Real Impact Of Global Financial Crisis On Baby Boomers

The Real Impact of the Global Financial Crisis on Baby BoomersBaby boomers are retiring a whole lot less wealthy

THE REAL IMPACT OF THE GLOBAL FINANCIAL CRISIS ON BABY BOOMERS | A.T. Kearney 1

The term “wealth destruction” has become the catchphrase forthe global financial crisis, with more than seven million references on Google. However, the Oxford English Dictionary’s definition of

destruction—the action or process of causing so much damage to some-thing that it no longer exists or cannot be repaired—suggests a more accurate term is required. While it is difficult to quantify, the data indicate that the majority of losses are sitting on paper and reside with large pools of institutional money and extremely wealthy individuals rather than across the general population. To what extent has there been material individual “wealth destruction” as a direct result of the financial crisis? Among which individuals and in what ways? What will have a larger longer-term impact—steep declines in real estate and equity values, or the knock-on effects of unemployment, low GDP growth, and the elim-ination of company benefits?

To answer these and other questions, we conducted analysis across a sample of countries that have some similarities and also very distinct differences in wealth distribution, savings rates, pension regimes, borrowing patterns and use of real estate: • The Anglo-Saxon countries of the United States

and the United Kingdom are at the epicenter of the crisis with equity and real estate bubbles, failed banks, and mature private pension indus-tries managing large pools of assets.

• Italy and Germany, representing the continen-tal European model, have higher savings rates, lower incidences of borrowing and lower use of equities. Retirees remain highly dependent on the state for funding, as private pension systems are still evolving.

• Australia’s compulsory pension savings regula-tion (superannuation) provides a valuable bench-mark for countries with low savings rates and aging populations.

• China, as an emerging market with no private pension system and the world’s largest propor-tion of citizens over age 60, faces its own set of complex challenges.

The global financial crisis is primarily an Anglo-Saxon phenomenon that will have a last-ing impact in the United States and the United Kingdom. The starting point for our analysis is a propri-etary methodology for segmenting and sizing populations by their age, liquid wealth and alloca-tion of assets across cash, securities and pensions.

THE REAL IMPACT OF THE GLOBAL FINANCIAL CRISIS ON BABY BOOMERS | A.T. Kearney2

This methodology, supplemented with Lorenz curve analysis of the evenness of distribution of wealth across each country’s population, enables us to identify where pools of assets are concen-trated, movement of households among wealth bands, funds flows and relative gains and losses in portfolios at a macro level. In this phase, we com-pleted the segmentation for the United States, the United Kingdom and Australia. We have focused on the “baby boomers”—those aged 45 to 64—who tend to control the largest asset pools in many coun-tries. Tens of millions of baby boomers (and their money) will be retiring over the next 20 years. That this most important demographic trend has collided with the worst economic down-turn since the Great Depression has led to much speculation on the future of mandatory retire-ment ages, the popularity of equities as an asset class and potential alternatives, financial advice, and the provision of public and private pensions. The epicenter of the global financial crisis has produced distinct “micro-segments” within each country that are challenging to identify via macro demographic analysis but whose plights are well known and documented. The following are included in these micro-segments:• The 6,000 investors who put a total of $320

million into structured products backed by Lehman bonds

• Victims of the Bernard Madoff and Allen Stanford schemes

• Individuals with deposits with now-defunct Icelandic banks beyond the coverage of investor

protection policies• Employees (current and former) of banks and

multinationals who have lost millions of dollars in anticipated wealth as stock options expired

• Thousands on the cusp of retirement who are sitting on pension portfolio losses upward of 20 percent in the United States and the United Kingdom

• Those whose own businesses have folded or whose homes have been repossessed in the wake of the financial crisis

These micro-segments have experienced wealth destruction in the true sense. While many people have suffered loss of income through unemploy-ment, short-time working or lower demand for their labor, there is little evidence of widespread destruction of wealth—so that it no longer exists or cannot be repaired—among the general population. Each of these micro-segments poses specific challenges both for regulators and the financial services sector. However, on a macro level, it is

The Anglo-Saxon countries of

the United States and the United

Kingdom are at the epicentre of

the crisis with equity and real

estate bubbles, failed banks, and

mature private pension industries

managing large pools of assets.


likely that the knock-on effects of the global finan-cial crisis—unemployment, closure of defined benefit pension funds, higher taxes and caps on salaries and bonuses—will have a far more mate-rial and lasting impact on a larger percentage of the population than the crash itself.

Stark Differences in Wealth Distribution There are two sources of wealth: capital, or pre-existing assets, and disposable income, which is put into savings and becomes capital. The imme-diate impact of the crisis has been on capital; the knock-on effects will be on disposable income. Substantive wealth creation is a function of large asset bases (capital) that can withstand market

shocks, while wealth creation from income is a longer and slower process due to many exogenous factors, as discussed below. Our Lorenz curve analysis enables us to see relative degrees of wealth or capital concentration among the countries studied (see figure 1). Why is this important? Understanding how much capital is in the hands of a few people, together with other factors such as the proportion of savings held in equities, enables us to identify how wide and how deep the impact of the market decline has been across age and wealth bands. There are distinct differences among countries:1 • Australia has the most even distribution, driven

by a combination of compulsory pension sav-1 Similar analyses for Germany, Italy, China, and other countries will follow in a subsequent phase of work.

