The Interviews: Industry Leaders & Innovators

Interview with Professor Meir Statman: Noted Authority on Behavioral Finance Explores Distinction People Make Between Capital and Income; Seeks to Bring Gaps Between Theory and Evidence Closer Together

statmanMeir Statman’s research focuses on behavioral finance. He attempts to understand how investors and managers make financial decisions and how these decisions are reflected in financial markets. The questions he addresses include: What are the cognitive errors and emotions that influence investors? What are investor aspirations? How can financial advisers and plan sponsors help investors? What is the nature of risk and regret? How do investors form portfolios? How important are tactical asset allocation and strategic asset allocation? What determines stock returns? What are the effects of sentiment?

Professor Statman’s research has been published in the Financial Analysts Journal, The Journal of Portfolio Management, The Journal of Finance, and many other leading journals. He is a member of the Editorial Board of the Financial Analysts Journal, the Advisory Board of The Journal of Portfolio Management and the Journal of Investment Consulting, and is an associate editor of several other professional journals. The recipient of a Batterymarch Fellowship and two Graham and Dodd Awards of Excellence, Professor Statman has consulted with many investment companies and presented his work to academics and professionals in many forums in the U.S. and abroad.

Macchia – Meir, to begin, would you describe your position at Santa Clara University, and, in general terms, the focus of your work?

Statman – I hold the Glenn Klimek Chair as the Professor of Finance at the business school of Santa Clara University. My work, broadly, is in behavioral finance, and behavioral finance is quite broad itself. Behavioral finance describes the financial behavior of investors, managers and consumers, such as saving, trading, and portfolio formation. It describes the interactions among investors, managers and consumers in financial and capital markets. And it describes how such interactions determine stock prices and trading volume. It also prescribes more effective financial behavior to investors, managers and consumers.
Macchia – Meir, what sparked your interest in behavioral finance? I mean, going back to your earliest decision to research in this area.

Statman – There was no behavioral finance when I started working on behavioral finance. I was attracted to it by what we know formally as ‘critical thinking,’ that is, putting theory and evidence side by side and seeing whether they fit.
An experience that sparked my early research relates to the distinction people make between income, such as dividends, and capital.

As students of finance know, Merton Miller and Franco Modigliani proved in 1961 that it is not rational to distinguish dividends from capital. I studied that in the late 1960s at the Hebrew University of Jerusalem. The theory makes sense. If an investor does not receive a dividend check she was expecting she can sell a few shares to generate ‘homemade dividends’ in an amount equal to what she would have received in a dividend check.

I came to New York in late August 1973 to study for my Ph.D. at Columbia University, just before the Yom Kippur War of October 1973 and the Arab embargo that followed. Oil prices zoomed, lines formed at gas stations and Con Edison, the utility company of New York, eliminated its dividend. The Con Ed shareholder meeting in 1974 was a riot. Elderly people screamed about the loss of dividends and some were ready to string Con Ed’s Chairman on a wire.

The facts of the shareholder reaction did not conform to theory. Why were Con Ed shareholders so upset? Why didn’t they simply create homemade dividends by selling a few Con Ed shares?

The discrepancy between theory and evidence stayed with me and later on, in 1980, along with my colleague Hersh Shefrin, I could see the connection between my observations and the work of psychologists Daniel Kahneman and Amos Tversky about cognitive biases and prospect theory, self control and regret.

I could find in that and similar work tools that not only enable me to see gaps between theory and evidence, but also bring the two closer together.

Macchia – Interesting. Meir, would you say that, then, in terms of what we describe as the field of behavioral finance, that you are the seminal individual in developing that field?

Statman –I was among the early ones but I surely was not the only one. The early group of economists and financial economist included Richard Thaler, Robert Shiller, Hersh Shefrin, myself and very few others .

Macchia – Thank you for clarifying that. I looked at some information about you on the web and , of course, I’ve heard you present. Wealth2k had the honor of sponsoring one of your wonderful recent addresses.

Statman – And I thank you for that.

Macchia – You’re welcome. This occurred at RIIA’s 2007 Managing Retirement Income Conference, and it was just a wonderful address that you gave. I know that some of the research questions that you focus on are actually specified on your website and I’d like to ask you about a couple of them. One of the issues that you deal with is the cognitive issues and emotions that influence investor behavior. Could you talk a bit about what you’ve uncovered in your research?

Statman – The cognitive biases have been uncovered by psychologists such as Daniel Kahneman, Amos Tversy, Paul Slovic and Baruch Fischhoff. What I have done is to ask whether these provide insights into the behavior of investors and managers. Let me illustrate with hindsight bias, a favorite of mine.

We all experience hindsight in our daily lives. It is the sense that what we know in hindsight we could have also known in foresight. The controversial example I’ll provide is not from finance, but from 9/11. Today, in hindsight, it is absolutely clear that all of the signs of the attack were obvious before 9/11 to anyone who bothered to look. But hindsight is not foresight. What we know at the end of a mystery novel we did not know a few pages before that end.

Once the stock market’s 2000 crash came it was absolutely clear that it was going to come. But if you actually look at the record you find that the famous Greenspan “rational exuberance” speech was in 1996, not in 2000. Look at pre-2000 issues of the Wall Street Journal and you’ll see that at any time there were people who said that the market would go up, and people who said that it would go down. What was clear in 2000 was not clear in 1996.

Hindsight causes us a lot of grief because it makes us feel stupid. “Why didn’t I get out of the stock market in 2000?” And yet hindsight gives people the confidence that can tell the future as easily as they can tell the past. So people try to time the market and usually end with more chagrin than joy. They finally decide to get out of the market in early 2003 when the market was at low and come back in 2007 when it is higher.

Macchia – You bring up something that I’ve found very interesting for many years, and I’ve often quoted the statistics that are published annually in DALBAR’s Quantitative Analysis of Investor Behavior, where the focus is on mutual funds, and the actual mutual fund returns that individuals realize compared to the S&P 500. What typically seems to happen is that over 20 year periods of time, the individuals underperform the index by perhaps 800 or 900 basis points.

Statman – The DALBAR numbers are exaggerated, but better studies show that investors underperform by 150-200 basis points per year because of poor market timing decisions. That is quite a lot. That is more than most financial advisors charge for their services. Advisors earn their fees easily if they only prevent clients from doing foolish things, like timing the market.

Macchia – Let me ask you about another topic that I know you’ve studied a great deal and that is insurance and annuities, and some of the reasons that they are arguable underutilized by individuals. What would your views be in terms of explaining why this occurs?

Statman – It is a fairly complicated problem, as you must know. Why don’t people annuitize their capital, when this seems the rational thing to do? After all, annuities provide income for life, eliminating the risk that we might run out of capital. I think that people stay away from annuities for psychological reasons. For example, people have difficulty with problems that involve money over time. An immediate annuity that pays $80,000 per year might cost $1 million. That annuity might be fairly priced, but it is hard for a man who sees himself as a millionaire to come to terms with the fact that today’s upper class million is worth no more than a mediocre middle class income of $80,000 per year.

Another psychological barrier is the distinction people make between capital and income. I mentioned it earlier in connection with dividends. People follow a rule of “consume from income but don’t dip into capital.” An immediate annuity is a clear form of dipping into capital and people are reluctant to engage in it.

Macchia – Let’s talk about another risk- the loss of one’s life. In the event of untimely death, life insurance is uniquely able to provide a large sum of money to beneficiaries in return for a relatively nominal amount in terms of the premium for the policy. It’s a big multiplier effect that over many years has provided the safe harbor for many families. It’s saved many families from financial ruin, yet most would agree that life insurance is underutilized and underappreciated. I have my own theories about why that might be and I’m wondering if you have some ideas?

Statman – I think that life insurance makes a lot of sense for many people such as those who are supporting children. Loss of life of parents is always a disaster for children but the disaster is compounded if money disappears as well. So why don’t all people who should buy life insurance buy it? There are really many reasons from, “I don’t think it’s going to happen to me” to “I don’t have the money for that.” People are motivated to buy insurance against hazards that are scary. Dying is scary but not as scary as dying of cancer or dying in an airplane crash. So some people are willing to buy insurance against dying of cancer or dying in an airplane crash while they are less ready to buy plain life insurance that covers these two causes of death and all other ones.

Macchia – Meir, I’m wondering if you think that there’s a role for life insurance for people who earn higher than average incomes, for whom, for instance 401(k) deferrals may be insufficient in order to set up enough retirement income. Life insurance in terms of say a variable universal life policy offers growth potential and the access to cash through policy loans is income tax free. Do you think that combination of benefits may make sense for some people who are looking for other, supplemental ways to create retirement security?

Statman – I wonder if combining elements of savings and insurance makes sense. Term life insurance covers the risk that an income earner might leave a family with no income at the early stages of life when wealth is low. Saving can be done separately. Separation of insurance from savings reduces complexity and there have been many stories about how complexity has been used to hide pretty high fees.

Macchia – Meir, I’d like to shift gears and ask you a couple of personal questions. These questions are a consistent theme in these interviews and I find them to be ones that generate some fascinating answers.
The first question is this: If I could somehow convey to you a magic wand and by waving this magic want you could affect any two changes relative tin they world of financial services that you wish to make, any two things at all, what would they be?

Statman – Good financial advisors are like good physicians. They know the science of finance as physicians know the science of medicine, but they also have a human touch. They listen, empathize, diagnose, educate and treat. Most physicians do just that, and so do most financial advisors. But not all do that. If I could have a magic wand I would use it to direct all the energies of advisors to their clients and all the energies of physicians to their patients.

Macchia – Next question: If you were not the Glenn Klimek professor of finance at Santa Clara University, but instead could hold any position in any other field, what would that be?

Statman – I really am one of those fortunate people who are in the right position. My work is varied and deeply satisfying. I get to write, do research, teach, interact with fellow scholars and practitioners like you, learning a lot from those interactions. Happiness comes with autonomy, contributions to others and the ability to develop one’s skills. I surely have all three. I pretty much control my time, have wonderful interactions with students, colleagues and practitioners, and I always push myself to examine new problems and engage in new projects.

Macchia – Not a bad life.

Statman – Not a bad life at all. I could have enjoyed a similar life as a scientist in many fields but surely not as a politician. Politicians must bend the truth to satisfy constituents. I would find it difficult to do.

Macchia – Well, you clearly made the right choice. I noticed that you didn’t say psychologist.

Statman – No, I don’t think that I would want to be a practicing psychologist. I don’t think that I would want to be a practicing financial advisor either. Advisors get a lot of gratitude from investors, and my sense is that the best clients are like my best students. I would enjoy educating them. But I don’t know if I would have been able to keep my cool in meetings with clients who complain that while they have done okay, Joe, their neighbor, has done better. I would probably say something that would make them clients of somebody else.

