INTRODUCTION
Nowadays social and economic development is characterized by the increasing role of the human factor. Today, human capital role takes on a new meaning. In business, it is the main criterion for evaluating the effectiveness of any company in achieving competitive advantage and ensuring qualitative parameters of economic growth, defined as the set of natural innate abilities, talents, creativity, moral, and psychological health; accumulated and improved as a result of investment knowledge and professional experience necessary for purposeful activity in certain sphere of social reproduction, bringing in the income to the owner. Moreover, analyzing human capital it is necessary to pay special attention to asset allocation determining, life insurance, retirement savings, mortality and longevity risks as they all interdependent. When handling asset allocation in the early life-cycle stages human capital and mortality risk should be taken into account and longevity risk should be considered in the late life-cycle stages. Thus, it is necessary to mix these issues in order to effectively avoid possible risks, add value to investor’s portfolio and protect human capital.
The main purpose of this paper is to analyze the problem of human capital, life insurance and asset allocation decisions role relying on several articles that report on these questions.
ANALYSIS
In the recent years individuals began to suffer greatly from the investing mistakes lacking enough knowledge about effective methods of money saving and reaching the financial objectives. Under this circumstances a question arises regarding creation such institutions and models that may allow people to avoid mistakes and have enough money for the older years. Unfortunately, scientists and researches give little attention to this problem; however, still there is some groundwork on this subject that will be analyzed in this paper.
Actually, the most important peculiarity of finance questions is money life-cycle. It means that individual income of people’s productive life-cycle should be distributed effectively over the whole people’s life. However, in the course of time this objective becomes extremely difficult to fulfill as emerging risks are extremely intricate and difficult to be timely foreseen.
In fact, while asset allocating the most dangerous one is the longevity risk as nobody knows how long he will live. The traditional method that is applied nowadays by the Social Security is DB pension (defined-benefit pension) that may guarantee the income to the retired people (Trammell, 42). However, many people don’t want to accept this technique. In this condition, annuity is widely proposed but it is not so popular and has many uncertainties which people can’t understand. Life insurance as the opposite of annuity is more acceptable as longevity risk here is almost fully diminished. However, life insurances are very seldom applied while individual asset allocation and in human capital questions. But it doesn’t mean that it is fully impossible. For instance, Peng Chan and his colleagues in their article «Human Capital, Asset Allocation, and Life Insurance» emphasize the importance of human capital while individual investors’ portfolio building. In their work they develop a framework within which human capital is analyzed in conjunction with asset allocations and life insurance (Chan et al. 97). It is pointed out that human capital and its changes play crucial role while decision-making in risk management.
First of all, the authors note that the main and the largest asset that people have is the human capital, which is very valuable for their future secure lives. Human capital is tightly interconnected with bonds, stocks, and real assets. These investments correlate within one structure, thus they extremely important. Moreover, human capital is also connected with annuities and life insurance as they have payments dependent on owner’s longevity.
The main problem here is the effectiveness of investments in human capital. Other risks involved in human capital issues are earner’s death or so-called mortality risks. Life insurance is the best way to prevent mortality risk. Therefore, human capital is interconnected with both effective assets allocation and life insurance as they are concerned to be the risk replacement tools when it comes to investors’ portfolios.
In their article, the authors present scheme of relationship among human capital, life insurance and asset allocation. According to it, investor’s wealth includes two main wealth types: human capital, which provides investor with future income, and financial wealth, which is quick-selling. To maximize their wealth, investors allocate assets and purchase life insurances. These actions are connected with human capital that makes the greatest part of total investor’s assets. However, within years financial capital tends to increase and become even greater than human capital. For instance, when people in their earning stage, their human capital is very big. Their financial capital, in its turn, is extremely low. As time goes by, human capital transfers into financial wealth because individuals earn and save money. It is the so called accumulation stage. When individuals enter their retirement stages, their human capital is almost exhausted, but financial capital is essential. Hence, any investor’s wealth is made up of two constantly changing and interacting capitals. Understanding of this interaction helps to manage and protect financial assets within people’s lifetime and coordinate people’s financial activity.
The mix of investors’ wealth, which constantly changes, influences assets allocation. The best assets allocation is greatly influenced by labor income in the framework of which the authors propose its main theoretical implication: young investors have more potential for investments and safe human capital allows investing more in stocks and in safe assets (Chan et al. 98).