Figure 1Lorenz curve model of global wealth distribution, 20081

% of households

Equal distribution

% o

f liq

uid

wea

lth

1As of December 31, 2008; all amounts are US$*A Gini coefficient is defined as the area between the Lorenz curve and the line of equal distribution divided by the area under the line of equal distribution. In this chart, the Gini coefficient related to the Lorenz curves depicted, Australia has the lowest number, followed by Germany, the United States and the United Kingdom. (For clarity, they are referenced as income Ginis and not related to the chart)

0% 20% 40% 60% 80% 100%

100%

80%

60%

40%

20%

0%

AUSTRALIATotal wealth: $1.4 trillionTotal households: 8.2 millionGini coefficient*: 35

Lowermass

market

Massmarket

Emergingaffluent Affluent Hyper

affluentHigh

net worthUltra-highnet worth

Source: A.T. Kearney analysis

GERMANYTotal wealth: $5.6 trillionTotal households: 39.8 millionGini coefficient*: 36

UNITED STATESTotal wealth: $23.2 trillionTotal households: 116 millionGini coefficient*: 40

UNITED KINGDOMTotal wealth: $3.6 trillionTotal households: 25.3 millionGini coefficient*: 36


ings and a lower cost of living relative to other countries.

• The United Kingdom’s curve looks similar to what we would expect to find in an emerging market, with 1 percent of the population owning 70 percent of the assets. Ninety percent of the U.K. population has an average £7,000 in liquid assets. They lost very little money in the crisis because they did not have much to begin with. The immediate impact has largely been contained to high-net-worth individuals with very large capital bases who have seen their portfolios recover significantly in the recent market rally.

• The United States’ more even distribution reflects a much larger base of affluent individuals.

The Gini coefficient, a function of the delta

between a Lorenz Curve and the line of equal dis-tribution, measures the equality of that distribu-tion; 100 is perfectly equal, zero is perfectly unequal. The Gini coefficients quoted here, compiled by the United Nations, measure income distribution. At 28, Italy has the most even distri-bution of income here; China, at 47, has the most unequal, followed by the United States at 41. Australia, Germany and the United Kingdom all have similar scores (35, 36), which is perhaps sur-prising given the significant differences in wealth concentration among the three countries. This points to a weak correlation between income and wealth creation. Germans and Italians simply save more money and keep a higher proportion of it in cash (see figure 2), a result of the impact of World War II

Figure 2Sharp increase in savings rates forecast for 2009

Note: China estimated 25% to 40% over periodSources: OECD, ONS, IMF, China Daily; A.T. Kearney analysis

10.2

5.2

2.4 2.3

1.8 1.8

2.0

6.0

9.4

10.5

–2.3

4.7

9.2

1.9

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seho

ld s

avin

gs(%

of d

ispo

sabl

e in

com

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–4

–2

0

2

4

6

8

10

12

14 Italy

11.3

9.910.3

5.1

2.1

–3.1–2.5

2.1

4.0

10.2

10.4 10.69.9

5.1

0.4

–0.8

0.7

1.4

4.2

9.0

10.510.8

7.9

2.2

2.1

0.61.8

2.02.6

9.3

11.4

5.4

5.1

11.2

12.5

1999 20012000 2002 2003 2004 2005 2006 2007 2008 2009estimated

4.8

2.4

9.5

8.4

Germany

United States

Australia

United Kingdom


and hyper-inflation. The relatively poor savings rates in the Anglo-Saxon countries—less than half those of their continental European counter-parts—are well documented, although savings rates more than doubled in the United Kingdom and the United States from 2007 to 2008. Australia’s recent increase demon-strates how effective their compulsory pensions savings scheme has been—the impact on savings rates and wealth distribution in a five-year time period has been dramatic. U.K. and U.S. take note.

Different FatesWhile stock indices lost almost half their value over the period 2007-2008, declines in individual liquid assets were a fraction of market losses (see figure 3). Index gains and losses are not a suitable proxy for estimating losses by individual investors, which is why many estimates of wealth destruction are greatly overstated. Investors in the countries analysed fared very differently in the market downturn due to funda-

mental differences in asset allocation and the structure and maturity of the private pension sys-tems (see figure 4 on page 6). The strong preference of the Chinese for cash, which accounts for an average 85 percent of their liquid assets, enabled

them to increase their wealth during the financial crisis, although this is likely driven by new funds flows from income rather than returns on existing assets. They also made money in securities. In Germany, where investments in mutual funds and direct equities have declined around 25 percent

Figure 3Decline in liquid assets by country compared to market losses1

12007-2008 except Australia, which is 2007-2009; peak to trough (August 2007- February 2009)Source: A.T. Kearney analysis