Macchia – I love your answer and here’s the last personal question: You’re 60 years old. I’d like you to imagine your own retirement in its most conceivably perfect form, where will you be and what will you be doing?

Statman – I have a boring answer, I’m afraid. I’ll be right here where I am and doing exactly what I have been doing for as long as my body and mind allow me. More generally, I see two groups of people. People like me who answer quite truthfully that they would retire only when they die and people who choose to retire at 62 when they can qualify for social security. I understand that different people have different circumstances and preferences but I feel sad for the second group.

Macchia – Your answer is remarkably similar to the one that I got from Moshe Milevsky. What came through to me in his answer was the passion that he has for teaching. He said that he wants to be teaching until his last moment. You didn’t say exactly that, but is it similar to you in terms of the teaching?

Statman – No…I wouldn’t say that. I think that teaching is satisfying, and I enjoy it. There is a wonderful sense when you leave the classroom and you see in the eyes of the students that they have learned what you were trying to teach and found it useful and stimulating. But teaching can become routine. I like to find and propagate new ideas. When I was little my mom would say, “Whatever people say, Meir, you must say the opposite.” She would say it with equal parts of pride and exasperation. I was a generally agreeable child and I’m a pretty agreeable adult today, but I continue to say, “Wait a minute. They say that this is true, but perhaps they are wrong.” There is special joy in overturning accepted truths. That joy animates me that I hope I will never lose it.

Macchia – I hope so too. And thank you. You just made me feel better about my 7 year old son’s future.

Statman – Exactly. Don’t raise conformists. By the way, I don’t know if you agree or if it has room in the interview. I think that parents today are fearful about the future and raise their kids in a regimented way that reflects that fear. I am optimistic about the future. I think that parents, I am one, need to lighten up, listen to kids and guide them with a lighter hand.

Macchia – That is really good advice. I’ve recently read Walter Isaacson’s wonderful book on Einstein. Einstein is someone who I’ve read about and is a personal hero of mine for many reasons. Einstein’s inclination to always challenge conventional wisdom, challenge authority and be an independent thinker is the notion that you’ve been describing. It certainly did well by him.

Statman – I admire Einstein even though physics is beyond me. I like science but I’m especially interested in science about people, such as biology and neurology, not in science about the physical world, such as geology or physics.

Macchia – I don’t know if you perhaps have 5 more minutes that you can give me for the exploration of another topic. This is in regards to the research that you’ve done, which I gather is a favorite subject and I’m interested to know, that is researching the investment performance of companies that are admired versus despised. You’ve recently co-authored a paper on this and I’m sure it’s not the first paper. How did you get on this topic and what did you find out of the research that you did in this area?

Statman – I started with this project many, many years ago. In fact, the first Fortune survey of admired companies appeared in 1983 and I read it and said, “Wow. Let me check if the most admired companies provide the highest stock returns.” My guess was that they provide the lowest returns because investors become enamored by admired companies and push their stock prices too high. That is what I found later in my research. But what is generally true is not true with every stock every day. In 1983 I put $5000 into 3 stocks that were least admired in the Fortune survey. I held them for a few months, maybe a year. Their performance was absolutely terrible. Eventually I managed to find the courage to realize my losses and move on. It surely taught me a lot about diversification and about the difference between short time horizons and long ones.

Macchia – Meir, I can’t thank you enough, for taking so much time, being so forthright in your answers and providing so much insight. This has been a real treat for me.

Statman – You are very, very kind. I really enjoyed speaking with you and hope that we will continue to keep in touch.

©Copyright 2007 David A. Macchia. All rights reserved.

EBRI’s Dallas L. Salisbury to be Featured in Leaders & Innovators Interview Series.

dsAn interview with Dallas Salisbury, President & CEO of the Employee Benefit Research Institute (EBRI) will be appearing soon as part of the Leaders & Innovators series.

EBRI is an unbiased research organization whose stated mission is to contribute to, to encourage and to enhance the development of sound employee benefit programs and sound public policy through objective research and education. EBRI is one of the 25 most frequently quoted “think tanks” in the world.

Salisbury joined EBRI as its founding in 1978. He is regularly featured at Congressional and Commission hearings, and in print and broadcast media around the world.

Salisbury assists as a member of a number of commissions, study panels and editorial advisory boards. He is a Fellow of the National Academy of Human Resources and a member of the Board of the NAHR Foundation, the Fidelity Research Institute Pyramid Prize Advisory Board, the Commission on a High Performance Health System, the Board of the NASD Investor Education Foundation and the Board of Advisors to the Comptroller General of the United States, the NACUBO Human Resource Quarterly Advisory Panel, and on the GAO Advisory Group on Social Security and Retirement.

He has served on the Secretary of Labor’s ERISA Advisory Council, the Presidential appointed PBGC Advisory Committee, the Board of Directors of the Society for Human Resources Management, the U.S. Advisory Panel on Medicare Education, and the Board of Directors of the National Academy of Social Insurance.

Salisbury has been honored with the Award for Professional Excellence from the Society for Human Resource Management, the Plan Sponsor Lifetime Achievement Award and the Keystone Award of World at Work. Dallas was a delegate to the 1998, 2002 and 2006 National Summit’s on Retirement Savings, and the 2005 White House Conference on Aging.

Salisbury has written, edited and lectured extensively on economic security topics, including 24 books and 129 book chapters and articles. His most recent books are: “Retirement Security in the United States: Current Sources, Future Prospects, and Likely Outcomes of Current Trends”, “The Future of Retirement Income in America”, “The Future of Social Insurance: Incremental Action or Fundamental Reform?”, “IRA and 401(k) Investing” and “Managing Money in Retirement”.

Prior to joining EBRI, he held full-time positions with the Washington State Legislature, the U.S. Department of Justice, the Employee Benefits Security Administration of the U.S. Department of Labor, (formerly known as the PWBA) and the Pension Benefit Guaranty Corporation (PBGC). He holds a B.A. degree in finance from the University of Washington and an M.A. in public administration from the Maxwell School at Syracuse University.

Interview with Chuck Robinson: Retirement Income Czar at Northwestern Mutual Cites Misalignment in Conventional Approaches to Income-Generation; Sees Need to Create “Marginal Utility” for Retirees When it Really Matters

8308Macchia – 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


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 ( 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.

Interview with ING’s Harry Stout. President of US Retail Annuity Business Cites Transparency as Key to Sales Growth; Predicts Fixed and Variable Annuities to “Harmonize” in Terms of Regulation, Selling Practices, Disclosure & Licensing

hsHarry Stout heads-up the $80 Billion Retail Annuity Group of ING. He is exceedingly aware of the long-term nature of annuity contract guarantees and has focused ING on managing risk “,…..very intelligently and very aggressively to make sure that you honor all of the economic policies and guarantees that you have in the contracts that you offer.” Stout believes that larger insurance organizations are inherently advantaged in terms of their potential to successfully manage complex financial risks.

In April of this year Stout moved aggressively to institute suitability standards for indexed annuities. This is in keeping with his long-term vision that fixed and variable annuities will “harmonize.” I wrote about this action in several months ago.

In the past I’ve publicly cited ING as a company that has consistently placed a high priority on the interests of consumers as evidenced by the comparative high quality of its annuity contracts. From my years of observing the company I never saw ING seek to boost its short-term sales by either compromising on quality or catering to agents and wholesalers seeking the highest commissions.

Macchia – Harry, It means a lot to me that you could do this. Thanks again. Let me begin by asking you to describe your title and the specifics of your role at ING.

Stout – Sure, I’m President of the US Retail Annuity Business Group and I have responsibility for the profitability, sales and management of all of ING’s variable and fixed annuity sales to retail outlets throughout the US.

Macchia – That’s obviously a very significant role and one that you would imagine would only grow in importance as the Baby Boomer retirement thrust begins to take hold. As you think about the Boomer retirement opportunity, Harry, how do you see the role of annuities and insurers specifically going forward? What’s your outlook on the viability of insurers in terms of reaching their potential in this opportunity?

Stout – I think that the products that we offer to consumers hit the sweet spot for so many of their retirement needs. There’s just no doubt about that. In terms of my outlook, I think that my outlook is tempered by the fact that our products are perceived in the financial press as being so complicated and so very expensive that consumers should not purchase them, when, in fact, an educated advisor will take a look at the products and the qualities and benefits that they have, and realize that these products fit very nicely for a portion of Baby Boomer savings or investment dollars.

Macchia –As you may know, you probably do know, much of the effort behind this blog is devoted to an exploration of just what you talked about, Harry. It’s the idea of your optimism being tempered by a prevalence of negative perceptions around insurance and annuity products. I wonder if part of the reason that we are where we are is that the very specific way the industry has fired back when criticisms have been levied against it. It’s responded with statements to try to show that perhaps what was said in the press was inaccurate or misleading, but to a large extent there has been no concerted efforts to address the sometimes legitimate criticisms that are foundational and seemingly intractable, and which lead to the bad publicity. I wonder if you buy into this and if you believe that there are some things at that level that need to be addressed before the industry can realize its full potential.

Stout – To tell you the truth, David, I don’t know if it’s as black and white as that. I think that the reason that our industry is not growing, say beyond the rate of GDP, despite the large Boomer population segment coming to fruition with their needs, I think it’s a combination of a number of issues that you described, while at the same time I think that it is a number of consumer factors including reluctance of the Boomers to want to deal with their retirement.

I don’t even know if I want to call it retirement, it’s just their livelihoods and their financial well-being as they age. I think there’s a combination of consumer awareness as well as a number of the industry issues that you’ve described.

Macchia – I agree. I think about consumers, it’s easier for them to avoid addressing these difficult issues. But I think a lot of it comes down to the advisors. I know you’re responsible for variable annuities, a very important product line.

When I look at the VA marketplace I see a very unique product which offers many benefits to consumers, but one which roughly four-fifths of advisors shun. Don’t you think that it really starts there, with the advisors, with reformatting their thinking so they can get a more accurate perception of how these products can be beneficial?

Stout – Yes, I do think so. I think that there’s a fairly broad perception that we’re still selling the first generation of variable annuity products and that a lot of advisors really haven’t taken the requisite time to take a look at the products that are offered, the guarantees, the options that are built into these products and how they fit in terms of their use in planning the financial futures of their customers.

There’s definitely an effort there of having education and awareness, and today I think a lot of the advisors are simply very, very busy. They’ve got a tremendous amount of things going on in terms of their practices. They really need to take the time to take a look at what these products are all about and the value that they have to offer.

Macchia – Is this not a challenge more of communications than product? Is it not an urgency to expand people’s thinking and do a better job of conveying about the needs based-benefits that the annuity business offers?

