retirement income spending. As that fell into place, it became very clear to us that there was a hierarchy or priority in terms of how you solve these problems.
It was then that I hit on this concept that the real things that ruin your retirement happen at the end of retirement not at the beginning. You really need to start at the end, you need to say, “How do I address long term care? How do I address heath care? How do I address out of pocket expenses? How do I address longevity?” We do those first and we then work backwards. The minute we started doing that, we started running examples and 95 seemed like the logical place to begin because there is a fair amount of certainty that we are probably planning for only one survivor beyond that point.
We then began running all kinds of scenarios to identify the most effective way to address the objective of creating financial security with the least amount of assets. It quickly became clear that using the leverage of the mortality premium and the power of risk sharing made sense because these risks tended to occur at the end of retirement and were so large and so difficult to predict that shifting some of the risk seemed the most efficient and elegant way to plan for these potentially catastrophic events. Co-insurance is a concept that seems to resonate with affluent clients
We began working backwards in 10 year increments on how much money you would need from 95 to 105 and beyond that. How much do you need from 85 to 95? And of course what we discovered was that it was possible to save a lot of the money that the conventional method set aside for those periods and move it to the front end of retirement, especially in our network where we’re dealing with many affluent clients who by and large are pretty heavily insured. And we sat down and asked the question, “What if we have somebody who is very affluent and is very heavily insured?” We looked at an example of somebody with $6 million that they could turn into retirement income and $3 million of permanent cash value life insurance.
You then ask the question, “How much money does that couple have to set aside beyond age 95?” The current odds are that 99 and 7/10ths percent of the time there will be only one person left, which means that the person who survives will have received either a $3 million payout from their insurance policy or they will have $3 million in cash value. It’s pretty clear that the heavily insured individual needs to set aside less money to fund the period beyond age 95. All of a sudden, all of the money set aside by conventional retirement planning methods to generate income beyond Age 95 can now be pushed forward to use earlier in retirement or can be set aside as a reserve. Of course, we also discovered we can fund the same amount of money at Age 85, in a worst scenario, using a lifetime annuity income with half the assets, which means the other half can be pushed forward to the front end of retirement.
Macchia – Chuck, where do I begin? Let me ask you a couple of questions. The strategy that you outline with great articulation and detail clearly would run counter to strategies that are developed more in harmony with the conventional wisdom that plans for income that gradually accelerates, ideally according to an inflation assumption over a long period of time. Why do you feel that more people- including many smart people, have not looked at this issue in the same manner that you have?
Robinson – I think you’ve hit on the key factor, which is intuitively people would look at that concept and say you’ve got it all backwards. We have been taught, we have been coached, that you save for that rainy day. I think the second reason that more people have not focused on this concept is that most retirement planning has been done by people with a background in investments.
If you read most of the articles and most of the research, these are folks who spent their careers as investment advisors or spent it in the investment advisory sector of the financial services industry. There are far fewer people who come from the life insurance or risk based side of the business. Most advisors don’t even think about lifetime annuitization or lifetime annuities or LTC Insurance as being arrows in their quiver, or tools they would use to solve for retirement.
Most investment advisors would readily admit they are unprepared to advise their clients regarding Medicare/Medicaid or projected retiree health care costs. Moreover, most do not handle LTC insurance. They may outsource it to a strategic partner, but they don’t have that expertise or background. In general, investment advisors have been comfortable relying on the widely accepted (but misguided) conventional wisdom that the affluent (more than $1 Million in investable assets) don’t need LTC insurance and are generally wealthy enough to self-insure for both healthcare and LTC.
Macchia – Do you think there’s a chance that a strategy like yours is given less attention than it deserves because it’s coming from a life insurance company?
Robinson –It’s possible. However, I should point out that, other than a few trade association presentations, we really haven’t done very much to publicize this concept outside our own distribution network prior to this year. Nonetheless, I personally think there may be a nugget of truth in your observation, David. I can tell you that I just had an article published in the Journal of Financial Planning in March, 2007. There was some concern prior to publication that the article might be dismissed as “ just another life insurance company trying to come up with a way to sell high priced and expensive products that most investment advisors would never offer to their clients.” There was also some question as to why the Journal would publish an article from an Executive of a Life Insurance Company about “a proprietary method that might preclude independent advisors from realizing any value from the concept.” What is so interesting about these viewpoints is that prior to publication, the article was submitted for peer review to several investment professionals. The response was overwhelmingly positive and the feedback I’ve received since publication has been uniformly favorable. One reviewer commented, “This is the best article I’ve ever reviewed for the journal.” Another reader said, “My gosh, we should get this on the agenda for our retreats and for our conferences. We should be talking about this and debating it and thinking about this.”