United Kingdom United States Australia Germany Italy China

–13%

–43%

–18%

–53%

–9%

–50%

–4%

–52%

–11%

–62%Wealth reduction

10%

–63%Stock market reduction

The immediate impact of the

crisis has been on capital;

the knock-on effects will be

on disposable income.


since 2005, the well documented preference for cash and more conservative investments also cre-ated a strong buffer to the downturn. The 18 percent loss in the United States, the highest of any country analysed, is driven by a high proportion of assets invested in equities. The United States and United Kingdom, which both have well established defined contribution (DC) pension sectors, experienced 15 to 20 per-cent drops in pension assets, triggering signifi-cant concern about the fate of baby boomers approaching retirement age and their ability to recoup their losses in time. Baby boomers typically make up 30 to 35 percent of the population in these countries, but hold 50 percent or more of the total assets. Older boomers, those in the 55 to 64 age bracket, are in

the period of highest capital accumulation, due both to capital gains on existing investments and to an increase in disposable income available for investment. They have entered their peak earnings years and tend to have lower expenses, having paid off mortgages and seen their children leave home. Because they have the largest pools of assets, it isn’t surprising that baby boomers also lost the most during the credit crunch. In the United States, 63 percent of the total $4.1 trillion lost from 2007 to 2008 belonged to boomers, with 38 percent ($1.6 trillion) owned by those 55 to 64 years of age. British boomers account for 54 percent of UK losses, the 55- to 64-year-olds 36 percent of the total. Figures for Australia are lower, with baby boomers experiencing around 40 per-cent of the decline.

Figure 4Overall market losses compared to average portfolio losses

3.85

9.76

11.39

–1.75

3.85

7.32

9.69

–1.75

1.51

1.36

1.21

–0.34

1.60

1.04

0.94–0.34

0.290.27

0.73

–0.09

0.190.33

0.65–0.09

2.26

2.01

1.51

2.42

1.60

1.540.69

3.81

0.72

3.99

3.79

1.35

3.32

1.44

23.25

19.11

3.753.25

1.20 1.08

6.07 5.83

4.50 4.715.13

4.76

2007 2008

Cash

US$ billions

Stock marketdecline (peakto trough)

Unsecureddebt

Securities1

DC pensions2

2007 2008 2007 2008 2007 2008 2007 2008 2007

United States United Kingdom Australia Germany China Italy

2008

1Defined as cash, securities and DC (defined contribution) pensions minus unsecured personal debt 2All figures are quoted in US$ at constant exchange rates, defined as the prevailing rate at December 31, 2008

–53% –43% –50% –52% –62% –62%


–0.28 –0.28


Detailed segmentation of markets in the United States, United Kingdom and Australia reveals fundamental differences in asset allocation between cash, securities and pensions by age band, as well as gains and losses by age and wealth band. Figure 8 shows the portfolio losses for all three countries. Australia. An importantfeature of the Australian market is its compulsory superannuation scheme (a form of defined contri-bution pension), which has been highly effective in recent years at increasing the savings rate and indeed at balancing out the dis-tribution of wealth (see sidebar: Australia Bets on Superannuation and Wins). Securities portfolios consistently lost about 35 percent of their value, while superannuation plans lost about 11 percent—less than half of that suf-fered by some American and British investors.

There are two primary drivers of this smaller loss: the dominance of multi-manager life stage funds, and a high incidence of pre-retirees taking financial advice. For retail investors, about 30 percent of the

market, the products sold through financial adviser networks are almost all unitized multi-manager managed funds; they have typical asset allocations of 20 percent cash, 25 percent fixed interest, 30 percent Australian equities, 15 percent global

Concerned about the demographic impact of an aging population and the inevitable strain on public cof-fers, in 1986, the Australian govern-ment and the country’s largest trade union agreed that employers would invest 3 percent of wages in a retire-ment savings account in their name, a number that eventually rose to 9 percent. By 2005, 90 percent of wage earners were participating in the country’s Superannuation Plan. Today, Australia’s 22 million inhab-

itants are the beneficiaries of one of the world’s largest pools of desig-nated retirement assets: A$1 trillion, equivalent to 119 percent of GDP, which is expected to double by 2015. Some Australians are retiring with more disposable income than they had during their working lives. The basis of the plan—choice, mobility and the option of self- management—have all stimulated competition and fostered industry innovations. A sizable wealth man-

agement industry has emerged to provide superannuation fund man-agement and advisory services to employers and employees. Currently there are more than 500 different superannuation funds active in the market and a network of approxi-mately 13,000 trained, licensed and regulated financial advisers, which has become a formidable force in the Australian economy.