Stout – Well, I think it is a communication and education effort. There’s no doubt about that. I think that in the last number of years the number and complexity of our products’ benefits has increased substantially. If you’re going to be in this market there’s a significant element of education that you need to take on, and it has changed a lot year to year.

I think we have a communication and an education effort, but fundamentally I believe that what we are selling is very, very good and dips again into the planning for the financial futures of so many of the aging Baby Boomers.

Macchia – The popularity, Harry, of guaranteed benefits in VA contracts is absolutely clear. I want to ask you how products morph overtime and what the implications may be.

What we’ve seen is the VA take on characteristics more and more of a fixed annuity. Over the past 10 or 12 years we’ve seen fixed annuities arguably take on the characteristics (for instance, equity linkage) that you typically associate with variable annuities. As these two product lines tend to morph and come closer together, what do you see are the implications in terms of the retail landscape and also potentially the regulatory landscape?

Stout – I believe that success for those companies involved in the manufacturing of the annuity products will mean that they need to offer both fixed and variable products, and have expertise in both areas. That’s going to be critical on a go -forward basis.

I agree with you. I think that the markets, to a certain extent, are harmonizing and moving together. Along with that I believe that regulation, selling practices, disclosure, licensing…. all of those key elements of the sales process are going to begin to harmonize and look more and more like each other. And the prior regulatory schemes for fixed and variable products will change. I think with recent initiatives and commentary by the NASD and the NAIC that you can see it happening.

Macchia – I saw ING show some real leadership in this area when you, not long ago, announced suitability processes for the purchase of fixed annuities. What went into your thinking in making that decision?

Stout – Well, David, I think this action along with a number of other actions that we’ve taken is important. We’ve tried to work over a 24 month period to begin to harmonize our fixed and variable annuity offerings, and so suitability, disclosure, these are all items that we’re working on to make the two, become more and more alike in terms of how the business is conducted.

Macchia – Harry, I heard you deliver an address at a NAFA conference in April. You were very articulate, in general, but very compelling on the point of larger companies having some intrinsic advantages as products become generally more complex, and that a greater level and a different type of resource set is required to be successful.

For instance, you mentioned financial engineering around guarantees and some of the risk management aspects of annuity products. I remember you talking about the staff of financial engineers that you have and it made me think that viability going forward, to some extent, may favor larger companies that are able to bring this level of resources to their enterprises. Do you fundamentally agree with that?

Stout – Yes, I do. I’ll cut through it with a very simple approach. The way we try to manage our business at ING is that recognize that we live longer than the policy owners that we insure.

If you take that as an approach, what you want to do is manage risk very intelligently and very aggressively to make sure that you honor all of the economic policies and guarantees that you have in the contracts that you offer. To do that I believe that organizations that are larger, who have larger balance sheets, who have significantly expanded their capabilities and competencies in the risk management area can take on, manage and diversify risk in a way that’s going to generate these long term benefits.

Along with that, David, I just believe that this is going to be more and more what this is all about. We’re really helping an aging demographic to risk manage their incomes and risk manage their retirements. The products that we have to offer are really fundamental to that process.

Macchia –Harry, as the blog has grown and has been the beneficiary to more and more contributions by smart people like you, certain themes seem to be repeating. One of the themes is that in terms of the insurance industry’s growth potential that what may hold it back, or what may be the key to igniting just a tremendous amount of growth in the future, is whether or not the industry confronts the challenge of providing a greater degree of transparency into its products.

For instance, Moshe Milevsky was very articulate on this point, not only calling for transparency, but even a mark to market for all types of insurance products, which is certainly a very aggressive vision. Others including Jeremy Alexander have said that transparency is going to be a real key to the growth formula going forward. I’m wondering if you agree with this assertion.

Stout – Yes, I very much do. I personally do. I think that as the demographic ages and more and more consumers look to purchase the products, they are going to want to really understand clearly what they’re buying, what the benefits are and what the costs of those benefits are.

I think over time this whole subject of transparency and being able to see clearly what you’re paying for in terms of the various benefits that you’re getting is going to be key.

Macchia – As transparency becomes more real, people are able to see more clearly into the cost structure of products. The pressure then is to reduce compensation. I wonder if you believe, looking 5 or 10 years down the road, in terms of how intermediaries are compensated on annuity products, that we may see something that takes root that looks much different than today. Do you think that’s a possibility?

Stout – I think that if we talked about advisor compensation that you could have a very lengthy discussion, a philosophical discussion about how individuals should be paid. I think that we have enough different compensation structures that are available for the financial advisor of today that we can accommodate almost anyone’s particular need.

I think that on a long term basis consumers are not going to be willing to take significant portions of their assets and to put those assets into a product or service without having the advice of an advisor. Therefore, we as an industry are going to miss a key part in how we deliver products.

We need to make sure that advisors are appropriately compensated for what they do. I don’t think that advisor compensation is going to be a key part of what happens on a go forward basis, David. I think market forces over time will determine what the appropriate level of that compensation is, but that it’s a key element for almost all of the carriers going forward.

Macchia –At Wealth2k, we’ve staked a large bet in terms of trying to create technology that will help the advisor become more successful, more productive and able to communicate his or her services to a greater volume of people, prospects. This comes out of the belief that, among other things, that the Baby Boomer cohort is so large that advisors are going to have to necessarily touch more people and interact and provide guidance to more people than they do currently. I’m wondering if you see it this way?

Stout – I would say this: I think that there’s going to be a segmentation of the marketplace based on the amount of investable assets that an individual has because with those individuals with smaller amounts of assets it’s going to be very difficult to provide face-to-face advice on a long term basis.

I think that’s a difficult proposition. I think new techniques are going to come to the technology base to be able to provide service to segments of the population. I do believe that they need service and they need the advice of a financial advisor, but I think there are going to be different models to reach them. I think those individuals with significant amounts of assets will continue to receive that face-to-face advice from an advisor, but I do think that new models, technology based, will emerge to help serve the broader mass of the marketplace.

Macchia – I’ve stated many times, Harry, my personal belief that given the high stakes nature of the Boomer retirement opportunity, and given the tremendous ongoing efforts in terms of the development of new products and processes, that while all of that is very important the enduring winners in Boomer retirement won’t be those companies that necessarily have the best products, but rather will be those companies that ate most effective at compliantly communicating their value to a large and fluid audience of consumers. I’m wondering if you buy into that belief.

Stout – Well, you know, I might look at it a little differently than you David. I think what I would look at is the process by which the industry delivers its product to consumers has to be better, has to improve. I think there are a number of investments being made by a number of organizations throughout our industry to improve the quality and the customer experience. Now, I think that one aspect of that experience is communicating key information about products and services rendered, but there’s got to be a better way for us collectively to be able to sell our product to secure the necessary signatures, disclosures.

I think there’s so much of an improvement there and I think that that’s another reason why these products are perceived as being harder to sell and haven’t reached their market potential because there is so much regulation and requirement around them. That’s okay; I’m fine with that, but I just think that there’s got to be a way to package and deliver what we offer in an easier and better way.

Macchia – So, for instance, if simple straight through processing were a reality right now for all annuity products how would you see the landscape different?

Stout – I think it makes the whole purchasing process so much easier, and I mean, we don’t have consistent standards on straight through processing at this time, although there is significant effort now underway with the regulators and the industry to come up with a way to do that. I think that’s got to help tremendously.

I go back to the days when it used to take you… look at the mortgage business; 60 to 90 days to get a mortgage, and now if you have all of the requisite forms and disclosures you can do it in several hours. I think that over time we’re going to have to condense all of the requirements that we have, the regulatory requirements that we have, which protect consumers and protect all parties in the process, if you will, and find a way to deliver that faster, easier and better. I think if you do that then we’ll gather more sales than we currently do.

Macchia – Going back to themes that emerge from the blog, one of them that I hear consistently Harry, is that a product sale designed to satisfy the long term retirement need is not likely to be what’s successful in the future, but rather positioning products in a larger context of a true solution designed to deliver long term inflation adjusted income. Do you see that as likely, or do you believe strongly that the product itself can be the answer?

Stout – That’s interesting. That’s a very, very good question, David. I don’t know if the product itself…I mean, I think that if you look at…if we were to have a conversation today about retirement risk management or what’s called longevity risk management and helping consumers be able to get their income needs met over a long period of time, I think that the advisors that are out there and the companies that manufacture products are probably going to have to become much more aware of all the needs that this growing and aging population has. Along with that goes design their delivery and their products to meet those needs.

An example would be the real significant need for funding healthcare as we age. The products may change to have more of an element that addresses that need. That’s just one example of a number that could be here. So, what I’m saying to you is that in the end I think that it’s a combination of product delivery and a really significant thinking about all of those aspects of retirement risk management.

Macchia – Harry, you’re heading-up a strategically important and very large business at ING. I know how seriously you take that role. If there’s anything that worries you that would tend to make you lose a little sleep at night about things that could happen, about things that could go wrong, what are the things that would worry you?

Stout – I think that I look across the landscape today and there’s significant protections built into our industry for solvency and for the pricing and delivery of products. So, I feel pretty comfortable about where we stand and I think that on a go forward basis the name of the game is going to be risk management on the part of companies.

The only thing, I guess, that would worry me is if we get aggressive players who don’t properly risk manage the guarantees that they are offering that could cause a hiccup for our industry, and I don’t think anyone wants that. I think that for all of us the time and energy that we put into properly managing the risks associated with the products we sell is the name of the game going forward. We need to be phenomenally responsive to the needs of the market while at the same time making sure that we can manage and diversify the risks that we’re taking on.

Macchia – Back to Moshe Milevsky, he was a critic of variable annuities for a long period of time, owing to the fact that he thought that they were excessively costly. But with the emergence of living benefits Moshe took a good hard look at the variable annuity again and came up with a very different conclusion that you may be aware of. And that’s arguably that insurers are providing consumers potentially too much economic value relative to what they are charging for guaranteed withdrawal riders. I wonder what you think about that.

Stout – I’ve seen his comments. I’m aware of them. Again it gets back to the overall premise that I’ve commented on throughout our conversation today. That is you’re offering a guarantee in the marketplace. You ought to be sure that you’re going to be there to honor that economic guarantee when the time comes.

I think that the discipline that you approach the risk management issue with and the thoughtfulness of how you present your guarantee is key. I think that we do offer significant benefits to the consumer and I think that we are able to do that based on our size and our ability to manage and diversify risk. So, I think we’re doing a very good job of doing it now.

Macchia – I’d like to make a transition to some questions that are more personal in nature if you don’t mind. The first one is kind of like the power of God being conveyed to you. If I could give you a magic wand, Harry, and by sweeping this magic wand you could convey any two changes you wish, anything at all, in the world of financial services. What two things would you change?