Macchia – Perhaps because it reflects my own experience and background having entered through the life insurance door, I’ve always felt that people who begin their careers with some years of experience working with retail clients carry through their careers a lifelong advantage in having a sensitivity and a perception of how products and strategies pertain more in the practical, real world sense, as opposed to a more sterile, academic view. Do you put any credence into that?
Robinson – It’s an interesting observation on your part and certainly in my career it’s been a huge advantage that I’ve had that field experience, and I had it with a company that was in the insurance space because there is no question that I never could have developed this strategy without having had that background. Number one, I had the experience of sitting across the table, face to face with literally hundreds of people planning for retirement, so I had done a fair amount of consumer research sampling, admittedly unscientific and not very statistically accurate.
However, I had a pretty good idea of what people wanted and what was important to them in retirement. And secondly, I don’t know if it’s because I worked for a company in the insurance business, because I was always in the investment division of the company, I was not someone who was a big life insurance producer. However, I didn’t automatically reject the idea of life insurance and annuities. I was exposed to a lot of background, education, and understanding of the importance of insurance products. I never bought into the concept that was so widespread back in the early eighties that you buy term and invest the difference. I just never believed affluent people would not need permanent life insurance protection beyond age 65, based on my understanding of what their needs would be as they got older.
Macchia – Perhaps the main reason that today I’m so passionately focused on improving communications, and improving the ability of organizations to explain their value to consumers in language that they can understand, comes out of years of frustration; frustration in seeing some of the truly unique and valuable products that insurance companies offer, and understanding their inherent value, and seeing them poorly appraised and misconstrued so often to the detriment of consumers and advisors, and the insurance companies themselves. I think the responsibility for this state of affairs rests primarily with the insurance companies who 25 or 30 years ago, and this is not true for all companies, but for most companies, reverted to the stance that, We’re going to manufacture products and not worry about anything else.” The development of sales people, the development of good, concept-grounded educational tools, the development of good communication strategies, was largely sacrificed n favor of a focus of just manufacturing product after product after product. Thus, a vicious cycle was ignited that culminates in the commoditized world that we have today, where insurance products fight an uphill battle to gain recognition and acceptance.
Insurers actually attempt to combat this syndrome through self-destructive, retrograde product development; certain products types become progressively less consumer oriented over time as insurers have only newer product with higher compensation with which to compete for distribution. Do you feel that this is an apt description?
Robinson – David, I think that is an incredibly insightful, if not brilliant, analysis of why insurance products have not been more widely accepted. It mirrors my 25 years of experience in the business, spot on. Insurance companies’ home offices are filled with incredibly bright actuaries, attorneys, and product development specialists, but by and large, with a few exceptions, there are very few people who really understand how to market, communicate and explain these products in a way that not only meets the needs of the consumer, but that resonates with them so that they are motivated to enjoy the benefits of the product. Most companies focus on features instead of benefits. The most successful insurance companies have been those that recruited, retained, developed and valued executives with the background and/ or insight to develop consumer friendly marketing programs that focus on providing solutions to consumer needs.
Macchia – And/or advisors.
Robinson – That’s right. Even when they are selling to their intermediaries, they don’t know how to explain it to the intermediary.
Macchia – Let me push this analysis a bit further then, because the result of this concentration on manufacturing has created another vicious cycle that I see. You can see this reflected in certain product lines, like say, indexed annuities where over the past ten years what was a very pristine idea and relatively consumer oriented in design became progressively more opaque, more complex, more cost latent and more anti-consumer.
I lay the blame of this syndrome again at this same division 25 years ago to abandon everything but manufacturing, because what happened is, the advisors and agents of the world were not given the tools they needed to properly explain products. They were able to engage fewer and fewer customers and they had to resort to tactics that sort of camouflaged their true agenda. Because they were engaging fewer customers, it became more important to maximize the compensation on each of their declining number of sales on an annual basis. Hence the attraction to higher and higher commission products, with the carriers feeding into that by meeting a perceived need of the advisors by manufacturing even higher commission products, resulting in the cycle of regulatory problems that we have today. If you agree with this, how does this phenomenon potentially impact retirement and a life insurance company’s role going forward?
Robinson – It’s a great question, David, and I think you raise a really huge issue about how the insurance industry is going to respond to the retirement opportunity and the retirement challenge. I go to a lot of conferences around the country every year and I hear people speak like Chip Roame at Tiburon, the folks at McKinsey, and people like Moshe Milevsky. These are really bright people talking about the retirement challenge.
Most of these independent experts have made the observation that most of the major issues in retirement are really in the risk based insurance area. Several have suggested that this is the insurance companies’ game to win or lose, and yet, I hear a lot of people talking about the investment portion of the industry as the leader in stepping up to the challenge. In my opinion, there are some visionary and perceptive executives on the investment side of the business who may take this away from the insurance industry in much the same way they took 401Ks and defined contribution plans away from them.