This article tries to put bonds, stocks, annuity and insurance products in one framework developing an innovative model of effective asset allocation. In total, proposed model is rather innovative as differs greatly from the previous ones. First of all, the authors linked human capital with insurances and assets allocation. Moreover, they pay special attention to heritage motivation influence on life insurance and assets allocation. Furthermore, they link changeability of labor income and financial markets and create investor’s personal survival opportunity.
In their article, the authors proved that human capital has peculiar risks and return features. They demonstrated reciprocity of human and financial capital and importance of life insurance and asset allocation correlation. They relied on the developed and enlarged model of human capital that may help investors to mix asset allocation and insurance products avoiding risks (mortality and longevity ones).
- Decisions on assets allocations and life insurance should be done simultaneously
- The central place in the framework is occupied by human capital
- Interdependence between risky assets and income is crucial
- High interdependence level may lower human capital value and consequently decrease life insurance demand.
- Heritage motivation is more valuable than human capital when analyzing life insurances demand.
The further analysis touches on strategic assets allocation which is discussed in the article written by Brian Jacobsen. In his article titled “Asset Allocation in a Crisis” the scientist explains why it’s so crucial for investors to implement an effective asset allocation strategy to avoid risks and bring in additional value to their portfolios. In his article Jacobsen emphasized the need not just to do the initial allocation but also to change it somehow applying some optimization program (11). Investors may apply different methods – quantitatively or market oriented – while strategic asset allocation. However, regardless of applied method investor should be aware of possible risks to be successful and to earn more. According to Jacobsen, allocation strategy may change with time as when people get older they bring more money to bonds. Thus, financial wealth increases and human capital decreases especially when individuals retire. Human capital accumulated in the form of individual’s income has optional features that enable an individual to choose where to work or when change jobs or a retirement date. Consequently, human capital is considered to be correlation of bonds and options. The author states that management strategies are characterized by option-like features and that the strategy of financial capital aggregation with human capital may help to establish an appropriate allocation strategy.
Much attention in Jacobsen’s article is paid to volatility of human capital. Changing economic conditions may influence asset allocation, and consequently, active market conditions activate allocation process. Investors with long-term market views may capitalize on market limitation that is called as the “fear index”. It is usually increases when investors buy life insurance as they add new options to their portfolios. Actually, investors purchase insurance when it is cheap and sell it when its price increases.
Time also plays a crucial role in asset allocation strategy especially for those investors who apply risk-return optimization to influence asset allocations. Many other risks may also influence investors’ behavior. For instance, international investing is greatly influenced by different political factors and they should be quickly managed and reacted.
Thus, Jacobsen proposes several ways of risk prevention when handling of human capital among which asset allocation occupies the central place. In crisis asset allocation may add value to investor’s portfolio (Jacobsen, 13). Moreover, investors should mind different economic and political factors to effectively coordinate their tactics.
In the previous two articles, the scientists studied human capital and its influence on life insurance and asset allocation decisions for investors in the first life-cycle stage (when individuals earn and save money for the retirement stage). The next article is devoted to the retirement savings and risks that individuals face when deciding to make investment funds in their retirement portfolio. In retirement planning today there is a considerable decrease. Susan Trammell in her article “ThevPool and the Stream” makes an attempt to propose several useful decisions of retirement savings increase and shapes structure of annuity products and ways of their marketing. The author illustrates common faults of investors when making asset allocation in retirement. Actually, in the recent years the retirement savings were considered to be the way of assets accumulating. However, there are too many risks involved here and, as a consequence, the retiree’s reward is very often influenced by inflation and may be reduced to zero (Trammell, 41). Three major risks that appear in the retirement portfolio while making investment decisions are the following:
- Longevity risk
It appears when an individual live longer than it has been planned before and outlive their assets.
- Capital market volatility risk
Financial market unsteadiness causes changes in value of investors’ portfolios.
- The risk of saving too little due to inflation
Inflation level constantly changes and may influence investor’s funds. As the result, they may lose their way in saving strategy and have little money in fund retirements.
However, longevity risk is very often assumed away. Thus, it is crucial to focus on significance of longevity insurance. Long life means for investor that funds should be accumulated for retirement longer than usually accepted. On the one hand, investors may take on all risks aiming to earn more in future. On the other hand, they may protect themselves against longevity risk and to buy insurance against it. Considering these factors, annuities propose their help in providing investors with their assistance against longevity risk that may appear in future and in doling out the accumulated retirement money reserve.
