Longevity Pooling and Financial Flourishing (w/ Jim Keohane)
ED HARRISON: Jim Leach, when I spoke to him, and Ramsey Smith, who you also know-- when I spoke to him, they both mentioned this mortality risk, risk pooling. You said that risk pooling and fees were the two biggest things. And we haven't talked about risk pooling at all, but tell me where does the big savings come in there? JIM KEOHANE: There's a couple of things. The first is-- well, there's three places where you get big risk pooling benefits. The first is if you were an individual and think you're going to retire in 2008, you may have had a 40% drought on your funds. He's off to take a much lower income in your retirement or you have to postpone your retirement activity. If you're in our plan, that risk gets absorbed across generations, so people are retired in 2008 got the same as they were expecting and it worked out fine. Second place is if you're on your own and you retire at 65, you've got this chunk of money, it's got to last the rest of your life. So you can't take a loss or you may find yourself in a very difficult position. So you have to actually dial your risk now. So you have to take a much higher fixed income component in your portfolio than you would otherwise have. So that actually reduces your return over-- which could be very long period of time. It's 20, 30 years, right? Whereas in our plan, again, because that's absorbed across generations, we can maintain the same asset mix all the way through that period, so we can maintain the returns. So again, that makes a big difference. The third place is longevity pooling. And so if you think of it a large plan like ours, we have 380,000 members in the plan. So our mortality becomes pretty predictable. And so in our case, it's about people over 65, the average mortality in our plan is about 87. So we know that we have to pay people for roughly 22 years. And we can charge people based on that. And so we can charge you less through you're working career, because we know that that outcome is pretty predictable. Whereas if you're an individual-- within our plan, some people pass away shortly after retirement, but a lot of people live a very long time, too. So we have members in our plan-- the oldest member is 104. And she actually retired in 1976, by the way, so she got a pretty good deal. ED HARRISON: Yes. JIM KEOHANE: But we actually have 72 members that are over 100. And we have 2,500 between 90 and 100. So people live a long time. So as an individual, you have to assume you're one of those people, because you don't want to run out of money when you're 90, right? ED HARRISON: You don't want to be eating cat food at 90. JIM KEOHANE: Right. So in our plan, you're going to get paid for your entire life, because that risk is shared across the membership. Whereas you as an individual, you'd have to save a lot more money to get the same outcome or you have to take a lot less money in your retirement in order to make sure it lasts through your career. So just that, even if you assume you're going to live five years longer than the average, that's a lot of money. ED HARRISON: That is a lot. And of those two outcomes, the second one is the one that gets me. You say you can either save more money or reduce your expenditure once you actually retire, because that has huge public policy implications. I mean, the whole concept-- when you're going from defined benefit to defined contribution, basically, what happens is all of the risk is loaded onto the individual and that individual changes their behavior. JIM KEOHANE: That's right. ED HARRISON: And that change is one that actually reduces consumption. It reduces your growth in the economy. JIM KEOHANE: And so we had a study done a few years ago-- it was done by Boston Consulting Group for us. And the objective the study was actually to look at how the distributions from defined benefit plans impacted local economies. One of the interesting things that came back out of that study-- I mean, they weren't looking for this, but that's what they found-- is that there is a very different spending pattern between people that were in defined benefit plans and had predictable income versus people that were not. And so people that were not generally hadn't saved enough during their working careers and became savers in retirement. ED HARRISON: Right. JIM KEOHANE: And they're all worried about outliving their money. And there was no predictability as to what the next check is going to be. So they became savers in retirement. Versus people that were in defined benefit plans knew they were going to get a check next month, so spent the money. And so one has a dampening effect on the economy. The other has a stimulating effect on the economy. But even if you go back to what we just talked about, that difference between in the working group, putting aside $1.2 million versus putting aside $300,000-- that puts $900,000 back in a person's pocket or in their working career they can spend on other things. So again, a stimulative impact on the economy. So that seems to get lost a bit. And in fact, that there are a lot of economic benefits to people having predictable income and , again not taking as much away from them during their working career. So efficiency makes a big difference.