It’s just fascinating that some of the investment companies have moved so rapidly to integrate annuity products, for example, and in some cases even life insurance. I look at some of these companies and can’t help but be impressed. I look at someone like Fidelity who is one of the top sellers of lifetime annuities and was one of the first companies to address the issue of funding retiree healthcare expenses. I look at somebody like Merrill who is putting together some tremendous programs that integrate annuities, insurance and investments. And, it’s also true of some of the banks. I look at a bank like Wachovia who I think has made tremendous strides in integrating all of those. Admittedly, there are also some insurance companies such as Genworth, Hartford and AIG that have done a wonderful job of manufacturing products that resonate with intermediaries and consumers.
In many cases, however, the investment companies and banks have stepped forward to take insurance products and use them more effectively than many of the companies in the insurance industry. I think it goes directly to your point and your issue of product manufacturers that don’t fully understand how to market, how to position this with the consumer and how to do it in a way that creates benefits for the consumer, the intermediary and the insurance company.
Macchia – I wish that I could put all of the insurance company presidents in a box and shake it in order to get their attention on this. Let me get back to the phased income approach. Tell me about your experience at Northwestern. When was the program introduced? How has it been received? And what are the results that you are finding?
Robinson – We started to introduce the phased approach back in 2004, so we’ve now had about 3 years where we’ve been talking about this concept at a very high level with advisors and the response has been overwhelming. The field intuitively grasped the importance, the advantage and the usefulness of this particular concept. However, the task of building out all of the supervision, compliance infrastructure, the technology platform, the training, the products, the services to be able to deliver it completely, is a pretty big issue for us. We anticipate that it will take several years to develop a robust capability to fully deliver our comprehensive vision of retirement planning. I don’t think that reflects the fact that the company doesn’t think highly of the concept or the opportunity. Obviously they’ve spent a fair amount of money applying for patents on the process, but I think it reflects that a project this big simply takes time.
Macchia – You say that the company has spent a lot of money applying for patents.
Robinson – They’ve spent a lot of money and a lot of support has been allocated. We have a high level, cross functional team that is working on this, but you’ve also got to remember that for the last two years we have had a major focus on transitioning financial representatives from being registered representatives to being investment advisors. These regulatory changes had an exclamation point put on them as a result of the court ruling that vacated the Merrill-Lynch exemption and Rule 202. Thank goodness we’ve spent a huge amount of resources and time to prepare for that. We’re in a pretty good place to respond to it.
Macchia – Are most of your reps now functioning as IARs?
Robinson – We have about 1300 who are advisors. 300 of them are Wealth Management Advisors who can charge a fee to do investment advisory or financial planning work. We have approximately another 1000 who are investment advisors who can use software that provides a comprehensive financial plan, but they don’t charge for the plan. That’s out of a total field force of a little over 7000. You might see a little more migration somewhere in that balance as time goes on. However, we think that ratio is about right. We’re huge believers in a network of specialists and we’re not sure that all of our reps need to become, or should become, an investment advisor, but they should have access to investment advisors for joint work in order to meet both the risk based needs and the investment advisory and financial planning needs of their clients.
Macchia – Is there any concern that some of the life insurance planning that the typical representative is doing can be deemed across the line into planning?
Robinson – Well, there’s no question that you always have to be focused on putting policies and procedures in place to make sure that doesn’t happen. We feel pretty comfortable that it’s manageable based on the current regulatory framework and environment. Obviously, that can change going forward. We think that the needs based solutions approach on the life insurance side is so focused that most financial representatives do not have to be Registered Investment Advisors. We’ve spent a fair amount of time educating inside the network as to what they can do, what they can say and how they can hold themselves out to the client. I
n the case of older, extremely successful life insurance representatives, they frequently prefer referring investment advisory work to one of our specialists in order to avoid the distraction, time and money required to build out their own investment advisory practice. In the case of younger representatives, with less than five years of experience, they are generally focused on building an insurance practice with younger policyowners who haven’t yet reached a point in their careers where their assets match the profile for investment advisory services. When they do run across someone who meets the profile, they can also do joint work with one of our investment specialists.
At the risk of oversimplifying the issues, I think the essence of the FPA lawsuit against the regulators is that we have way too many people holding themselves out as advisors when in fact they are sales people. I think that is the crucial point that the FPA has tried to make, and legitimately tried to make; that when I’m a consumer and I engage a financial professional, it should be clear to me whether they are acting as a salesperson or serving as an advisor with a fiduciary responsibility. I think the dispute over the last couple of years between the FPA and the SEC has helped to clarify that distinction. It has meant a huge amount of change and it has not been easy or inexpensive to turn around a ship as big as Northwestern Mutual or any of the other distribution systems, but I am guardedly hopeful that it will end up being a good thing for consumers and for the industry. However, the risk and cost of delivering a fiduciary standard of care is significantly greater and, as a result, there is no question that many consumers will end up paying more for advice and/or some segments of the consumer market may be underserved. In the long run, I would not be surprised to see industry and consumer groups seek legislative relief.