Annuity is a particular insurance type that modifies accumulated money into earnings that insurance institutions pay out during investors’ lives. This payout type is opposed to life insurance products which are bought by investors because of their fear of early dying and leaving their families in financial difficulties. Annuities, in their turn, are bought by investors who plan to live long lives and are afraid to run out of their assets within their lives. Thus, insurance agencies guarantee life-long payoffs for those investors who buy lifetime annuities.
There are two main types of annuities – fixed and variable. Fixed annuity has fixed payment for a fixed period of time. Variable annuity payment may change in accordance with chosen annuity type.
Nevertheless, the Americans annuitize their savings very seldom because of such factors as inheritance motives, high risks level and annuity pricing. It is called the annuity puzzle. In spite of annuity record of 2006 ($236.2 billion), almost two thirds of U.S. households prefer mutual funds (Trammell, 41).
Finance professor Jeff Brown supposed that return on retirement investments is connected with mortality risk that can hardly be managed and overcome. Thus, people should protect their money against being poor at older ages. Researches hold by Brown and other scientists proved the fact that the U.S. consumers eschew annuities preferring investment frame rather than life annuity. However, people’s decision-making and choice depends greatly on the way how the product benefits are presented. For instance, several minutes slide show may impact people’s decision. Brown’s study confirms that women are not so influenced by changed presentation options as men are who prefer the product, which features are positively described.
It is noted in the article that insurance managers sometimes ignore asset managers’ help in creation of effective solutions while longevity protection. However, in the recent time some companies have come to understanding of close cooperation between insurance companies and asset management.
In this article, the retirement savings and main risk factors were presented among which are longevity risk, capital market volatility risk and the risk of saving too little due to inflation. The attention was focused on lifetime annuities that may prevent longevity risk. The analysis presented the idea that combination of two annuity types – fixed and variable – and traditional investment instrument, for instance mutual funds, may help in supplying the retirement income. This article shows that payout annuity is an effective way of longevity risk preventing, however not many people apply for annuitization. Thus, combining common assets with annuitized ones investors may successfully overcome the basic risks occurring in the financial market.
CONCLUSION
In this article we have described how individuals should manage their investment portfolios and resolve financial difficulties within their lifetime involving asset allocation, insurance products and other instruments. The key factor here is human capital which in correlation with financial capital makes the total investor’s wealth. The human capital stimulates income in the accumulation stage of investor’s life and can be protected from the possible risks with the help of life insurances. With time, human capital converts into the financial wealth which increases with investments adding. At the retirement stage the human capital is substituted with pensions and retirement payoffs.
Thus, each article discussed is important in better understanding of human capital importance and its difficulties and problem issues. The conclusion can be drawn that human capital plays a very crucial role in modern society development. It’s greatly influenced by many factors and interconnected with other important concepts among which asset allocation and life insurance obtain the central place. According to Peng Chen and his colleagues, assets allocation and life insurance decision should be made together. These decisions are greatly influenced by human capital, its volatility and magnitude. Additionally, it is underlined that mortality risk is the peculiar risk of human capital. However, life insurance is the effective tool against this risk. The importance of effective asset allocation is emphasized in the second article written by Brian Jacobsen. He insists that applying this tool, investors may diminish risks and add value to their portfolios. The third article is devoted to annuities and retirement savings that are interrelated with assets accumulation.
These articles are extremely important as they reveal the main complications of human capital. The research results are important for new strategy development as currently the effective asset allocation and life insurance are considered separately. That’s why the whole mechanism of investment in human may fail. It is suggested to develop a new model of human capital handling, relying on scientists’ research results analyzed in this work which would help to avoid risks, make effective assets allocation, and to add more value to investor’s portfolio.
Works Cited
Chan, Peng, Roger Ibbotson, et al. “Human Capital, Asset Allocation, and Life Insurance”. Financial Analysts Journal January-February 2006: 97-109. Print.
Jacobsen, Brian. “Asset Allocation in Crisis”. CFA Magazine March-April 2010: 11-13. Print.
Trammel, Susan. “The Pool and the Stream”. CFA Magazine March-April 2008: 41-45. Print.