Stout – In terms of what I would change, I think that the first would be that individual consumers had a greater awareness of the risk that they are taking on at retirement and the risk associated with providing themselves with a level of income that they can’t outlive.

If there was somehow the ability to do a mass education effort with consumers to get them to truly see the need that they have, I think that would revolutionize what we do because I think that we’d have a much larger market for the products and services we sell.

I also think that…….I think the second item is that we’ve got to find a way to streamline the regulatory process such that we are able to meet the needs of the consumers that we’re selling to. We need to have the requisite sales practices and disclosures in a much more compact, cost effective way.

An example would be the prospectus that we offer with our variable annuity products. There have to be more and more meaningful and effective ways of disclosing and communicating in our products other than just exposing the consumer to significant amounts of paper.

Macchia – Alright, let me ask the next personal question: if you were not the President of ING USA’s annuity business, and you could instead have any job in any other industry, what would you choose to do?

Stout – I think what I would choose to do is to do a national call in radio program on financial issues.

Macchia – So you would be the host answering questions?

Stout – Yes.

Macchia – Interesting. What about that do you find attractive?

Stout – It’s always something that I’ve wanted to do.

Macchia – Were you an actor in high school, or…?

Stout – No, no, not at all. I grew up in the Philadelphia area and one of my role models growing up was a gentleman that worked for the CBS television affiliate. His name was John Facenda. You may be familiar with John Facenda. He worked for NFL Films for years. He was known as “the voice of God.” I think that he stirred in me an interest in media, and in particular I think that the radio waves did very well for me. I think I would enjoy doing that.

Macchia – You are well spoken and poised, and I can envision you on television or video. Have you ever thought of doing any video presentations?

Stout – Actually I’ve done a little bit of work there, but I think personally I’d feel more comfortable behind the mic.

Macchia – Okay. Last question. I’d like you to imagine your own retirement in its most conceivably ideal form. What will you be doing and where will you be?

Stout – I think the ideal retirement for me is to have the ability to control my time, to do those things that I find most meaningful, be that volunteer work, be it travelling, be it time with my family.

I think the control over my time and my ability to do what I want to do is what I’m striving for in my own retirement. I love to travel, I love to spend time with public causes that I care about, and I love my children. I think that just the ability to do what I want, when I want to do it, that freedom to me is the most important thing. Because ultimately, I think, as we age I think we find more and more of that control over our time is the greatest luxury.

Macchia – Sounds like a pretty nice vision to me.

Stout – Thank you.

Macchia – I want to thank you because this has been most enjoyable and enlightening. Is there anything, Harry that I haven’t covered that you would like to get out in the interview?

Stout – No David, I think I’m fine.

Macchia – Thanks a million.

Stout – Okay great. Thank you very much, David. Take care.

Disclosure notice provided by ING:

You should consider the investment objectives, risks and charges, and expenses of the variable annuity and its underlying investment options carefully before investing. The prospectuses for the variable annuity and underlying investment options contain this and other information. You may obtain free prospectuses by calling your financial professional or 800-366-0066. Please read the prospectuses carefully before investing.

Annuities are issued by ING USA Annuity and Life Insurance Company (Des Moines, IA). Variable annuities are distributed by Directed Services LLC (Westchester, PA), member NASD. Both are members of the ING family of companies.

All guarantees are based on the financial strength and claims paying ability of the issuing insurance company, who is solely responsible for all obligations under its policies. Variable insurance products are subject to investment risk, are not guaranteed and will fluctuate in value. In addition, there is no guarantee that any variable investment option will meet its stated objective.

©Copyright 2007 David A. Macchia. All rights reserved.

Lincoln Financial Group’s Heather Dzielak to be Featured in Industry Leaders & Innovators Series

Senior Vice President, Heather Dzielak, heads-up the strategically important Retirement Income Security Ventures Group at Lincoln Financial. She is responsible for the strategic leadership of retirement income security strategy across markets, products and processes at Lincoln Financial. Dzielak reports directly to LFG’s COO, Dennis Glass. On November 13 of last year when announcing Dzielak’s appointment to lead RISV, Glass commented about her, “She is uniquely qualified to mobilize the company in the direction of its strategic intent, the retirement income security market.”

Dzielak is a dynamic leader with a bold vision. I look forward to exploring with her the progress the RISV group has made since its formation last year.

New Blog Excerpts Book Now Available for Download: François Gadenne’s Thought-Provoking Essays on the Future of Retirement and the Role of the Retirement Income Industry Association

Now, just in time for your Holiday weekend reading pleasure…
During the first-half of May, Francois Gadenne assumed control of this blog and created a series of essays that constitute must reading for anyone interested in Baby Boomer retirement and all implications for financial services. The essays combine to create a potent examination of issues that are important to many of my readers. Therefore, I’ve decided to create a book of Francois’ essays. I’m sure that you will enjoy it.

You may download the book at no cost by clicking here

Enjoy the Memorial Day holiday!

©Copyright 2007 David A. Macchia. All rights reserved.

Interview with Dr. Moshe A. Milevsky: Leading Financial Strategist Calls for Greater Transparency and Broad Secondary Market for Insurance Products; Cites Importance of Effective Communications in Retirement Income Business Success

moshe-milevskyI’m a lucky man. I’ve just returned from a spectacular vacation in Greece made one day longer due to a strike by aircraft controllers in Athens. Danke to the unhappy Greek controller for allowing my family and me to enjoy an unexpected and delightful day of sightseeing in Frankfurt!

My hearty thanks to Francois Gadenne. Thank you, Francois, for taking over this blog in my absence and delivering even more than I promised you would!

Now that I’m back I’ve got a big, big treat. One of the greatest pleasures I receive from my work at the blog is having the opportunity to interview so many world-class individuals, the “Leaders and Innovators” of financial services. I get to learn a lot, and so do you.

Moshe Milevsky is likely the world’s leading authority on the interplay between financial risk management and personal wealth management. His best-selling books, scholarly articles, public speaking appearances and consulting work made him well know to all who are seriously interested in the future of retirement income.

In this extraordinary interview, Milevsky addresses many timely issues including the need for a secondary marketplace for insurance products (well beyond the present life settlement market), the necessity for financial services companies to excel at communications, transformation in the variable annuity market, the need for greater financial literacy, and the prospects for life insurers in terms of Boomer retirement.

Milevsky also reveals some deeply personal insights which demonstrate his devotion to teaching… and warm weather! Enjoy!

Macchia – Moshe, you are an international authority on retirement issues, a PhD, an associate professor of finance at York University, a best-selling author, and Executive Director of the non-profit, Individual Finance and Insurance Decision Center and CEO of the recently launched QWeMA Group. You’ve also written over 40 scholarly research articles, the most prestigious business journals worldwide seek out your views…and you’ve just turned 40. For most people, that would be a lifetime of achievement. You however still have decade’s worth of life expectancy. What are your goals beyond that which you have already accomplished?

Milevsky –I appreciate all of the kind comments and I’m not really sure where to be constructive in terms of answering that question. My interests now lie in bringing together the very, very distinct fields within personal wealth management, which are the traditional asset investment management side versus the liability and insurance side of the personal balance sheet.

For many, many years these two fields, both academically and from a practical point of view operated on a completely different level with different language, different silos, different organizations. When you would buy your car insurance or your home insurance or even your life insurance, nobody asked you about your asset allocation and your risk tolerance, or whether or not you preferred stocks to bonds and what your retirement goals were.

One was an insurance discussion and the other was a financial discussion, and my overall philosophy is to bring these two things together and to have a comprehensive risk management approach to wealth management. In that area I think there is much, much work to be done. I’ve spent a lot of time focusing on annuities and retirement income and pensions. The fields of insurance, like long term care, disability, critical illness, UL, variable universal life, term life insurance, require a more rigorous and comprehensive framework, and I’d like to develop some more academic research into how to go about modeling that in a consistent framework.

Macchia – Interesting. Your answer leads me to recall a question that I’ve asked of a couple of previous interview subjects.

When I entered the life insurance business in 1977, the insurance industry pretty much controlled the pension business. It then seeded away those assets to the mutual fund complexes that approached consumers with an arguably better model in terms of greater transparency as well as the ability to create greater clarity and comfort for consumers.

I’ve often used the analogy that the life insurance business was then like a “black box.” People made purchasing decisions based upon their faith and trust in their agent, without truly understanding the product they were purchasing. I think that you could argue that in the intervening decades this hasn’t changed very much. I’m wondering if you feel that greater transparency is going to be a requisite in terms of the insurance companies and their products reaching their full potential in the income distribution phase?

Milevsky – Absolutely. In fact, I think I’ll take the transparency issue one step forward. It’s not just the matter of transparency in terms of the process and what you’re paying for and what it costs, but a transparency in creating a mark to market value of all your insurance holdings. Dare I say that a secondary market is needed for those same insurance holdings so that you can take a look at whatever you own and sell them at a market price if you don’t need those products anymore? That will increase the transparency as well because then you will have traded market values for these instruments, and you can make much better financial decisions with regards to them.

Contrast that vision with the current state of portfolio holdings and other assets. The black box of investments no longer exists; you can drill down to literally the stocks, the companies that you own. I think that’s what’s going to happen with many of the financial insurance products out there. Obviously, this is a controversial issue. For example, the whole topic of the life settlement business, a secondary market for unwanted life insurance. Open up the newspaper in Florida and you’ll see 12 different advertisements for seminars on how to get rid of your unwanted life insurance policy. Many, many people in the industry think that’s not good, a lot of insurance companies will say that they don’t like that trend, but I think that it’s happening and that’s another step in the transparency process. We have to rationalize pricing. I’m more of an observer than a participant in these markets, but I definitely think that transparency is a good way to describe it.

Macchia – Do you believe or could you buy into the assertion that insurers are going to have to come to terms with handling some short term pain in order to configure themselves for greater long term success?

Milevsky – I think so. In fact, one of the things that I observe is that at the same time that the insurance industry opposes certain developments quite vocally on one side of their mouth, on the other side they are actually developing the infrastructure, the subsidiaries and the ventures to capitalize for the event that they lose what they are arguing on the other side of their mouth. I think that’s an interesting development and they are prepared for the fact that they might have short term pain, but in the end they will be the ones gaining because they are the best entities equipped to manage the markets in mortality, longevity and morbidity risk.

Macchia – Moshe, I would like to ask you about some of the things you’ve said that I’ve read in various articles. I’ve heard you say that retirement is not just about asset allocation, it’s also, and very importantly also, about strategic product allocation. Is this something that you could elaborate on?

