For decades, the serious risk of a demographic time bomb exploding the public finances has loomed as a potential threat. However, what’s ticking loudest currently is not government debt but private pensions.
Because of a raft of emerging forces, the Obama administration’s newly-proposed Department of Labor Fiduciary Standard will be the start of a battle that will reshape the U.S. pension industry and the landscape of the financial industry overall. The rule mandates that retirement advisers offering financial planning advice always act in the best interests of their client.
The financial industry has made its objections to the rule, which they say will raise costs and making getting good advice harder for the middle class, part of public debate since its inception. But this urgent question has been less discussed: why is this new rule such an explosive demographic threat?
The first answer is longevity trends, which all indicate that many more people are living longer and will continue to do so. Today, around 72,000 people over 100 years of age live in the United States, but if current trends continue, that number will reach approximately 1 million by 2050.
Over the last two hundred years, life expectancy has increased by two or three years every decade. Given these trends, it’s possible that more than 50 percent of children born today in the United States have a realistic expectation of living beyond 100. Even those in their 40s and 50s know they are living longer than their parents and therefore will need to work beyond 65. The percentage of Americans age 65 and older who are at work has increased continually since 1983, rising from 10 to nearly 19 percent. Meanwhile, a new study shows that the funding of public worker pension plans in the United States remained unchanged in 2015.
People are living longer, but the amount and the way we pay for their pensions is staying the same. This growing longevity means many people probably haven’t saved enough for retirement. In response they are working longer, but are also searching for better investment returns. In a period of historically low interest rates, management charges become all the more noticeable and have the potential to wipe out already meager rates of return. A fiduciary rule to ensure the choice of a product is based on the needs of the investor and not the size of the management fee paid to advisers becomes more important when returns are so low.
Another factor prompting the need for a fiduciary rule is the growing complexity of pensions and the increased need for customization. When life expectancy was 70 years, we created a three-stage life of education, work and retirement. However, as Lynda Gratton and I suggested in our recent book, this three-stage life cannot be stretched over 90 or 100 years. A 100-year life requires a 50-or 60-year career in order to finance a pension; that length of career is unsustainable.
The result will be a multi-stage life with transitions between different career stages. Different individuals will make different choices at different times about when they want to retire, when they focus on making money versus a better work-life balance. Some individuals age 70 will still be working — some won’t. Some will be interested in mortgages and risky investments — others will be interested in safe investments and income. This diversity will require much more complicated financial advice and less standardization. When everyone has the same needs, then the same product can be used. With greater diversity and needs among investors comes the need for greater customization and rising importance of a fiduciary rule with customers at the heart of the process.
The DOL requirement that financial professionals put their clients’ interests before their own when selling products fits strongly with these emerging trends — no hidden charges that lower the value of returns and the importance of customized advice. So the demographic time bomb starts to tick between individuals pressed financially by their longevity and the financial profession, concerned about the risk and obligations of the proposed fiduciary rule.
However, the DOL requirement also sets another fuse burning. Not everyone is benefiting from these longevity increases. One recent study documents that the richest 1 percent of American men have a life expectancy 15 years more than the poorest 1 percent; since the millennium, the richest have seen their life expectancy increase by three years, but the poorest barely at all.
This creates very real problems. We can tackle income and wealth inequality by taking from the rich and giving to the poor, but we can’t do this with years of life. While the better-off in society wrestle with how to customize a 100-year life, poorer members of society will face much lower life expectancy.
Further, if professionals cannot recoup fees from products they sell, but charge for professional advice, then it’s likely only the higher income individuals will pay for this. Others will find themselves without advice and faced with simple standardized products. Less life expectancy, less money and less advice — it’s not an attractive prospect.
How society deals with longevity inequality and meets the needs of those with longest life expectancy, but also secures support for those with less money, fewer years and less financial knowledge, is an increasingly urgent question that will — and should – dominate the political agenda. Given longevity trends, society must change its approach to long-term financial planning and the pension industry and its regulators must adapt, but at this point the question is how?
Until someone comes up with an answer, that time bomb will continue to tick.