Macchia – Let me ask you about something we talked about a moment ago. You mentioned the loss of the 401K business. I remember 30 years ago, when I came into the business in 1977, and the insurers owned the pension business. Then they progressively lost it to the mutual fund complexes. Now we’re staring at this great opportunity of Boomer retirement security. If you were to give it odds on the basis of 10% to 100% that the insurers will get it together and seize the day, and take back the prominent role, how would you evaluate the odds?
Robinson – I was on a panel a couple of years ago and they asked that question and they had people on there from all of the major distribution channels. The panel was composed of representatives from the wirehouses , discount brokerage firms, banks, insurance companies and independent RIAs. Everyone was asked to respond to the following question: “Who do you think is going to win the race to acquire the Baby Boomer retirement assets?”
My response was that everybody is going to win. This is so big. The assets are so large that each of those various distribution networks are going to get a very large piece of it. However, I think what you’re really asking me is a slightly different question which is, “Will the insurance companies increase their market share or stay the same or will it decrease?” Everybody’s opinion is probably valid here and I have no particular crystal ball, but if I had to guess, my guess is that the insurance industry, as a whole, will not increase its share of Baby Boomer retirement assets.
Of course, there will be a number of insurance companies that will hold onto their share, maybe individually they will even increase it a little bit, but I don’t see across the board the insurance industry making the same kind of organizational, marketing, communication and platform changes that I see at companies like Fidelity, Merrill, Wachovia and others, especially the Independent RIAs. Every marketing survey I’ve seen indicates the consumer views the RIA channel as the one that is best positioned to address their retirement needs. Over the last ten years, the number of RIAs and their market share has steadily increased. Some financial services companies have moved quickly to organize themselves to meet this challenge and to position themselves to capture Baby Boomer assets. In my opinion, the insurance industry, with a few notable exceptions, has tended to lag behind the other distribution channels.
Macchia – I have said many times publicly, and continue to believe, and I’ve been called a romantic for believing it, that those organizations which will succeed in Boomer retirement will not be those with the “best” products, but rather will be those that are the best communicators, those able to compliantly communicate their value to a large and fluid pool of customers. I’m curious to know if you agree with my belief?
Robinson – I buy into it completely. I think that you are absolutely right, I think that you have loads of examples of that, and I also believe that this is one of those cases where retirement planning is so complex that it is difficult to comprehend. The consumers are so puzzled and confused that they are going to gravitate to those distribution networks that have a clean, clear message and that simplify these issues for them and explain the challenges and how to solve them in very simple, direct language that consumers will understand.
I think there are still large numbers of companies whose approach to the market is so complex, whose products are so complex, that not only do the consumers not understand them, but the intermediaries representing them don’t fully understand them.
Macchia – I so much agree with that. I try to get people to understand that effective communications equals clarity in the consumer’s mind, equals confidence, equals conversion. It’s too bad that you and I weren’t 20 years younger.
Robinson – I say that all the time, David, and I say it when I’m speaking with audiences of younger people entering the financial services industry and certainly younger groups of representatives at Northwestern Mutual.
For 25 years this has been one of the greatest runs that I can imagine. However, I wake up every day and think that the prior 25 years pales in comparison to the career opportunities to capture assets that young people have today. I’m like you. I wish I was 20 years younger.
Macchia – Thank you for your time and insights. I really enjoyed it.
Robinson- I did too, David.
©Copyright 2007 David A. Macchia. All rights reserved
DISCLOSURE PROVIDED BY NORTHWESTERN MUTUAL:
Northwestern Mutual Financial Network is the marketing name for the sales and distribution arm of The Northwestern Mutual Life Insurance Company, Milwaukee, WI (Northwestern Mutual) (life and disability income insurance, annuities) and its subsidiaries and affiliates. Northwestern Mutual is not a broker-dealer, registered investment adviser or federal savings bank. Securities are offered through Northwestern Mutual Investment Services, LLC (NMIS), 1-866-664-7737, a wholly-owned company of Northwestern Mutual, broker-dealer, registered investment adviser and member of the NASD (www.nasd.com) and SIPC. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide and is a subsidiary of Northwestern Mutual. Northwestern Mutual Wealth Management Company, Milwaukee, WI, a wholly-owned company of Northwetern Mutual, is a limited purpose federal savings bank. Each network representative represents one or more, but not necessarily all of these entities. Products and services are offered and sold only by appropriately licensed entities and representatives of such entities.
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