The Retirement Car Crash

by: Jeremy Josse

Summary

There’s a retirement “car crash” waiting to happen for not only those of modest incomes, but now for even fairly well paid six-figure executives.

It is the consequence of multiple factors – revolutions in medical care, longevity, excessive debt and unabated material expectations.

Yet many, apparently well off, executives remain in denial.

But a life policy structure employing still more debt may strangely be a possible solution.

The so called "retirement gap" (the gap between income and expected expenditure during retirement) for those with modest incomes has been recognized for a long time. It was well documented in, for example, "A Tale of Two Retirements," a research paper put out recently by the Institute for Policy Studies, a self-identified progressive think tank that researches economic and social issues such as inequality. Authors Sarah Anderson and Scott Klinger explained just how America's inequality crisis has reached into retirement, with a collective failure of the 401(k) system.

You do not have to be some socialist to see that the report is a worrying indictment, with the report citing troubling facts such as:

  • Out of current 56- to 61-year-old US workers, 39% anticipate depending entirely on Social Security's average $1,239 per month and some are forecasting Social Security bankruptcy by c. 2028/29
  • A sample of the top 100 CEOs have more in retirement assets than 75% of all US Latino families put together

But now it is increasingly recognized that the retirement gap has spread pretty far up the income chain, probably starting to affect even the so called 1%. Today, many seemingly well-heeled executives (on six-figure or even multiple six-figure salaries) are facing a "retirement gap" also. In particular, whether planned or unplanned, retirement prior to or at age 65 may present many executives with an income gap which involves material scaling back in living standards (even with some pension entitlements being in place). The complexity surrounding stock-based compensation clouds the issue somewhat, as does where you work ($100,000 in, say, Sioux City goes much further than $100,000 in Manhattan), but the problem is becoming increasingly stark.

How you might ask is it that an executive earning say $200,000+ a year ends up with a retirement shortfall? Well it is a number of factors:

  • There has been a medical revolution such that over the last 20 years people have started living significantly longer. A retiree already aged 65 can expect probably to make it to his 80s or well beyond;
  • The cost of medical care during that retirement period however skyrockets as medical issues become more and more complex and not everything turns out to be covered by insurance. Approximately 85% of all medical expenses occur in the last ten years of life;
  • We became a society with unrealistic expectations. The $200,000+ executive expects a fine house, two cars, two holidays a year, private schools, to pay for his kid's university tuition, and so it goes on. And this is not to mention the tax bill he's paying on his earned income. A bunch of all this was really debt-funded, so effectively the executive spent chunks of his retirement money during his working days. Wealth inequalities have not helped tame these living standard expectations; in fact they've only exacerbated them;
  • What's more, as the technology revolution progresses, the actual jobs available, even for the well educated, is probably declining as AI systems turn out to be better at accounting systems than accountants, or can offer superior diagnostic systems than doctors, etc. So the retiree may find even his well educated graduate child still depends on their parents for income!

A story about the German industrial revolution rather says it all. In the late 19th century, as Germany was rapidly industrializing, unions formed and started demanding of the then famous German Chancellor Bismarck for there to be the introduction of a state pension. Bismarck, being the wily politician that he was, got his actuaries on the job, who told him that by the age of 65, 99% of all the workers demanding said state pension would be dead. At which point Bismarck announced all German workers were entitled to a state pension at … 65 years old!

Somehow that 65 years old retirement figure has stuck notwithstanding the radical change in longevity, so no wonder the retirement gap is rapidly exploding. Now the average retiree is typically expected to live 22 years in retirement…

So, what is to be done?

Well peculiarly one solution might be the use of still more debt. Is the solution large-scale corporate insurance premium finance? Let's assume the modern executive is just no longer capable (culturally or financially) of saving adequately for retirement himself. An alternative solution is that, certainly for major corporations, policies over a large cohort of senior executives (1,000+) might be offered as a corporate emolument (one either wholly or partly paid for by the corporate employer). But the premium on such a large emolument might be some millions of dollars a year. Neither the corporation nor the executive (as we have just identified) necessarily have the cash flow to pay for the policy. Instead the policy premia are borrowed and the debt used to pay the premia is collateralized against the policy itself.

When done professionally by some of the leading arrangers of these policies (such as companies like NIW Inc) the policies are always high quality insurance level policies issued by A or AA rated insurance carriers. The debt funding cost is inevitably therefore low (say L+1.00 to 1.75) and the policy itself is used to pay down the accruing interest and principal on the debt. After 10-15 years or so the insured has a policy that is then entirely for his own benefit having been (as it were) spoon-fed a disciplined savings regime. When well structured, the cash value of the policies never falls below the redemption value on the debt. And if it ever did fall close to the debt outstanding, it would cause an immediate acceleration of the debt, unwinding of the structure and thus the debt would be made whole by the policy cash value.

It's a neat trick that is becoming an increasingly popular emolument for large blocks of senior executives, or even large groups of other highly paid specialists - e.g. perhaps anesthesiologists. NIW's corporate policy structure is known as Kai-Zen© and the firm has seen very material growth in demand for the product as executives finally start to face up to the retirement wall ahead of them.

For sure other structural social solutions need to complement products like Kai-Zen - for example, the technology age is probably putting too much money in the hands of the owners of IP and may well be destroying jobs even as it progresses. Nothing of course is more important than human life, but at what point is someone in a semi-vegetative state to be kept technically alive given the cost. A spoiled society itself needs to adjust its expectations and live according to its means. People will need to work longer, or else we will need to find significant new sources of materially higher GDP growth. However, products like Kai-Zen are a critical and robust piece of financial engineering that can help us as we go through the economic revolution wrought by technology and, in particular, the medical technology revolution.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.