Australia Bets on Superannuation and Wins

Because baby boomers have the

largest pools of assets, it isn’t

surprising that they also lost the

most during the credit crunch.


equities and 10 percent property or infrastructure (there is some debate about whether listed prop-erty behaves similar to equities or property). Asset allocations are automatically rebalanced toward more secure investments as the investor nears retirement and needs to protect principal. The flight to cash by Australian investors in 2007-2008 was dramatic (see figure 5). A large per-centage of the 25 percent drop in securities was due to positions being liquidated and parked in deposits. As a result, the majority of Australians over age 45 and with assets less than $180,000 (A$200,000) actually made money in 2008, with the highest losses concentrated in the youngest and wealthiest segments—those who are best able to take paper losses and ride the markets back up.

United Kingdom. The largest net declines in assets, about 15 percent, were among the younger or wealthier segments of the market (see figure 6). Compared to Australia and the United States, losses in securities investments were considerably lower, primarily because 44 percent of these investments were in actuarially based, illiquid life-assurance products such as investment bonds and with-profits funds, which have a greater proportion of assets invested in corporate and government bonds. Only 12 percent of assets are held in direct mutual fund investments, in stark contrast to the United States. Although funds flows into cash are nominal com-pared with Australia, Germany and Italy, invest-ments into cash ISAs, a form of tax-deferred savings account, increased 1300 percent 2007-2008.

Figure 5Australia: Total liquid wealth by age group and year

Households(millions)

2007 2008 2007 2008 2007 2008 2007

AUD$(billions)

Baby boomers: 36% of households, 54% of total wealth

2008

1Cash is generated from existing assets including land and buildings, labor and other productive assets. In addition, it can be generated through other contractual obligations, including annuities and defined benefit pension payouts.

3.6 1.67 1.31

Age 45 to 54Age 15 to 44 Age 65+Age 55 to 64

1.65


–74

31

262

63

77

358

–73

20

232

41

94

314

–33

15

320

87

74

464

–32

10

283

57

91

409

–15

30

309

66

86

476

–15

19

274

43

105

426

–428

153

147

100

423

–418

135

65

179

394

Equities

Super-annuation

Unsecureddebt

Cash1

Trusts


The largest declines in assets, 30 percent or more, were in defined-contribution pension plans held by those aged 55 or older—those at or near-ing retirement age. Almost 90 percent of all indi-viduals with a DC pension choose the default fund (made up entirely of equities until approxi-mately 10 years before retirement, when a propor-tion of assets is shifted into bonds). There is a perception in the U.K. life and pensions industry that investors don’t know enough or care enough to take an interest in actively choosing their pen-sion funds or managing their money; there is a significant amount of market data to support this perception. The financial crisis hasn’t helped. Contributions to personal pensions are one of the casualties of the financial crisis, with new

business flows down 25 to 40 percent depending on the type of pension. Few British pension inves-tors, except the very wealthy, are offered financial advice in managing their pension. This is a major gap—and an opportunity—for the industry. Managed funds, similar to those offered in Australia, could provide British investors with a valuable alternative to default funds. United States. There are three striking obser-vations in the United States: the high concentra-tion of money held in securities within all age groups and consistent losses among baby boomers in the affluent and higher wealth bands; a decline in cash positions; and an increase in unsecured debt (see figure 7 on page 10). The proportion of equity ownership is far higher than in any other

DCpensions

Securities1

Unsecureddebt

Cash2

–18

447

82

240

751

–20

409

357

122

868

–43

334

272

232

794

–44

323

311

328

918

–68

156

131

178

397

–60

154

155

209

458

–102

137

79

152

265

–100

149

99

157

305

Figure 6United Kingdom: Total liquid wealth by age group and year


2007 2008 2007 2008 2007 2008 2007

£ (billions)


2008

1The net including capital losses, new capital flows and intra-asset capital flows. 2Cash is generated from existing assets including land and buildings, labor and other productive assets. In addition, it can be generated through other contractual obligations, including annuities and defined benefit pension payouts.



9.9 4.4 4.2 6.510.1 4.5 4.2 6.6


major economy and is consistent across age bands. Strong stock market performance over many years has resulted in more equity exposure than is pru-dent, particularly for retirees, who hold a smaller proportion of their assets in cash than their peers in other countries. The United States is the only country we analysed that actually showed a net reduction in cash wealth among those over 65, compared with an average 9 percent increase in the United Kingdom. One American we inter-viewed summarized the pro-equities cultural men-tality well: “My father, who is 85, had a lot of money in stock. I know this was risky, but the markets had been so good for so long, that you felt foolish not keeping money in stocks. You felt if you weren’t you would be missing out.”

Although life-cycle funds are available for 401(k)s, few Americans invest in them. As of year-end 2007, the typical 50-year-old had 48 percent of his 401(k) assets in equity funds and another 11 percent in company stock. The typical 60-year-old had 40 percent in equity funds and 9 percent in company stock. (The impact of high concen-trations of company stock is explored in the next section). Like their British counterparts, few Americans, with the exception of the hyper-affluent and high-net-worth individuals, use a financial advisor to help them manage their 401(k)s. Few company plans make this service available to their employees. It is a massive gap in a massive market that poses a significant opportunity for advisors and for 401(k) plan providers.