Milevsky – Sure. That’s something that’s very close to my heart right now because I’m actually writing quite a number of research papers and developing some intellectual property (IP) via the QWeMA Group to try to build on that. To position what I’m saying, imagine you visit any asset management firm as an individual or as an institution and you’ll probably be shown a beautiful pie chart with how your assets should be allocated amongst many different investments. You’ll have a little sliver of the pie chart that shows emerging markets and a little sliver that shows alternative asset classes and real estate and large cap/small cap value growth. You get this instruction sheet that tells you, “Here’s how you should allocate your assets.”

Right now, however, no one in the industry has that type of approach for the universe of insurance products. That is to say, you as an individual sitting down with someone who says here’s how much long term care you should have, and here is how much critical illness insurance, and here’s how much annuity, and here’s how much of a reverse mortgage you should allocate, and here’s how much life insurance, and most importantly here’s how it all fits with your asset allocation, human capital, personal balance sheet, etc.

What I’m describing is the same kind of thinking used for accumulating wealth for retirement. But when you start to withdraw money, and you have to create your own personal pension, I think it’s critical that we start to think in terms of product allocation and asset allocation combined.

Macchia – I’ve heard you make the analogy while discussing the example of withdrawing money for your own retirement, that you have the personal ability to buy out-of-the-money put options funded by selling out-of-the-money calls, but that most people can’t do that. They’ll need to look at packaged products to achieve the same sort of result. Knowing all that you know, what do you see on the horizon in terms of the evolution of packaged products designed to meet the mass market need?

Milevsky – I think that you’re going to see kind of a bifurcation occur in the way the industry approaches this. I know that when I talk to some of the large producers for some of the wire houses they listen to what I have to say about risk management and retirement income and they immediately have the light bulb come on in their head and they say, “Hey, if the first few years are so critical when you’re withdrawing money, why not buy some puts and fund it by selling calls?” And, “If longevity risk is such a big deal, then why don’t I buy a little bit of the out-of-the-money longevity option, essentially a deferred annuity that pays off if I get to age 95?”

They are financially engineering or creating the packaged products themselves, and they are coming to the realization that they have to do it. But, for many, many other people it’s impossible or just too complicated to manufacture these themselves, and for many smaller investors it becomes prohibitive from a transaction cost point of view. We’re going to see structured products developed that are meant as income vehicles as opposed to accumulation vehicles. It’s not going to be about an indexed linked note that accumulates for 15 years and guarantees you a sum of money. It’s going to be about products where the sum of money is given now or over 5-10 years and it produces incomes with certain guarantees. I personally think you’re going to see much more development in the structured market as a replacement for Define Benefit (DB) pensions.

Macchia – In terms of structured products filtering down to the mass market, when do you expect to see it begin, and what do you think the result will be for insurance companies in terms of potentially significant new competition?

Milevsky – It’s tough to predict these things but I can tell you that as one big company moves in that direction other companies follow very, very quickly soon after. You have to predict when is the first mover going to do it and then everybody else fills in the gap. I’ll give you an example, a case study. I’m a business school professor, so I live on case studies.

In Canada for many, many years we did not have any variable annuities. We had something similar called a Segregated Fund, but there were some important differences and none of them offered any guaranteed living benefits. We certainly didn’t have any GMWBs, GMIBs, etc. Remember that in the US you’ve had them for 6 or 7 years now.

Four months ago the first company in Canada launched the guaranteed minimum withdrawal benefit (GMWB) similar to what is offered in the U.S. within variable annuity contracts. It was Manulife. About four months later the second largest company here, Sun Life, announced that launch of the exact same thing. Another traditional fund company partnered with a Bank to offer a similar product and there will probably be one other insurance company jumping in very, very soon. Seven years we see nothing and then within a six month period everybody steps in.

I think that’s what’s going to happen with some of the innovation in structured products in the US. Wherein there are a number of traditional asset management shops that are thinking about it, and they are talking about it. They’ve been talking about it for years. This is not something new to them. As soon as one of them makes that final move and brings it to market, everybody else will step in. I think that’s what’s going to happen. When will this happen? It’s tough to predict, but my sense is there is going to be clustered. I wouldn’t be surprised if two years from now there are 12 companies offering a new class of products that didn’t exist two years ago.

Macchia –Your comment is very interesting to me, and I’m quite familiar with this copy-cat syndrome among insurers, and deal with it in terms of the technology communications innovations that are my focus.

But I want to go back to variable annuities and income benefits, which you just raised. For some time you were well known as a critic of variable annuities. I believe that you looked at variable annuities anew in the context of the newer guaranteed income riders. I believe that your research concluded that the insurance companies offering these benefits- or at least some of them- may not be charging enough money for the economic benefits that they provide through these riders. Is this accurate? Is this an accurate way of describing your conclusions, and, if so, what are the implications?

Milevsky – As any good academic will tell you about a subject they have written a lot of papers on, it’s difficult to summarize in one paragraph the entirety of the various research results. But the bottom line is, yes. For many, many years the imbedded guarantees and some of the protection features that you had within these products, in my opinion, were overpriced relative to the capital markets value of traded options.

In the language of financial economics we talk about replicating payout more cheaply. You can cook these things for less. In a sense you are paying more than the actual embedded value of the guarantees. This result was described in a number of research reports that I’ve written over the years which got widely cited, and I kind of lost academic interest to be honest in this whole variable annuity market. I’d gone away from this in the late 1999, early 2000 period saying, “I don’t get this whole market. It doesn’t make sense to me. Buy some life insurance. Buy a tax efficient mutual fund, hold on to it. What’s the point?”

Then literally 5 years later with the explosion of living benefit products I took the opportunity to look at these things again, expecting to see the same conclusions that I had seen 5 years earlier. The results were very, very different, however. The features now made more sense to me because they were made to protect against living as opposed to protecting against dying. The features in there were meant to create pensions, and many of us are losing our pensions. The features in there were essentially put options that matured over long periods of time, which are quite expensive in the capital markets.

I inevitably had to change some of the conclusions on these products because the features had changed. There’s actually a story about Prof. John Maynard Keynes, the famous economist. Apparently he was approached by reporters after he released some policy recommendation and they accused him of changing his mind on something. He had been against a certain policy and then had changed his mind in favor. The reporters said to him, “Professor Keynes you’ve changed your mind. Why did you change your mind?” His reaction was, “Look, when the facts change I change my mind.
What do you do?, he said to the reporter.

That was his response to the reporters. Obviously when referring to Prof. Keynes one has to be careful since he is in a completely different league, but I kind of feel the same way here. For many years reporters and writers would call me to basically get negative quotes about variable annuities. Yes, some of them would call with an open and honest intention to discuss the pros and cons of the product, but many others simply wanted to get a live quote from the “professor and researcher” who found that VAs are overpriced. More recently these same people call to discuss the new generation of guaranteed living benefits and now I have to say, wait a minute, you’re talking about the exact opposite exposure here; longevity risk. This is income for life. This is not easy to hedge individually. In fact, call up your favorite OTC put-option market maker. It’s a lot more pricy to replicate. It’s not easy to quantify and do proper risk management. Many of the popular financial writers are still thinking in terms of the old products and guarantees. I finally decided to write an article about this and confess my current frustration, and let it go from there. And that’s what I published in January in Research Magazine.

Macchia – The insurance companies have put a lot of financial engineering behind the development and hedging around these riders. Do you think they are just making a big mistake?

Milevsky – No, absolutely not. I can’t use the word mistake to describe any of this. I think that many of them are making strategic decisions based on a careful cost/benefit analysis. For example, if living benefit riders on a variable annuity generate only 2% of your company’s revenue, and you have exposure to the opposite mortality and morbidity risk then no matter what happens in this particular market it’s not going to impact your overall firm exposure. They can be more lax about hedging out every single possible path. They can be more relaxed about risk management, after all they have natural hedges in place.

On the other hand, if you’re a small company, and this is generating 70% of your revenue, this is starting to pose some systematic risk, especially if you are using static assumptions about policyholder behavior. Practically speaking, it is the stock analysts that have to be weary about profits and earnings. The credit market analysts have to be concerned and the regulators have to be alert.

I know from looking at these things that they are very complicated to hedge. They depend on policy holder behavior, who is going to lapse, when are they going to lapse. They depend on competing products. If somebody comes out with a better product, people are going to lapse, but if they don’t then they are going to hold on. It depends on education, it depends on the intermediary. This is not like put options that you buy on the CBOE where they are commoditized yet, so there are a lot of assumptions there.

Bottom line is I’m wondering, are people getting this right? That’s it. The recent overseas experience with similar products has implications in the U.S. It’s what happened in the UK with Equitable Life. It may be a personal bias, but I was giving a lecture at the London School of Economics a few years ago when the Equitable Life fiasco blew up. This was the largest, most venerable, most prestigious insurance company in the UK having sold guaranteed living benefits. In the year 2000 they literally had to shut down. They were declared insolvent soon after because essentially these guarantees matured in the money and they didn’t have the risk management and hedges in place to cover 100% of the promised payouts. Anybody that lives through that has an obligation to ask how do we make sure that this doesn’t happen in the US? One of the ways is to just make sure that you are vocal and ask questions about risk management practices. I don’t want to be a Cassandra, but at the same time the more that we remind people due diligence is also about risk management, the less the chance this is gong to happen. If insurance companies are selling instruments that are supposed to transfer risk from my personal balance sheet to their corporate balance sheet, I want to understand how they are managing that risk. The answer: “We have scale economics and use the law of large numbers to diversify risk” doesn’t cut it for me.

Macchia – Now, I’d like to ask you about something different. That is the work that led up to the awarding of a patent to you and Dr. Peng Chen. I’m wondering if you could talk about the work that you did that led to that patent, and how you see that patent unfolding now to help financial services companies. How do you see the patent actually impacting the marketplace?

Milevsky – Sure. To be absolutely clear and up front, this is a patent that I developed that was transferred over to Ibbotson Associates, so although I am the inventor, the co-inventor with Dr. Peng Chen, they are the ones that are taking the lead in terms of business and business development, and you should probably ask then a lot more than you should ask me what their strategic plans are.

The research that had led up to it was the very simple question that I was asked almost 10 years ago: What is the most optimal allocation to annuities? How much of my money should be annuitized and how much should not be annuitized? How much should be left liquid? This is a very fundamental question in economics. Asset allocation and portfolio choice has been studied for 20 or 30 years, but nobody ever asked the question in terms of insurance products. The questions were always posed: How much international exposure should you have? How much bonds versus stocks? How much cash versus how much invested? Nobody actually looked at how much should be annuitized.

The research that I had done more in a theoretical point of view was to try to determine an optimum and what kind of framework do you use in order to develop this optimum. That’s kind of the theoretical work behind it. My work with Ibbotson over the years was about trying to implement that in a way that could be understood and used by individuals. The question then got flipped around: What kind of questions do we have to ask people so that their answers will lead us to an optimal allocation of annuities versus non-annuities?

