Risk and investment planning are often regarded as two separate conversations, but in many respects the objective of both these conversations is exactly the same – protecting your income.
“We view risk planning as protecting you from the risks that prevent you from being able to earn an income, allowing you to create the wealth that you need. Investment planning is around helping you grow that wealth so that one day you can replace the income when you no longer need to or want to work… Both of them have exactly the same objective,” says FMI CEO, Brad Toerien.
The problem, Toerien argues, is that both risk and investment planning are driven by conventional wisdom, which in many cases is no longer true.
Myth 1: You will earn a continuous, steadily increasing stream of income until retirement
This is the future most people envisage – they will work and make enough money to retire and tour the world, often at a fairly young age and nothing will go wrong.
“The reality is obviously far from that. Seven out of ten people are going to have at least one injury or illness in their working lives that will prevent them from earning an income [at least temporarily],” Toerien says.
This is according to FMI’s own claim statistics. “What is even more scary is that once it has happened to you once, it is probably going to happen again.”
Toerien says more than half the claims they pay are from individuals that have claimed before. A big concern is that people’s decisions are informed by their current situation. Even where investors have a rainy-day fund that can provide an income for two or three months, this is only enough to support them during the first temporary injury or illness in many cases. Moreover, temporary disability or interruptions in income can have long-term or permanent consequences – also on the individual’s retirement savings.
“Protecting your income is not actually enough. It is choosing the right type of cover, making sure you have the appropriate waiting period. Making sure you can protect 100% of your income at every single point in time.”
Toerien says future insurability – tools that allow an individual to increase or decrease the cover even amid changes in health – is also important.
Just having your claim paid is insufficient – investors need to ensure they choose the shortest available waiting period. If they have to wait 60 days for the money, it is likely that they would already have missed payments and credit records might be affected.
Myth 2: You know exactly how much you’ll need to retire
Toerien says this is often driven by two rules of thumb – that investors need 75% of their final salary as an income in retirement (a 75% replacement ratio) and that 20 times that amount is a sufficient lump sum to invest at retirement.
But the 75% replacement ratio likely won’t be enough where retirees still have debt and/or dependents. Healthcare costs and medical inflation can also have a significant impact on the amount of money they’ll need.
“The cost of long-term healthcare and how that impairs your retirement income is a massive concern.”
Investors need to save more, work longer or accept that they will need to live on less in retirement, he says.
One of the ways South Africans can save more is by taking a different approach to their risk planning, which can have an effect on the investment side of the equation. Toerien argues that the best way to do this is by using a life insurance product that provides a combination of monthly income and lump sum benefits in the event of temporary or long-term disability or critical illness.
“If one recognises that income benefits are a much better fit to the way you approach your life and that they are much cheaper, it will affect the way you select your risk benefits.”
By taking a different approach to risk cover, investors can stretch their retirement income by several years, he says.
Myth 3: You will retire at 65 and live until 90
The reality is that people retire at 65 because this has been the retirement age for a long time. Yet, life expectancy has increased significantly since the retirement concept was introduced.
Work gives people a sense of purpose. People are 30% more likely to die in their first year of retirement than in their last year of working, Toerien says. This is not because of risky hobbies, but because they’ve lost their sense of purpose.
While only a small percentage of South Africans can afford to maintain their standard of living if they retire at 65 and many people don’t want to retire, this reality hasn’t been built into financial planning yet, he says.
Two-thirds of the income protection policies they receive and accept monthly have a cease age of 65 or less, Toerien says.
“We know our clients aren’t going to be retiring at 65, yet that is still the selection we are making on the risk policies. We have to start using the reality as we know it today to inform the decisions we are making today.”
People are living longer. In England and Wales, the older-than-90 population increased by 33% between 2002 and 2012. By 2012, there were around 500 000 people in that age group. One study suggests that babies born today will live to 104 on average.
“We have to accept that the world has changed. We have to accept that our lifestyles are different and retiring at 65 is no longer realistic. Planning your finances around dying at 90 also does not make sense anymore.”
Saving more, working longer and changing the approach to risk planning can change the type of retirement reality people can expect substantially, Toerien argues.
“Risk planning and investment planning aren’t two separate conversations. They are inextricably linked…Your approach to one can have a significant effect on the result of the other.”