DCpensions

Securities1

Unsecureddebt

Cash2

–196

1,298

2,816

2,816

6,733

–171

1,316

3,143

3,825

8,113

–337

991

3,033

2,200

5,887

–316

1,006

3,865

2,899

7,455

–437

922

2,449

1,625

4,559

–410

941

2,944

2,148

5,622

–913

576

1,393

721

1,777

–813

621

1,529

1,004

2,342

Figure 7United States: Total liquid assets by age group and year


2007 2008 2007 2008 2007 2008 2007

US$(billions)


2008

1The net including capital losses, new capital flows and intra-asset capital flows. 2Cash is generated from existing assets including land and buildings, labor and other productive assets. In addition, it can be generated through other contractual obligations, including annuities and defined benefit pension payouts.3Assumes annual household growth rate of 0.5%



47.8 24.1 19.7 24.448.3 24.4 19.9 24.6


Wealth Concentration=Loss ConcentrationSo far, we have talked about some large declines in asset values, over half of which are held by baby boomers on the cusp of retirement and more than one-third by retirees in the United States and the United Kingdom. Do we need to prepare our-selves for a massive increase in demand for govern-ment pensions? Perhaps, but not because of losses in portfolio values incurred from 2007 to 2008. Impact outside high-net-worth households. In the United Kingdom, the United States and Australia, high-net-worth and ultra-high-net-worth households—those with the largest capital bases and therefore best positioned to ride out the market turmoil—took 70 to 75 percent of the losses. However, there were fairly significant differences in how the remaining losses were dis-tributed among the other wealth bands in these countries (see figure 9 on page 12). In the United Kingdom, where 90 percent of the wealth is controlled by the top 2 percent of households, the hyper-affluent—those house-

holds with liquid assets of £500,000-£1 million—accounted for 23 percent of losses, with the balance of £30 billion or just under 7 percent evenly distributed among the affluent and mass market. In Australia, the affluent and the rela-tively small hyper-affluent segment took the bal-ance of losses, 15 percent or A$33 billion. In the United States, which has large middle and affluent classes relative to other countries, losses are evi-dent in every wealth segment: the mass and mass-affluent (6 to 7 percent), the affluent (14 percent) and the hyper-affluent, which accounted for 18 percent with close to $1 trillion in total losses. These small percentages make for some very sig-nificant absolute losses. Not surprisingly, because they hold the greatest concentration of assets, baby boomers aged 55 to 64 account for the vast majority of losses (70 percent or more) in each wealth band. Overall, these losses have not been sufficient to effect any dramatic proportional shifts in wealth distribution in the United States or the

Figure 8Portfolio losses are concentrated in younger and wealthier segments1

1Losses December 2007- December 2008 measured in local currency Source: A.T. Kearney analysis

Losses:Gains: <4.99% <5.00 to 9.99% <10.00% to 11.99% >12.00%

United Kingdom

Port

folio

val

ue (G

B£)

Age 18-44 45-54 55-64 65+

0 to49,999 –9% –12% –9% –2%

50,000 to99,999 –12% –11% –8% –4%

100,000 to199,999 –16% –13% –9% –6%

200,000 to499,999 –15% –14% –11% –8%

500,000 to999,999 –16% –15% –13% –9%

1 million + –15% –13% –12% –8%

United Kingdom

Port

folio

val

ue (A

UD

$)

Age 18-44 45-54 55-64 65+

0 to49,999 11% 10% 8% 0%

50,000 to99,999 –2% 11% 9% 4%

100,000 to199,999 –15% 7% 9% 5%

200,000 to499,999 –12% –12% –6% –2%

500,000 to999,999 –12% –14% –13% 1%

1 million + –24% –21% –19% –19%

United StatesPo

rtfo

lio v

alue

(US$

)Age 18-44 45-54 55-64 65+

0 to49,999 9% 61% 8% 2%

50,000 to99,999 –6% –10% –11% –5%

100,000 to199,999 –12% –15% –19% –9%

200,000 to499,999 –13% –19% –18% –11%

500,000 to999,999 –16% –20% –21% –15%

1 million + –17% –17% –20% –19%


Figure 9Relative losses among wealth bands (2007 versus 2008)

Note: All figures are in domestic currency and rounded.1Lower mass market, on average, are net debtors. Source: A.T. Kearney analysis

Liquid wealth

£ (b

illio

ns)

United KingdomTop 1% hold 70% of liquid wealth

2.2trillion

2.5trillion

High- and ultra-high net worth

Hyper affluent

Emergingaffluent

Affluent

Mass market

Lowermass market1

Percentageof house-

holds

2007liquid

wealth

2008liquid

wealth

89

4

17070

100

190

270

1,760

160

7090

180

190

1,530

3211

Liquid wealth

US$

(bill

ions

)

United StatesTop 1% hold 48% of liquid wealth

19.0trillion

23.5trillion

Percentageof house-

holds

2007liquid

wealth

2008liquid

wealth

9

66

753

1,235

2,766

2,481

11,883

7761,420

3,293

3,101

14,855

8

9

44

Liquid wealth

AU

D$

(bill

ions

)