Macchia – There are not that many individuals like yourself who stand at the top of the food chain in terms of understanding all of the intricacies and economic factors and issues that will impact peoples’ retirements. In your view what is the toughest concept for ordinary investors to understand when it comes to their retirement?

Milevsky – I think that they are a collection of behavioral-almost fallacies or behavioral mistakes that people make, and they all have to do with very long and uncertain horizons. I believe that when you tell someone to plan for something that may last only 5 years, or that may last as long as 35 years they then commit a series of mistake behaviorally that all relate to the fact that they don’t’ really know hold long they are going to live. Those mistakes can then become things like not planning to have income for the rest of your life because you don’t know how long it’s going to last. Or a misunderstanding of the impact of inflation. Or not understanding the impact of healthcare costs and what that means in the long term. Or how markets behave in the long run versus the short run. If I can summarize it, the biggest misunderstanding is how to handle horizons that are stochastic.

Macchia – Moshe, a great deal of my work involves the development of the next generation of communications technologies.

In part, my investment in this area derives from my sincere belief that while products and processes will be important in the future, there will be a different driver that will, to a large extent, determine a financial services company’s future success in the retirement income business. I mean by this that the greatest success will not necessarily come to an organization with the “best” product, but rather will come to those organizations which are the best at communicating their value to a large and fluid marketplace.

I believe this is true for many reasons including my own substantial practical experience, as well as the fact that the Baby Boomer cohort is so vast, and the number of financial advisors arguably insufficient to meet all of their needs, that only by using communication tools effectively will companies be able to successfully engage large numbers of consumers. I’m wondering if you can buy into what I’m saying.

Milevsky – I do. In fact I’m really resonating with the first comment that you made that it’s not necessarily the best product that’s going to win. I’m seeing that now, and it would be nice to have kind of a coherent framework to understand why it’s always going to be the second and the third best product that’s going to win.

It might very well be because of their ability to communicate their message better as opposed to the first one that put all its effort into product development and forgot about the second and third steps which are to make sure that people understand this and to communicate it and people absorb it. I see a lot of wholesalers in action that do these seminars and I get to listen before and after to some of the folks that get up and pitch various products. I see that the ones that are able to communicate in an almost simplistic way what a particular product or strategy does end up winning as opposed to the one that comes in with the very long list of product features and kind of confuses people.

Even though it’s really a better product they are not the ones that get the business. It’s almost as if I scale back on the bells and whistles and focus on the 2 or 3 really good things about your product and put the rest of your effort into explaining this to individuals as opposed to the other way around. I really do resonate with that. It’s only with time that I’ve come to appreciate how important the communication part is.

As a graduate student at university you never really appreciate or are taught the importance of clear communication. A professor with a Nobel Prize standing at the black board scribbling with chalk is a genius. It doesn’t matter if he can communicate or not. It’s the thoughts that count. It’s the papers that they wrote. It’s the products that they have helped develop. In time I’ve realized that it’s much more about communication, inspiration and clarity of ideas than it is about the actual development. It’s certainly a combination of the two. I do resonate with your earlier comment.

Macchia – Moshe, I’d like to ask you about the non-profit organization for which you serve as Executive Director, the Individual Finance and Insurance Decision Center. Could you describe the work that you’re doing there and what you’re aiming to achieve?

Milevsky – Sure. The IFID Center is a not for profit that is currently housed at the prestigious Fields Institute in downtown Toronto. Some of your readers might not recognize the Field’s Institute but will have heard of the Field’s Medal. It is a prize that’s awarded every few years to the best mathematicians in the world, similar to the Nobel Prize.

The Fields Institute has incubated and housed The IFID Centre for the last seven years. What we tried to do is to create a network of academic researchers who are interested in personal financial problems. Helping individuals make better decisions in their financial wealth from a distinctly mathematical point of view. We’ve done projects over the years, many of them funded by government agencies, increasingly lately by actual institutions, and many companies in the financial services sector.

They will approach us with a question such as: Is it better for our clients to take on a variable (adjustable) rate mortgage or a long range fixed rate mortgagee? We’ll do a statistical analysis, we’ll develop mathematical models and we’ll tell them things like 80% of the time you’re better off doing that versus this. Or, here are the conditions under which the decision makes sense relative to other assets and liabilities on the balance sheet.

As another example, companies will ask us whether it is better for our clients to have term life insurance or whole life insurance or some combination thereof, and we will again look at the underlying mathematics and analytics and give them rigorous recommendations. That’s what we’ve been doing over the years. We have an affiliated network of researchers, some of them at my own institution, York University, some of them in the US, South America and Australia. They are literally across the world at this point. They collaborate with us on a research projects, present results of their research at seminars and the end result, the output, the deliverable is a white paper or presentation that’s placed on our website and that’s available free for all to the world to download- which then generates its own research.

Macchia – Speaking of research, you have collaborated with Research Magazine on what’s called Retirement Income University where your- and these are by the way extremely well written- efforts to help advisors focus in on some of the insights that they may be lacking. What led to Retirement Income University and what’s your aim with it?

Milevsky – One of the editors (Gil Weinreich) of the magazine contacted me more than a year ago and asked me whether I’d be interested in writing a column for them on the subject of retirement and retirement income. At the time I had a lot of commitments and it was hard to commit to do this on a monthly basis. Gil was very persistent and I would get a weekly email from him asking if I would reconsider and I met with him.

Finally, I realized that his might be a good thing to disseminate some of my ideas beyond just publishing research papers on the website at the IFID Center. What I’m trying to do with the column is to cover systematically what you need to know to be an intelligent practitioner in the field of retirement income planning. I’ve got this list of concepts that I will be elaborating on one month at a time that I think enhances people’s knowledge on retirement income from a slightly academic point of view. To me it’s a bit of a curriculum, where at the university you spend 2 or 3 weeks in a given course and you systematically cover another topic. That’s what I’m trying to do in the column. I believe that this month’s column is on inflation. What do retirees experience in terms of inflation? How does it differ from the rest of the population? Next month I’m looking at the subject of longevity risk, and we’re going to talk about long term care and living benefits on annuities, reverse mortgages, what do people need to know about Medicare, Medicaid, what you need to know about a particular topic condensed to 2000 or 3000 words. That’s the agenda for the next few months.

Macchia – I see. Let me ask you about what’s happening at ground level in terms of retirement income distribution solutions. The way I observe it, and often make the analogy to describe what’s occurring, is that people are coalescing around philosophies that I can almost compare to the various religions that we have in the world. There’s the religion of time segmented or time weighted strategies, there’s the religion of lifetime annuitization, the religion of systematic withdrawals, the religion of combining annuitization and a target date retirement fund. I wonder if you see it as I do and, if you do, do you view this phenomenon as short term or long term in terms of how it will actually play out.

Milevsky – I definitely see that now. It’s almost frustrating to me, at times, to have discussions with people that are entrenched, almost fundamentalists of a particular viewpoint, and to them everything is solvable with one of those philosophies.

You talk to someone who sells or wholesales mutual funds and everything is about proper asset allocation created systematically with a withdrawal plan that is will last, and you should be okay if it’s tax efficient. They don’t see the need for any kind of guarantees or downside protection or annuities or longevity insurance.

You talk to a shop whose specialty is annuities, whether immediate, deferred, fixed, variable or equity-linked and that’s all they do, as you pointed out. Everybody should be annuitized, and the sooner the better.

It’s very much where you happen to land that you then develop this approach and of course the true solution is a combination of all of the above. Anyone who comes in and is able to create- again the word product allocation- but the framework that combines all of these, and maps personal preferences into a combination of these strategies is, I think, the one that’s going to win. I call this comprehensive product allocation taking into account the personal balance sheet

I have actually done some historical research on this. I’ve looked at the genesis of the money management industry. Thirty years to forty years ago you had folks that believed that everybody should have their money in “a few good stocks”. You invest in 2 or 3 companies, you pick utilities, you hold the utilities, you get dividends, there’s no point in buying anything else. There was no rigorous framework for systematic asset allocation across thousands of stocks and tens of asset classes.

There were others that were invested entirely in the Dow 30 stocks, the nifty fifty. You’d have this vehement discussion in the media and all of them kind of ignored the idea of broad asset allocation. Now everybody understands that you’re managing a small piece of your client’s investments and then we have to be diversified across countries, sectors, styles. I think that’s what’s going to happen with these strategy classes. People are going to realize that you need them all in small pieces.

Macchia – That makes sense. Right now, Moshe, I’m reading Walter Isaacson’s wonderful book about Albert Einstein. Einstein has been a hero to me over the years. I’m wondering if he’s a hero to you, or if you have others that you admire?

Milevsky – Absolutely. I sometimes joke that he’s my intellectual grandfather. I use the word grandfather because one of his key students, Arthur Komar, was a professor of physics of mine when I went to Yeshiva University in the late 1980s. In academia your pedigree is based on who are your parents and grandparents and great-grandparents. I’m one generation removed. Einstein trained him at Princeton and then he came from Princeton to train students at Yeshiva University and I got to sit at the knees of the child, or the intellectual child, of Albert Einstein.

Obviously he passed away well before my time so I never got to meet him. But, absolutely. It’s impossible to describe in words the way he changed the world. I mean a patent clerk sitting in Bern, and literally processing patent claims, and when you think about who works in the patent office these days it’s just stunning to believe that he could create a theory that literally changed the way in which we think about the world.

And not just once or twice, but three or four times. What many people don’t realize is that many of the models that we use in financial management are based on these underlying stochastic stimulation models, were actually put on a foundation by Albert Einstein in 1905 – 1906 in his work on Brownian motion. If you’ve ever heard the term Brownian motion applied to modeling stock prices, he’s one of the people that developed that framework and we’re essentially using his model in finance as well.

Macchia – Since we’re thinking in such a broad spectrum right now I’d like to ask you three personal questions.

Milevsky – Sure. You can ask then I’m not sure you’ll get an answer.

Macchia – Well, we’ll see. The first is this: If I could convey to you a magic wand, and by waving this wand you could affect any changes in the world of financial services that you wish to, and could make these changes instantly, what would be the first two changes you’d make?

Milevsky – Oh boy. These kinds of questions have to be mulled over. I’ll probably revise this, but I would say that financial literacy would be the wand that I’d like to wave. I’d like people to graduate from high school with a much more sophisticated financial view of the world than they have right now. I get to see them in their second and third year of university or college and those are the elite ones that actually come to our school and are studying business, and it is very depressing… the level of lack of knowledge.

