Risk Exposures During the Career Development Stage

The career development stage involves clients who have progressed economically. Advisors in this stage must update all client data, including income, pensions, budgets, and economic balance sheets. Unlike the early career stage, clients in the career development stage often:

• Possess more assets and savings.
• May have bought a home or homes.
• Earn higher salaries.
• May have slightly lower human capital.
• Are starting families.
• Could be working towards pensions (private or governmental).
• Might be caring for aging parents in some capacity.

Example Economic Balance Sheet: Career Development

$$ \textbf{Economic Balance Sheet} $$

$$ \small{\begin{array}{l|r|l|r}
\textbf{Assets} & & \textbf{Liabilities} & \\ \hline
\text{Savings account} & 80,000 & \text{Mortgage debt} & 45,000 \\
\text{Stock Portfolio} & 140,000 & & \\
\text{Accrued DB government} & 250,000 & & \\
\text{retirement plan (Husband)} & & & \\ \\
\text{Accrued DB government} & & & \\
\text{retirement plan (Wife)} & 130,000 & & \\ \\
\text{Employer pension value (Wife)} & 12,000 & & \\
\text{Property (main residence)} & 320,000 & & \\
\text{Husband’s human capital} & 798,000 & {\text{PV of lifetime} \\ \text{consumption needs}} & 2,379,000 \\ \\
\text{Wife’s human capital} & 1,100,000 & & \\
\textbf{Total assets} & \bf{2,830,000} & \textbf{Total liabilities} & \underline{\bf{2,424,000 }} \\
& & \textbf{Net wealth} & \underline{\textbf{406,000}}
\end{array}} $$

In contrast to the early career stage, the economic balance sheet during the career development stage often reveals higher asset levels. Additional factors include employer-sponsored pension plans and a residential property with an associated mortgage. Furthermore, the present value of lifetime consumption needs may vary, increasing with the addition of children or decreasing as individuals approach retirement age.

Example Annual Budget: Career Development

$$ \begin{array}{l|r}
\text{Combined yearly gross pay} & 220,000 \\
\text{Less taxes and Social Security contributions} & 60,200 \\
\textbf{Net pay} & \bf{159,800 } \\ \\
\text{Less living costs (including mortgage cost)} & 75,000 \\
\text{Less (house repair, maintenance, service charges)} & 2,000 \\
\textbf{Cash available for insurance and savings} & \bf{82,800 } \\
\text{Insurance premiums} & 3,500 \\
\textbf{Funds available to save or invest} & \bf{79,300} \\ \\
\textit{Currently used to:} & \\
\text{Fund investment portfolio} & 60,000 \\
\text{Add to savings accounts} & 15,200 \\
\text{Contribute to wife’s employer’s pension plan} & \underline{4,100} \\
\textbf{Total} & \underline{\bf{79,300}}
\end{array} $$

Identification and Evaluation of Risks in the Career Development Stage

Earnings Risk

Clients with substantial human capital are more vulnerable to income loss. Occupations with volatile earnings require a greater need for disability insurance. Families with numerous dependents face higher earnings risk. Advisors should understand unemployment benefits, their amounts, and timing. For example, if state benefits equal half of an annual salary upon job loss, how would this affect the family budget? A loss in income might reduce contributions to investments and savings and lead to cost-cutting.

Investment Portfolio Risks

Clients in this stage often accumulate assets, like equity portfolios. Advisors must consider the correlation between portfolios and client human capital. For instance, clients heavily invested in their industry may have high correlation between their earnings and portfolio performance, especially if they receive employer stock discounts. This increases the risk of losing personal wealth.

Analysis of Retirement Savings Plans

Advisors should estimate final pension benefit amounts based on factors like current contributions and growth rates. This helps assess retirement income needs and adds to the economic balance sheet. It informs clients about their retirement savings progress.

Other Risks

These risks encompass health insurance and personal liability insurance. Health coverage should suffice for unexpected medical expenses, while personal liability can arise from auto use, residences, or rental properties.

Recommendations to Manage Risk Exposures in the Career Development Stage

Disability Insurance

Calculating the recommended purchase of disability insurance can follow a method similar to the one demonstrated earlier. In the previous section, this calculation was performed when the couple was in the early career stage, with 37 years until retirement. However, in this stage, the couple has less time until retirement but higher salaries. This results in a higher need for disability insurance, though it's important to note that this increase isn’t always guaranteed in later stages of the economic lifecycle. It depends on the balance between having less time to earn and the extent of the increase in earnings.

$$ \begin{array}{l|r|r}
& \textbf{Husband} & \textbf{Wife} \\ \hline
\text{Annual salary income (net) to be replaced} & 30,100 & 245,000 \\ \hline
{\text{Amount of annual disability coverage} \\ \text{provided by the social security system} } & 18,000 & 18,000 \\ \hline
\text{Shortfall} & 12,100 & 227,000 \\ \hline
\text{Benefit period (years until retirement age)} & 20 & 20 \\ \hline
\text{Assumed annual benefit adjustment (nominal)} & 2\% & 2\% \\ \hline
\text{Discount rate} & 3.8\% & 3.8\% \\ \hline
{\textbf{PV of future earnings replacement} \\ \textbf{required (calculated as PV of annuity} \\ \textbf{due)}} & \bf{(203,390)} & \bf{(3,815,662)}
\end{array} $$

Life Insurance

In the career development stage, it's crucial to update life insurance needs. Two common methods, the needs analysis and human life value methods, can be used. Many clients in this stage have dependents, creating a need to provide for them in case of premature death. Human capital is generally lower, but earnings are higher at this stage. Time until retirement is shorter in this stage compared to the early career stage. Often, both methods are used together to determine the needed coverage range.

Obtaining life insurance while in good health is highly important. If clients develop medical conditions later in life, acquiring such insurance becomes more challenging, and available coverage may come with exclusions and limitations. Temporary life insurance is an option, offering coverage until retirement, which is typically around 20 years in the future, coinciding with the expected independence of at least one child.

Question

Compared to the early career stage, clients in the career development stage tend to have all but which of the following?

1. Higher salaries.
2. More human capital.
3. More dependents.

Solution

The correct answer is B.

Human capital represents the present value of future earnings an individual expects during their working years. As people progress in age and career, their time until retirement shortens. Despite typically earning more, they have less time to accumulate these earnings, resulting in lower total present value.

A is incorrect. Clients in the career development stage do tend to have higher salaries compared to those in the early career stage. As individuals progress in their careers, they typically experience salary increases.

C is incorrect. Clients in the career development stage may have fewer dependents compared to those in the early career stage. As individuals progress in their careers, their children may grow up and become financially independent, and they may also pay off some of their financial obligations. This stage often involves a decrease in the number of dependents rather than an increase.

Reading 15: Case Study in Risk Management – Private Wealth

Los 15 (c) Identify and analyze a family's risk exposures during the career development stage

Los 15 (d) Recommend and justify methods to manage a family’s risk exposures during the career development stage