AustraliaTop 1% hold 34% of liquid wealth

2.2trillion

2.6trillion

Percentageof house-

holds

2007liquid

wealth

2008liquid

wealth

37

21

53128

187

251

444

658

58

130

253

411

168

523

21

3

16

1

United Kingdom, although our analysis indicates that approximately 220,000 U.K. households actually “traded down” in wealth band over the past twelve months. Australia is a different story: high-net-worth individuals own 4 percent less of the total pool of wealth than they did a year ago, most likely because their average liquid assets sit close to the A$1 million lower boundary of the wealth band. It is highly likely, however, that many inves-tors recouped a significant proportion of their losses in the recent market upswing. Our models indicate a time horizon of three to four years to recoup all losses incurred 2007-2008, based on

a conservative scenario that references historic stock market performance post corrections.

Citigroup: The Impact of Equity Compensation on Wealth DestructionThe use of company stock as a core element of compensation has accelerated rapidly since the 1980s, coinciding with a sustained bull market and the baby boomer generation entering its peak earnings years. The financial services sector was one of the leading proponents of equity compen-sation, a practice far more common in the United States and among large multinationals than in Europe. Options were the ultimate form of pas-


sive savings, providing baby boomers with a capi-tal base that offered the potential for significant wealth creation with very little effort. Then the market crashed, taking down such prominent institutions as Lehman Brothers, Bear Sterns, Merrill Lynch, RBS and Citigroup. How much wealth was destroyed for employees of these banks who had substantial stock positions, either via outright ownership or options? We tapped Citigroup’s alumni network to ask them about what the impact has been on their net worth.2 In July 2007, the month in which CEO

Chuck Prince claimed that Citigroup was “still dancing,” the stock price was at $51.64. It went into free-fall soon after and is currently trading at $4.04. While 30 percent of Citigroup alumni responding to our survey lost nothing (“I sold everything in 2006. It is the best decision I ever made”), the remainder suffered an average $620,000 hit to their net worth—roughly 25 to 45 percent of their portfolio value—the majority of which was via outright share ownership (see figure 10). “I have lost about $400,000,” one told us. “The impact is material. I was hoping to take

Figure 10Findings in Citigroup survey

Notes: Total number of respondents = 78; average losses since June 2007 (assuming negligible trading volume within period);expired options assumed to have strike price of three years prior value with no discount; dividend income losses annual

Sources: Citigroup alumni survey;A.T. Kearney analysis

Capital losses

Estimated losson live options

Dividend incomeloss (1 year)Loss on expiredoptions

>45%

10% to 25%

26% to 45%

<10%

Composition of losses from Citistock collapse by wealth band

$620,000 average loss Total losses (US$ thousands) Percentage of respondents

Retirees lost an averageof $843,000

Years until retirementUS$ millions

Average net losses to net worthranged from 10% to 45%+

<$0.50

78% 78%87%

82%

64%

1%

25%

10%

2%

11%

6%

2%

7%5%

2% 2%

3%

17%12%

9%

$800,000$930,000$530,000 $840,000$280,000

$0.50to $0.99

$1.00to $2.49

$2.50to $5.00

>$5.00 Retired

$843

$632

$456

$698

$297

0 to 5 6 to 10 11 to 15 >15

Age

<45 45 to 54 55 to64 65 to 75 >75

2 Note: Among study respondents, 85 percent are baby boomers primarily 55 to 65 years of age. More than half are high-net-worth individuals with more than $1 million in liquid assets. The rest are considered affluent, with assets ranging from $100,000 to $1 million. Most are Americans; 65 percent are vice presidents, 20 percent senior and executive vice presidents. Roughly 25 percent are now unemployed, with several reporting that they are victims of Citigroup’s layoffs after many years of service and express concern about finding work at their age. The average tenure is close to 20 years. Additionally, 89 percent of respondents over the age of 45 are members of the Citigroup final salary pension plan, which they anticipate will contribute 20 to 30 percent to their monthly retirement incomes.


my capital base in Citi stock and diversify it so that I could grow further. Now I can’t.” Those within five years of retirement have serious decisions to make about when they will stop working. “I would have been able to retire comfortably in five years. Now I may have to work at least another five.” On a percentage basis, the affluent and the lower end of the high-net-worth group lost the largest proportions of their portfolios. Many respondents admitted falling foul of a fundamental tenet of sound invest-ing: they put too many eggs in one basket. The Citigroup dividend is one rational justification for this. Retired respondents estimate an annual dividend income loss of close to $15,000, those aged 55 to 65 losing approximately $10,000. “The portfolio loss is bad, but I could have ridden that out. The real crisis for me is the dividend, which is a major portion of my retirement income. I am going to have to sell part of my portfolio at a loss and switch to other equities that have a steady dividend income stream.” Citigroup’s policy since 2003 of mandating that 25 percent of all bonuses be put in restricted com-pany stock—and then strongly dis-couraging trading when they vested—was also one of the drivers of excessive portfolio concentra-tion in Citi stock. The false promise of anticipated wealth from options has had a significant impact. “I am at least 10 years behind where I thought I would be,” said one alumnus. Our small sample of respondents had more than 300,000 options between them with an average strike price of $42—ten times the current stock price. One-third of these options have already expired worth-