They will be able to fix your iPod and reconfigure your internet connection and literally do mind altering things when it comes to electronics and gadgetry, but when it comes to simple questions like mortgages or checkbooks, or how do you manage money, or compound interest, they were just never taught this. I think that a magic wand that would increase the level of financial literacy across the planet in terms of the financial services industry would do wonders to avoid many of the problems that the industry faces. On issues like suitable sales, and seniors that didn’t understand what they purchased, and individuals that buy bad products that speculate on things that will never make money. Financial literacy would be a big help, and I’m a big advocate of that. I sometimes get flack when I say this. I have 4 children in school. Let’s teach them a little less Shakespeare and a little more asset allocation.

Macchia – Well said. The next question: If you were not Dr. Milevsky doing what you’re doing now, but instead could have any other career in any other industry or field, what would you choose to be?

Milevsky – I would probably, oddly enough, be a pulpit Rabbi. That’s what my father was (Chief Rabbi of Mexico), and my grandfather was (Chief Rabbi of Uruguay), and my great-grandfather was (Rabbi in Lithuania). I was kind of the black sheep. I was the one that said, you know what I’d like to do is something a little bit more practical or realistic.

Hey, it’s a tough life being a Pulpit Rabbi. The pay isn’t very good and you have a community to manage. Many of them are cranky members of your synagogue. It’s a tough life, but I could see myself doing that in another life. Certainly, not in this one. Obviously it would be a very, very big change for me and I doubt that I will ever do it, but that’s kind of in an alternate world what I would be doing. Probably not the response that you expected.

Macchia – I expect nothing. Whether you said Rabbi or trumpet player I would have been equally unsurprised. You get interesting answers to this question. Now, last question: I’d like you to describe your own retirement in its most conceivably perfect form. What will you be doing?

Milevsky – It terms of the daily activities, I believe deep in my heart that I will continue to teach, lecture and speak until the last day on this earth. I will be speaking in front of undergraduate students or graduate students or fellow research faculty members of even industry practitioners. I hope to be giving seminars until the last possible day.

That said, I most probably won’t be living in Toronto, which is where I and my family are based right now. It will probably be somewhere nice. I think Southern California. Specifically, Orange County and Laguna is very appealing to me. Of course the housing prices there are ridiculous on a professor’s salary, but perhaps 30 more years of saving will get me there.

I will also definitely be writing and publishing research articles. It is an interesting question to ask since last week I attended and gave a presentation at the MDRT meeting in New York. They organized a conference called Boomer Retirement and they invited some very well known speakers. It was a huge honor that I was asked to speak as well, since speaking the night before was Alan Greenspan as well as Ken Dychtwald and other notables..

The reason I mention this is that Alan Greenspan was also asked what he was going to be doing in his retirement. His response was, retire to what? He said: “I’m going to continue doing what I’ve always been doing. Maybe a little more golf.” That was his response to great laughter. , To me he was saying, look, this is what I enjoy doing and plan to continue doing it. That really resonated with me. If I wanted to do something different I would do it now already. I never do an activity where at the end of that I say, Gee, I can’t wait until I retire. I probably won’t be doing the volume and pace of what I do now, probably a little less intense, but definitely teaching and writing.

Macchia – I like your answer. Laguna is one of my favorite places and right now I’m looking right behind my desk and there’s a photo of my wife with a building on the beach that says Laguna Lifeguard Station with her standing in front of it. It’s a special place.

Milevsky – That’s definitely where I’m going to end up. I also spent a couple of years in Mexico when I was a kid growing up, so I’ve picked up Spanish quite fluently, and I like the kind of Latin environment close to Mexico and the fact that everyone there, especially in the services sector, speaks Spanish. To me it’s a special place, not just because of the natural beauty and lifestyle. I will probably be sitting on the Laguna Beach somewhere typing and giving webcasts or something but definitely writing. I have a whole bunch of books that I’m still trying to write, so I need time to do it.

Macchia – The good news is you might have 60 or 70 years left to do it. Hopefully with the right annuitization.

Milevsky – And the right healthcare provider and a better diet and a long list of other things that my wife reminds me of.

Macchia – Moshe, is there anything that I’m forgetting that you’d like to talk about that we haven’t. Anything you think readers…

Milevsky – I think we’ve covered a long list of things and it’s certainly reflects a broad range of my interests. So, the answer to your question is “not that I can think of”, especially as it pertains to retirement and retirement income and financial literacy, so you’ve touched on all of the hot spots.

Macchia – I’ve enjoyed it immensely. Thank you, Moshe.

©Copyright 2007 David A. Macchia. All rights reserved.

Interview with Phil Eckman: President & CEO of Transamerica Retirement Management Cites Lack of Insurance Industry Progress Despite Years of Intense Product Focus; Calls for New Communications Strategies

philipeIn this wide-ranging interview, Phil Eckman, CEO of Transamerica Retirement Management, talks about Transamerica’s view concerning the importance of the Boomer retirement income business as evidenced by the company’s decision to create an entirely new business unit. Eckman also addresses the challenges arising out of the inherently greater degree of complexity of insurance products, and stresses the need to develop superior, consumer-facing communications strategies in order to overcome that complexity.

Macchia – Phil, let me begin by asking you about your work. Please begin by telling us your title, your role and your responsibilities.

Eckman - My title is President and CEO of Transamerica Retirement Management, which is a new business unit that we’ve created within the AEGON USA/Transamerica Companies. My responsibilities center around building a new business unit that is solely focused on the unique needs of the boomers as they move into this transition called retirement. We’re leveraging what we have to offer from our various companies across AEGON/Transamerica family to help with these unique issues that folks are facing.

Macchia - Okay. I understand. Now, the progression of developing a retirement income solution at a large company can sometimes, if not often times, get bogged down with conflict among silos. Sort of the belief system that it’s my solution…no it’s my solution…no it’s my solution. Is what you’re doing at Transamerica an effort to cross silos in an effort of incorporate the best of all silos?

Eckman - Exactly. I believe that while it may not be an explicit objective, I think implicitly as we build out our group, we will cross silos and take ideas that have been working in one area of the company and have them cross over that line and bring them forward in another part of the company to reach a new consumer base. So absolutely, practically what’s going to happen is we will be taking ideas across silos and exposing them to mew markets that otherwise would not have the opportunity to see them.

Macchia - In terms of Transamerica Retirement Management and how it was developed, what thought process led to the creation of this entirely new business unit?

Eckman - Our CEO of AEGON USA, Pat Baird, about 2 ½ years ago challenged the management team of the organization to look ahead, think forward about this large retirement market that’s going to be coming upon our industry; to think hard about how we as a company can best serve the group, putting aside some of the typical issues around silos and short-term business objectives. A task force was put in place to look into these questions. One of the recommendations was to start a new business unit.

Macchia – And I gather the decision to start a new group implies that the entire retirement income business is deemed to be something of a very high strategic priority for the corporation.

Eckman – Absolutely. It has not been a cultural business strategy within the AEGON group to start new business units like this. We have strong, autonomous growth targets and we have a history of acquisitions, so to start a new group like this was entirely new.

Macchia - Phil, would you describe the introduction of Transamerica Retirement Management as an incremental change to the existing business model, a moderate change to the existing business model, or even, potentially, a large change?

Eckman - I think it’s a potentially large change. If we wanted to take an incremental approach, we would get working groups together, we would have senior management from the different divisions collaborate and then go back to their day jobs.

Macchia – As I observe it, Phil, distribution strategies seem to be evolving along somewhat philosophically- based lines. I often liken this to religions, in the same manner that we have various religions in the world. So, we have religions of distribution planning popping up, such as the religion of systematic withdrawal programs, the religion of laddered strategies, the religion of time-weighted strategies, the religion of lifetime annuitizatioin. Do you buy into this description what’s developing in the marketplace, and if you do- or if you don’t- explain how you see it, and where Transamerica Retirement Management might play in this context.

Eckman – You and I have talked about your description of this sort of religion analogy, and I think it’s a pretty good one. Each manufacturer or advisor is going to have a core philosophy around income management. Just like there are many ways to invest and accumulate assets, there are many ways to convert these assets into income. Some are simple, some are complex. Some are product based, some are planning based. Some offer guaranteed lifetime income, some do not.

We generally believe retirees should build two income streams. The first is guaranteed for life and is made up of Social Security, pensions, and some form of lifetime annuity income. This income stream covers the basic living expenses around food, housing, health care, etc. As retirement may last over 30 years for some couples, they have the piece of mind knowing that these essential expenses are always covered. The second income stream is not necessarily guaranteed and made up of a systematic withdrawal strategy, possible ongoing employment and possible home equity release strategies. This income stream covers the discretionary expenses of travel, entertainment, etc. Of course, the art is working with the customer first to build a plan that meets their unique situation and, second to support them over time to execute and tweak the plan. I guess you could say this is our religion.

Macchia –I did some searching on the internet and read where one of the missions that Transamerica Retirement Management has undertaken is to leverage AEGON’s extensive network of internal and external distribution partners in order to deliver solutions. Is that, in fact, true? And if it is, can you comment or go a little bit deeper into the strategy?

Eckman – Sure. We have to prioritize the opportunities before us as we build this group and march it forward. We’re starting in terms of distribution by connecting with our pension organizations, Diversified Investment Advisors and Transamerica Retirement Services. We are bringing product development, marketing strategies, and an advice platform to these organizations that leverage some of the capabilities across AEGON.

Macchia – I can look back over the period since I came into financial services inn 1977 through the insurance door, and I can remember that the pension business back then was pretty much owned by life insurance companies. Over the course of my career, during the last three decades, we’ve seen life insurers cede away that business to the mutual fund complexes. I wonder if when you look at the distribution opportunity, you see insurers as ready to or potentially able to take back those pension assets, or do you think that there are some fundamental challenges that insurers face that will conspire to hinder their progress in reaching that goal?

Eckman – I think your premise is true. The asset management industry certainly has done a fantastic job serving customer needs within the 401K and general savings space. It’s not surprising because the primary need through the working years is accumulation and investing. But as these investors age and get closer to what we call the third stage of life known as retirement, their priorities and needs change. While investing and accumulation is still important to them, they need to understand the new risks associated with income planning such as longevity and healthcare.

Those sorts of issues obviously play into insurance industry strengths, and our capacity to build solutions to help these folks manage these risks that now have come and moved up the list of priorities as they have moved along in their own life. The insurance industry is in a position to certainly help folks with these important issues.

It’s going to be a lot of work for us, particularly on the marketing side and on the education side. These types of issues, these risk management issues, by their nature are more complicated. So, how can we help people understand the issues and questions? How can we help them make the right choices? Those are going to be the key issues that will determine how the insurance industry, as a whole, and how individual insurance companies will succeed in this opportunity ahead.

