Gaffney: EBRI has worked on these issues since 1978 when President Carter appointed a national commission on pension policy in anticipation of demographic changes that would come as baby boomers retired. What is the most significant trend since that time?

Salisbury: The shift from defined benefit (DB) to defined contribution (DC) pension plans is one, and this has been accompanied by a significant change within DB schemes themselves. Today the essential norm of many remaining DB plans is single-sum distribution rather than annuities, which would most readily prepare individuals to avoid running out of money before they run out of life. However, even at their peak in 2001, DB pensions were being paid to only 21% of private-sector retirees over 65. That they came to everyone along with a gold watch is a myth. Most individuals have always had primary responsibility for their own retirement.

Gaffney: When my father retired from IBM with a lifetime annuity, I don’t believe he understood exactly how his retirement was going to work, but he felt comfortable and secure. The world has changed. Today people need to make retirement decisions that the previous generation never faced. Martha, have the types of questions changed over the 30 years of your experience and how are companies responding?

Schweppe: There has been a shift in the questions people ask toward how to evaluate products. Therefore the thinking of financial advisors has also had to change, too. I decided early on to adopt a planning approach, so I obtained my CFP in the 1980s, but for many years I struggled to be a planner in a sales organization. I also struggled with software tools that were inefficient, but in the last five years our firm has provided marvelous tools with Monte Carlo simulations and this has transformed our practice.

Gaffney: And in terms of client awareness of issues?

Schweppe: Our clients are affluent individuals, so probably more knowledgeable than many Americans.  But most people, even sophisticated individuals, focus on what they do for a living. There is a huge role for financial advisors to support them with planning, but many advisors have not yet made that shift.

Gaffney: You work mainly with a subsection: affluent individuals. Who advises those people that don’t qualify, those who will be the bulk of future retirees?

Schweppe: It is a dilemma. Smaller investors can’t always access our services. Employers providing more would be ideal, but I am not sure it will happen.

Salisbury: IBM was mentioned. That’s an example of a company that, as it has changed from DB to DC approaches, has ensured that employees have access to comprehensive planning and advice. More large employers are adopting this type of approach.

Gaffney: IBM recognizes employees should have the best possibilities to retire with dignity. But I worry about companies not in the top ten of best practices. And I wonder if financial advisors are equipped to guide people through the accumulation phase into the income drawdown phase.

Schweppe: I think managing an income-planning practice is a different challenge to an accumulation practice. There is definitely more work to be done – more than training and certification. Even in our firm, where we have amazing tools in place, I see financial advisors that have not fully embraced them.

Salisbury: Martha, you’re right, the tools are there. I don’t think the understanding and acceptance are. I was at a meeting recently where, in response to a question, one financial advisor said if the person in question didn’t have enough money to accommodate a 50% loss then he shouldn’t have retired anyway. I don’t think the client would see this the same way.

Gaffney: What is the proper way to draw down income in retirement? What kind of vehicle can protect individuals against just this type of experience?

Schweppe: Some portion needs to be a guaranteed income stream, particularly for investors not covered by DB plans. Annuities seem the best way to do that, but they are complicated and expensive. Plus, they are perceived negatively by many investors, and even by some advisors who have yet to embrace the more complicated products.

Salisbury: The industry’s communication has been focus-grouped and designed for high-net-worth individuals, but the advertising is shown to the general public. This reinforces negative attitudes to life income protection that Martha described. Yet, as you move down the asset levels, life income protection should play an increasing role relative to your worth so as to provide  long-term protection. Personalization at each net-worth level is one way financial advice needs to redefine itself.

Gaffney: But protection cost can be prohibitive?

Salisbury: Yes and no. I think the companion factor is that we have had at least nine major financial system dislocations since 1982. These have raised the issue of financial and insurance company solvency. Simply put, how can people rely on guarantees? It has almost become a headline in ads these days that the annuity “shall be subject to the ability of offering company to pay.” So even small annuitants need the ability to buy life income protection cost-effectively from more than one company so as to diversify annuities as with an asset portfolio.

Gaffney: Dallas, you’ve touched on trust. From an advisor’s perspective, they believe they have done the right thing by clients in the accumulation phase, they followed the guides of their parent companies and created proper allocation strategies. Suddenly they are dealing with clients who may have seen a decline of 20% to 30% in assets. That must be difficult for both the advisors and their clients.

Schweppe: It is often scary from where I sit because I advise people on what I think will accomplish their goal, yet I cannot guarantee it. I have to add all the caveats and disclaimers. Certainly everyone’s confidence has been shaken over the last year.

Gaffney: Sometimes I think that, as the industry simplifies complex ideas, it builds vehicles that don’t perform as proposed. Target date funds (TDFs) are an example. They haven’t delivered in their current form.

Schweppe: I believe in simplicity. I’ve seen Wall Street come up with many complicated products and many don’t deliver. I tend to stick to tried-and-true basics. I still believe in the TDF concept and hope last year was an anomaly. We have to provide understandable solutions for the sake of clients and for the sake of the financial advisor.

Salisbury: To take up your point on TDFs, they raise exactly the type of fiduciary obligation issues being looked at by the Securities and Exchange Commission and the Department of Labor. To an extent, a lot of simplified products out there are designed and appropriate for maybe 2% to 3% of the population. Yet they are sold broadly. I think addressing that is a challenge for the industry, a challenge that, for the first time in my 35 years of experience, the regulators are looking at – and it is reflected in the president’s proposal for a consumer financial protection agency.

Schweppe: It is imperative that we re-instill confidence with the investing public. It has always been a source of frustration to me that we work so hard to establish trust with our clients and periodically firms or the industry will do something unreasonable or unethical and it sabotages everything we’ve built. I don’t think business as usual is the answer. More regulation, better regulation and better enforcement all need to be considered.

Gaffney: Finally, do you think financial advisors will play an increasingly important role in the future?

Salisbury: Yes, because of the continued efforts of employers to make financial advice available to their workers. And also because of the continuing focus by the federal government in the US to have financial advice provided to a broader range of people and to find additional ways to encourage base levels of life income security for individuals.

Schweppe: I hope so. I don’t mean that to sound self- serving, but given the type of planning we do and the fact that not many individuals have the time, knowledge or expertise to do it for themselves and, as it is probably even more important to plan during the distribution (decumulation) phase, that should bode well for our practice.

Gaffney: Thank you for your perspectives.

Published by PROJECT M in September 2009