less, while another one-third have an exercise date for the fourth quarter of this year. “I have lost $250,000 to $500,000. If they had given me my bonus in cash rather than stock, I would have been able to pay off my mortgage.” While the majority of these losses are still on paper, few are optimistic about the stock returning to pre-crash levels any time soon. Most are recali-brating their expectations for their retirement, as

they will be considerably less wealthy than they expected. “I thought I would be really well off and not have to worry about anything. Now I think I will just be comfortable—I hope.”

The FindingsOur analysis has enabled us to construct a fact base for dissecting the real impact of the global financial crisis by age and wealth band. There is minimal evidence of widespread wealth destruc-

“The real crisis for me is the

dividend, which is a major por-

tion of my retirement income.

I am going to have to sell part

of my portfolio at a loss and

switch to other equities that

have a steady dividend income

stream.” — Former Citigroup

employee


tion, with the majority of losses being on paper and concentrated among high-net-worth individ-uals and pension funds. The global financial crisis is primarily a U.S. and U.K. issue. The following are the major observations from our study: • True wealth destruction is contained to cer-

tain groups. Wealth destruction has been lim-ited to specific and unfortunate segments of the population, such as employees of businesses, including Citigroup, who have seen 40 percent or more of their wealth go the route of the share price, individuals who have lost their homes, and victims of the Madoff Ponzi scheme.

• Most losses are concentrated among the wealthy. About 70 percent of losses—the majority of which are on paper and being recouped—are concentrated among the wealthy, who, with their large capital bases, are the best positioned to ride out market volatility.

• Baby boomers have been hit hardest. Baby boomers aged 55 to 64 have the greatest con-centration of assets in all countries studied, given that they are in peak earnings years and have more disposable income. Because they are the segment with the most money, they are also the segment that lost the most in the crisis, particularly from their pension funds.

• The wealth of U.S. and U.K. baby boomers was not well diversified. They had too high a per-centage of their pensions invested in equities, violating the basic principle of shifting a greater proportion of investments into cash and bonds as the date of retirement approaches.

• The general lack of financial advice taken by Americans and Britons in setting up and man-aging their defined contribution pensions is a significant gap, as is the use of managed or life-stage funds that can guide asset allocation.

• Australia’s superannuation plan helps bal-ance wealth distribution. In Australia, the com-

pulsory superannuation plan has had a dramatic impact on evening out wealth distribution and driving up savings rates from a very low base in a short period of time. The use of financial advice and managed funds protected Australian investors in the downturn. The United States and the United Kingdom have a lot to learn from this.

• The role of company stock in employee com-pensation leads to dangerous portfolio over-concentration in one equity. To what extent do companies need to take on greater fiduciary responsibility to their employees? Given the sustained bull market, many, particularly in the financial services sector, thought their stock would only go up. Unfortunately this hasn’t proven to be the case for employees of Citi-group, RBS, Lehman Brothers and Bear Sterns, among others.

• The latest crash is part of a cycle rather than an inflection point. The rally that began in March 2009 has seen assets flow from low-yielding cash back into equities, evidence of rational behavior on the part of investors. The pattern is comparable to what happened after 1987 and following the dot com crash. This makes the latest crash look more like part of a cycle than an inflection point.

• The after-effects will be worse than the impact of the initial crisis. The knock-on effects of the crisis—unemployment, higher taxes and cut-backs in company benefits, for example—will have a far more substantive impact on baby boomers and the age group behind them than will the drop in the markets.

• The global financial crisis is most likely the final nail in the coffin of defined benefit pensions. For years, defined-benefit pensions have allowed people to avoid taking responsibil-ity for saving for retirement—their employer


did it for them. Well over half of all U.K. and U.S. boomers will receive retirement income from their employers. These plans have become far too expensive for companies to sustain, and are cited as one of the major causes of the bank-ruptcies at Chrysler and General Motors and economic difficulties at Ford, British Airways, BT and others. The result has been a flood of

plan reviews, with many prominent global com-panies either closing their plans to future accru-als or capping benefits. U.K. corporations have saved an estimated £1billion over the past 12 months by cutting back final salary benefits. Similar cuts are also being made to defined con-tribution plans, which already offer far lower benefits to employees. Saving more is the only way to make up for the loss in these benefits. The proposed tax increases in the United States and the United Kingdom will certainly not help. In addition, the United Kingdom’s pro-posed elimination of pension tax benefits for high earners seems ill-advised.

