Michelle is due to retire next year, and most of her savings are in equity. Having reaped the benefits of equity investments for the past 30 years she will continue to park her savings in equity instruments well into her retirement. Sounds mindless?
There is a commonly cited rule in investing for retirement where an individual’s equity exposure should be about 100 less their age. Many advisors are revising this to a 110 or even 120 to account for increased life expectancies and protracted inflation (read about rising equity glide path)
Equity, as an asset class, is considered precarious and is often looked at with a myopic lens: with most people not staying the course because of short-term volatility. If there was a simple way to hedge or insure money in equity instruments against market downturns, where people can pay a small premium to safeguard their money (within certain boundaries) from a market slump – equity exposures could be high irrespective of the investment horizon. Not everyone needs their money at the same time, and by spreading the risk across many equity investors, one could ensure that persons having to withdraw at a particularly bad time are not as adversely affected as they otherwise would be.
Today the risk diversification happens at the portfolio level where people divide their investments into various options such as equity, property, debt, gold, cash etc. to balance out the risk rewards. Methods available to safeguard equity investments are call/ put options either at an individual stock level or at the index level; however, there are few takers because of (a) a lack of understanding of these options, (b) high costs, and (c) the inability of these derivatives to insure investments such as mutual funds.
The ideal insurance would look something like the wage insurance proposal by the Obama administration – where workers who blamelessly lose their jobs or switch to a new job that pays less than $50,000 are insured for a sum of $10,000 for upto 2 years. The insurance premium estimate for this scheme is fairly inexpensive – about $25 per year.
An affordable insurance policy such as the one proposed above that protects equity savings could be very beneficial for individuals, more so for retirees to help them beat inflation. It could relieve individuals of the hefty fees charged by managed accounts and/or target date funds /model portfolios that rebalance periodically to balance out risk. It could replace or supplement any life insurance covers and can potentially decrease social security payouts as well.
A substantial increase in equity investment will bode well for the markets and the economy as well. One cannot predict contingencies, much less the markets, and this sort of insurance will allow a higher equity exposure without having to worry too much about market downturns.
Now for this sort of program to work, the industry will need
1. A central regulatory body that safeguards interests of individuals and ensuring that institutional investors do not benefit at the cost of the retail investors
2. A well-designed insurance policy that incentivizes persons to adopt it, one that is available widely across different equity portfolios and one that is not expensive.
3. Stringent rules and enforcement of the same to avoid any unfair practices – like a cap on the benefits, restrictions on the number of withdrawals that can be taken under this scheme, timing of withdrawals, insuring close to withdrawals etc.
4. Education to improve financial literacy of individuals
Finally, we will need an insurance company to break out of the mould and experiment with something like this. Radical as it may sound, the underlying concept is quite simple. The TAM (Total Addressable Market) is a fairly large one and there is little risk of adverse selection. With the amount of individual data available today as well as the sophistication of mining and underwriting tools to assess risks and prices, it should not be difficult to come up with an appropriate model for equity insurance. This could very well be the next game changer in the Insurance and Investment industries.