Macchia - I think that’s a very insightful observation. You indicated that the very nature of the products that are going to have to be distributed and explained in the future are more complex by definition. Does this make you think that new strategies for communication are going to be in order, and if it does, where does technology play into that? How important do you think technology will be in the coming months and years? How do you see the whole customer communications issue fleshing out in the future?

Eckman – I think it is going to more complicated and it’s going to be challenging. Whether we in the insurance industry are trying to come up with new ideas to help advisors carry the load and get this point across with their customers, or, whether we’re talking to a customer directly. We have to make it clear, transparent and understandable.

Trying to reach people differently, trying to leverage technology to help explain products is definitely an opportunity for the industry. The other point that we haven’t talked about are the compliance issues. With the more complicated suite of products that need to come of the fore, we need to make sure that advisors are able to clearly explain what they need to with their customers. We must have the right tools in place to deliver compliant, clear presentations so that customers fully understand the issues and the options available.
Leveraging technology to help with this challenge is a real opportunity. Video, electronic presentations, those sorts of things, by their nature, can be controlled more effectively.

Macchia – Phil, when I think about the role of consumer-facing technology in the future, one of the issues aside from compliance, and aside from consistency in message- and a myriad of other advantages- when you get down to the very basic question, you realize that there are gigantic numbers of individuals that are going to need to be contacted and provided guidance in the distribution phase of their lives, with a relatively small base of advisors to reach them. Is this something that you at Transamerica Retirement Management have thought about and if it is, what do you foresee as potential strategies that you may use to address this very issue?

Eckman - It is something we’ve thought about and wrestled with. We are like a lot of companies in our position. We have a large advisor community that we distribute through, and they are always looking for help in good, compliant presentation and educational programs that allow them to bring value to their customers.

We’ve got work to do with some sister groups to put that type of tool together in the short and long term. I think that companies like us are going to have to be very successful on that front if we are going to get the time and the attention of the advisor base moving forward. Beyond the advisors there is certainly an opportunity to more effectively reach those individuals that either are not working with an advisor today, or prefer to just do it themselves.

There’s a chunk of the Baby Boomer population that are going to want to do it themselves, and providing more avenues for them via the web and other technological tools so that they can understand, become educated and ultimately make the right decisions for themselves, is going to be an opportunity for the industry, for sure

Macchia – Phil, I’d like to ask you next about products. In our industry there is no end to the talk about new types of products that are being developed, may be debuting in the near future, and may transform the way that products work. It’s stated by many that these new products are going to be very important in meeting Boomer needs.

There is another philosophy that’s sort of out there in parallel that says- and this was reflected to me most recently in an interview that I hadwith Jeremy Alexander- that we’ve got longevity insurance, we’ve got lifetime annuitization, we have products that guarantee principal and simultaneously provide upside potential, we have lifetime annuitization products, and guaranteed withdrawal riders. We have mutual funds, we have equities, we have bonds. In other words, the products are already there. It’s a matter of figuring out how you package them to work synergistically to deliver good long term results for the consumer. I wonder how you feel about this issue.

Eckman – I would agree with it. The product innovation on behalf of the insurance industry is never going to stop, and I don’t know if it will ever slow down. But I think we’ve seen, looking back over the last five years or more, that most of us in the industry are not terribly happy with the results that we’ve had in really driving the growth in all of the income product innovation that’s taking place.

We’re making progress, but in the big picture of things, relative to the mutual funds and other more traditional accumulation focused investment solutions, I don’t think any of us are comfortable with where we’re at. Which then leads you to the question as to yes, products are important, but is it the communication, is it the method or context in which we’re describing them. Do we need to look harder at that?

Macchia – You bring up something that I’ve talked about and written about a great deal. In fact, I’ve said quite publicly that the winners in Boomer retirement are not going to be those companies that necessarily even have the best products, but rather will be those companies that are the best at communicating their value to a large and fluid market place. Does this strike you as true?

Eckman - It does. I’ve heard you say it a couple of times and every time I hear it it rings very true to me. It’s something that is easy to say, harder to do, but the more I think about it the more I realize we must become better communicators.

I think this is coming back to us as feedback from a lot of advisors that we work with in this organization. They want to be more effective in the way that they communicate to their end customer. Let’s not over complicate the product so that we can’t clearly explain its value and ability to solve a customer’s need.

Macchia - When you look forward in the context of your position of heading up this business unit, what do you define as your greatest challenges?

Eckman – I think there’s an inherent education gap that we as an entire industry need to focus on. It’s making a connection between savings and income. In all of the focus groups we’ve done, every consumer understands the notion of a nest egg.

But, when you start asking questions about, “How are they going to put that nest egg to work to replace an income stream or how will they develop an income plan to manage a 30 year retirement?” They have no answer. They have not thought about it. We, I think, have a big job to just close that educational gap and help people to think about income earlier on as they approach this transition so they can start to plan and really understand the issues at stake, and sort of change their way of thinking. They’ve got to begin to think, “Now, I need to move into more of an income management and financial risk management mindset.” That’s a big task.

Secondly, I think it really gets back to your communication point that our products within the insurance industry are going to be more complicated, making it even more critical for us to succeed on the communication front. Finally, we have to understand that to the end consumer, retirement isn’t in their minds primarily a financial event. We come from the financial services industry, so we think of it as a financial event, but they don’t. First and foremost, it’s a life event to them.

We need to understand that reality, and help them with this whole life transition, and help them understand how the financial part of it is certainly an important component, but it doesn’t start with that. When they come to a meeting with an advisor, when they are talking with an advisor on the phone, or when they are going online to a website, they are coming to that meeting or they are coming to that website not wanting to jump right into financial planning, but to just get some general perspective around this life event that’s coming their way. Once this context is laid, it’s easier to weave in the financial aspects of the transition.

Macchia - That’s a very… reality-based take on the issue. Which reminds me of advertising. The advertising that’s been done to date to the Boomer audience has struck me as very odd and, arguably, disingenuous. On the one hand you have all manner of statistics that indicate that the typical Boomer is not well positioned to generate a significant retirement income over a retirement that may last a very long time. Social security is uncertain in terms of what may happen to it in the future, the national savings rate is very low, and typically Boomers have more debt than net assets.

So this is a mixture of facts that doesn’t bode well for mass market retirement security. At the same time, we’ve seen advertising that consistently describes retirement as a time to enjoy all of the exotic activities that you’ve never been able to previously enjoy; that retirement is the time to learn to snowboard, for instance, or parachute, or take an around-the-world cruise. I’m wondering if you feel that financial services companies, thus far, have been real and candid? If you feel that the current trend in advertising is misguided? I’m wondering how Transamerica Retirement Management will view the issue in terms of its own advertising?

Eckman - Within our organization we have made it a point to be realistic with all of the content and images we use in our literature and on our website.

It’s possible to be both realistic and optimistic. From a planning standpoint, our group is committed to helping the middle market/mass affluent retiree understand how Social Security, possibly a pension, supplemented by some other form of ongoing lifetime income, and, realistically for a lot of people, some sort of ongoing employment on their terms, can all work together to form a sound income plan.

Let’s face it; the typical picture of the couple on the yacht or in front of the second home on the beach is not realistic for a lot of people. Nonetheless, these folks have the potential, if they do the right kind of planning up front, to have an incredibly fulfilling and financially secure retirement, which is what it’s really all about.

Macchia - Phil, I’d like to ask you three questions that are entirely personal in nature. I’m going to, starting with this interview, include these questions in every interview going forward. The first one is this: if I could somehow convey to you a magic wand, and by sweeping this magic wand you could instantly institute any change that you want to see occur in this industry, what are the first two changes you would make?

Eckman – that’s a tough one. So any two changes within the industry…

Macchia - Anything, this is virtually the power of God I’m describing.

Eckman - Other than tripling everyone’s investible assets to put towards retirement, I presume that’s off the table!

I think number one….I just think a general increase in awareness of the issues and risks- and I don’t mean risks in that scary, negative sense- but just an awareness of the issues that people need to be thinking about when it comes to retirement.

If we can wave the wand and implant that knowledge in peoples’ minds, I think that obviously would be an enormous benefit for all of us.

Secondly, I think there are a lot of things, clarifications that need to be addressed from a regulation standpoint between the groups that govern equity products, insurance products and pension products. There’s a lot of confusion and red tape that needs to be resolved, that slow us down from putting the right kind of education and solutions and guidance in place to help people. So, if I could wave the wand and clarify a lot of issues and get some consistency across all of these different regulatory organizations that govern the various parts of our business, I think that would ultimately be a big help to the end consumer.

Macchia - Good answer. Next question: If you were not CEO of Transamerica Retirement Management but you could have any job at all, in any other industry, doing anything you wished, what would it be?

Eckman – I think that I look back at my career and experiences, some of the most rewarding work I’ve done involves working individually with people on their own issues. Honestly, if I could actually get into the chair of the advisor and truly help individual retirees successfully plan and make this transition into retirement, I think that would be incredibly rewarding.

Macchia - Lastly, I would like you to imagine your own retirement in its most conceivably perfect form, where perfection is anything you want it to be. Tell me what you’d be doing.

Eckman – I think I would be engaged with my kids’ and grandkids’ growth and lives, hopefully in a very active way. I would be enjoying, certainly, time with my wife doing the things we like to do together. I think I would also be engaged in some kind of ongoing professional endeavor or volunteer work.

Macchia - Sounds like a pretty nice vision. I want to thank you for your time and for your answers. I’ve enjoyed it.

Eckman – I have too, David. Thank you.

©Copyright 2007 David A. Macchia. All rights reserved.

Blog Excerpts Book Available for Download: Thought-Provoking Interviews, Vision and Insights on Major Financial Services Challenges and Opportunities

Now, just in time for your weekend reading pleasure…

In just a short time some of the best minds in financial services have contributed a wonderful collection of insights to my blog. In addition to my own ruminations, I’ve taken some of these contributions and published them in the form of a downloadable book. You may download the book at no cost. Download the PDF here.

You will see that the book is organized into three distinct sections:

The Annuity Industry: Challenges & Opportunities
Retirement Income
Interviews with Industry Leaders & Innovators

From time to time I’ll aggregate future content in this format for you to be able to conveniently retain and reference. Download by clicking here

Phil Eckman, President & CEO of Transamerica Retirement Management and Fred Conley, President & CEO of Genworth’s Institutional Retirement Group to Appear in Industry Leaders & Innovators Series: Retirement Income Industry Leaders to Address Broad Range of Strategic Opportunities and Business Challenges

I am pleased to announce that two of the retirement income industry’s leading lights will be the subjects of interviews in my Industry Leaders & Innovators Series. Phil Eckman and Fred Conley are articulate and talented individuals charged with significant strategic responsibilities within their respective organizations. Their visions and insights will be welcome by all who are concerned with the future of U.S. retirement security.