Risk Management
by Robert Powell
Monday, May 26, 2008
provided by MarketWatch.com


The top five risks you face in retirement, and tips on how to handle them

They say risk is opportunity, but that's true only if one knows what the risks are and how they might be managed.

To that end, the Society of Actuaries has boiled down its list of 15-plus retirement risks to a manageable list of five, along with what it calls "actuarial approaches" to manage those risks.

1. Inflation

There's no doubt about it: Inflation is a big risk for would-be retirees and current retirees. From 1980 to 2007, the annual inflation in the U.S. for all goods and services ranged from 1.1% to 8.9%, but averaged 3.5%, according to SOA. That means an item that cost $1 in 1980 would cost $2.82 in 2007.

But for retirees, the rate of inflation can be even worse - especially for expenditures that represent a big and growing portion of their budget.

Take health care expenses, which tend to rise much more rapidly than general inflation. The cost of medical care has risen nearly four-fold in the 26 years since December 1982, according to the Bureau of Labor Statistics' little-known Consumer Price Index-Experimental (CPI-E) that tracks the rate of inflation for Americans 62 and older. The CPI-E was first introduced in 1982.

Health care that cost $100 in 1983 cost $387 in April 2008, according to the CPI-E. That might not be so bad if health-care expenses as a percentage of a retiree's budget remained the same over the course of a 20-year retirement. But health care represents about 5% of expenditures before retirement, 10% during the first half of retirement (ages 65 to 74) and 15% during second half of retirement (ages 75 and older), according to some studies.

That means health care would not just cost $387, representing 10% of expenses, but it might cost $580, representing inflation and 15% of expenses, given its cost as a percentage of expenditures. Viewed another way, increases in Medicare Part B premiums are far greater than benefit increases in Social Security, according to SOA. And Social Security is the only inflation-indexed benefit that most retirees have.

So what can be done to manage the risk of inflation? According to the SOA, retirees and would-be retirees should consider investing in equities, a home and other assets, such as Treasury Inflation-Protected Securities (TIPS) and annuity products with a cost-of-living adjustment. In addition, the SOA recommends would-be retirees "stage a semi-retirement to delay tapping retirement assets."

2. Outliving One's Assets

For today's 65-year-olds, average life expectancy for American men and women is 17 and 20 years, respectively, says the SOA. But 30% of all women and 20% of all men age 65 can expect to reach 90 years old, making retirement a 25-year affair.

To be sure, it's hard to predict whether one will be among those who live to 90 or among those who die before 70. But there are ways to manage the risk of outliving one's assets. The SOA recommends strategies that preserve principal, including investing in joint-and-survivor annuities and deferred annuities that commence at high ages, such as 75 or 80. "Longevity remains a key risk, and the under-appreciation of longevity risk continues to be important," the SOA said in its report.

3. Loss of Spouse

Women have longer life expectancies than men and traditionally have been younger than their husbands. That means periods of widowhood of 15 years or more are not uncommon, according to the SOA.

Not surprisingly, for many women the death of a spouse is accompanied by a decline in living standard. More than four in 10 widows have no significant income other than Social Security, for instance. And according to some research, a single person needs almost 80% of the income needed by a married couple, yet the Social Security benefit paid to a survivor typically varies from between 50% to 67% of what the couple received, the SOA says.

Again, the SOA recommends managing this risk by using income-producing investments, including joint-and-survivor annuities, and purchasing life insurance.

4. Declining Health

The cost of long-term care in later ages may amount to $1 million or more for a couple over a lifetime, according to the SOA. It's also expensive when viewed not over a lifetime but on a per-hour or per-year basis. According to a recent Genworth Financial report, it costs $18 per hour for a non-Medicare but licensed home-based service, $38 per hour for a Medicare-certified nurse, and $59 a day for adult day care. What's more, Genworth reports that it costs $36,096 per year for an assisted living facility and $72,800 for a nursing home.

Such costs can be mitigated by committing to a healthy lifestyle that includes eating right, exercising on a regular basis and using preventive care, the SOA says. In addition, the SOA says long-term care insurance can pay for the cost of caring for disabled seniors.

And the SAO suggests -- not without reservation -- that retirees look for a continuing care retirement community that caps monthly costs for assisted living and skilled nursing care. Many facilities do cap costs; however, this means some financial risk is being assumed by the facility, and ultimately the residents, and the practice of capping costs needs to hedged adequately.

5. Medical Expenses

Given that medical costs for a retired couple not covered by Medicare could, given a catastrophic illness, exceed $1 million over their lifetime, the SOA suggests retirees and would-be retirees manage this risk by purchasing medical insurance and Medicare supplemental insurance.

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