Thoughts About Client Mortality Assumptions in Planning
Thoughts About Mortality Assumptions in Financial Planning
-William H. Keffer, CFP®
August 22, 2017
Preface: These are
some notes I took while doing an assignment for a course I am taking through
the College for Financial Planning. The
course is “Portfolio Management for Financial Planners.”
A financial planner’s assumption about client mortality has
a more significant impact on the results, and thus on the planner’s
recommendations, than is often understood.
On the one hand, it would be dangerously aggressive to assume that a client
will live to their average life expectancy, setting them up for a 50%
probability of failure (Evensky, 2011, page 37). On the
other hand, some planners may use ages well past any reasonable probability of
the client’s surviving, such as age 100.
This perhaps unrealistically conservative approach may impose an
impossible and unnecessary burden on the clients in terms of their spending
Evensky argues for the use of an age to which the client(s)
have at least a 70% probability of survival.
And for those in excellent health with a history of family longevity,
the planning ages to which they have an 80%-90% probability of surviving may be
a better choice. Another important
consideration is the fact that couples collectively have a longer time horizon
than either of them individually. The Evensky
text offers the example of a couple for whom there is a 30% probability of
living beyond 88 for the husband and 92 for the wife. However, even though they individually have
just a 30% chance of surviving beyond these ages, there is a 51% probability that
one of them will live past those ages.
A third major take-away is the importance of customizing
these assumptions for each client or client couple. A simple set of questions regarding smoking
habits, current health, and family longevity can be used in conjunction with
some financial planning software to set planning ages for clients tied to
mortality tables at a greater level of specificity. I use this feature in Money Guide Pro.
In a 2011
presentation to “NAPFA University,” a training program for planners, Cheryl
Krueger, CFP, FSA, and a team of her colleagues from the Society of Actuaries
and NAPFA struck many of the same themes as the Evensky text, identifying these
key points for planners to bear in mind about longevity:
People routinely underestimate their longevity
Longevity is highly variable
Couples’ collective longevity is greater than
their individual longevities
Longevity is positively correlated with
education and income
Longevity is increasing, it is expensive, and it
support of the need for a more nuanced approach to choosing a planning horizon,
Wade Pfau points out in a 2016 article in the Journal of Financial Planning (pages 40-41), that planners and
clients may get longevity assumptions wrong for three reasons:
Measuring life expectancy from the wrong age:
Life expectancy at birth is lower than the life expectancy of someone who has
actually attained a higher age, such as 65.
Use of current rather than future mortality
rates: Mortality has and will continue to improve in the future. Planners should use cohort mortality tables
that take this into account.
Clients of financial planners tend to be
longer-lived than the general public: This speaks to the correlation between
income and education and longer lives.
I use the
longevity planning tool in Money Guide
Pro financial planning software which allows for the entry of tobacco,
family longevity and state of current health to arrive at live expectancies and
the associated probabilities. This
allows for a higher level of personalization and takes into account the ages to
which the clients have already survived.
Evensky, H., Horan, S.M., & Robinson, T.r. (2011). The
New Wealth Management, The Financial Advisor's Guide to Managing Clent
Assets. Hoboken, NJ: John Wiley & Sons.
Krueger, Cheryl, et al (2011), "Understanding Longevity:
What to Tell Your Clients"; Presentation to National Association of
Personal Financial Planners in collaboration with Society of Actuaries.
Pfau, W. (2016). "Helping Clients Understand Their Longevity
Risk". Journal of Financial Planning (pages 40-41).
November, 2016 issue.