• The speed of wealth creation in the tradition-ally high-income professional services sectors is likely to slow over the next few years. Close to 500,000 jobs have been lost from the finan-

cial services sector, 55 percent of them in the United States and 45 percent in the United Kingdom. Search professionals estimate that investment bankers could see an average $500,000 to $1 million decline in compensa-tion owing to political fallout over bonuses (although several senior bankers report that there will be minimal disruption to compensa-

tion policies, the majority of which are structured accord-ing to long-term incentives). High earners will also bear the brunt of proposed tax hikes, which will further dent dis-posable income and hence wealth creation. Already, the United Kingdom is seeing an outflow of wealthier profes-sionals to countries such as Switzerland after the govern-ment announced a 50 percent tax rate for those with incomes

above £150,000. These segments of the popula-tion are the “sweet spot” for private banks, bro-kers and wealth managers, who may find themselves with fewer new clients to target over the short-term and lower average asset inflows.

Implications for the Financial Services Sector We don’t expect the global financial crisis to drive seismic, transformative change in investor behav-ior; rather, we expect the change to be additive and incremental. There are substantial growth opportunities for the fleet of foot, however, and threats for those in the industry pursuing business models that are at risk of obsolescence: Work out how to make money from lower margin products. It is inevitable that margins will shrink further. The trend for transparency will only

About 70 percent of losses are

concentrated among the wealthy,

who, with their large capital bases,

are the best positioned to ride out

market volatility.


accelerate, as the crisis has made investors even more aware of the prices they pay for advice, trades and funds. The industry will need to determine how to make money out of index funds, exchange traded funds and cash. The heightened awareness of risk also requires more rigorous reporting of underlying investment vehicles, requiring large systems investments by most wealth managers. Get back to the basics of sound investing. Diversification, asset allocation and mitigation of principal risk within older age groups are all basic principles of sound investing. Equities become a bad investment when they are an individual’s sole or primary asset class, particularly for those approaching or in retirement. The crisis has been a reminder that markets go down as well as up. Prepare to adapt business models for the end of defined benefit pensions. Asset managers need to prepare for the fast approaching day when the large pools of institutional assets that they manage for corporate defined-benefit plans go into run-off. Defined contribution plans have lower monthly deposits, higher administration costs and less scope for economies of scale. Bring new advice and distribution proposi-tions to the DC pension sector. Providing finan-cial advice to defined-contribution pension investors is wide-open territory, as are model port-folios and multi-manager products that can support investors in finding the optimal asset allocations for their risk profile. Targeting corpo-rate benefits and HR departments will be the most effective route into this group. Deferred DC pension plan members are also a significant and potentially more urgent oppor-tunity. As ex-employees, they are an expense ata time when companies are cutting their benefits programs. Our research with former Citibankers reveals that the company has outsourced deferred members to a relatively unknown company which

seems to provide only basic model portfolios. As one Citi alumnus said in frustration, “I don’t need some company I have never heard of to draw me a pie chart. I want someone to help me figure out how to fill the gap between what I have and what I need to retire.” Develop compelling propositions for baby boomers. Baby boomers, particularly those 55 to 64 years of age, are an important opportunity. The considerable drop in many of their portfolios creates a catalyst to engage them in advisory rela-tionships that could span 25 years. The financial services industry needs to begin building value propositions based on service, advice and prod-ucts that span multiple phases—peak income accumulation, quasi-retirement that often involves part-time work, active retirement, and the later phases, where capital release and cash flow become paramount. These value propositions should include innovative ideas around health insurance and health care provision. Find ways to engage profitably with the less wealthy. The industry needs to be able to provide advice to individuals with assets less than $500,000 in the United States, and less than £250,000 in the United Kingdom. Provision of financial advice is woefully inadequate among these mass-affluent and affluent segments.

ConclusionThe global financial crisis triggered a barrage of news reports over the past 12 months with big numbers: $30 trillion in market value wiped out; £200 billion crisis hits company pensions; 350,000 people may have to delay retirement or risk living on a smaller pension; millions set to suffer as financial crisis ravages retirement nest eggs. The tone has shifted 180 degrees with the recent market rally: Rallying market recoups $10 trillion in losses; flood of investor dollars flows back into


equities; levels not seen since the dot com boom. Our analysis has enabled us to look behind the headlines at the real impact of the global finan-cial crisis in key countries by age, wealth band and major asset class. While there have indeed been significant declines in portfolio values, there is very little evidence of widespread wealth destruc-tion. Losses tend to be concentrated among afflu-ent and wealthy individuals, who have in fact

recouped a significant proportion of these losses in the rally that began in March 2009. However, many baby boomers have endured substantive losses to their pension plans and have watched the promise of a well-off lifestyle in retirement evaporate. This perceived gap between actual and anticipated wealth warrants closer consideration by the financial services industry as boomers retire a whole lot less wealthy than they had hoped.

Authors

Penney Frohling is a partner based in the London office and head of the firm’s financial institutions group in the United Kingdom. She can be reached at [email protected].

Neil Dennington is a principal based in the London office. He can be reached at [email protected].

The authors wish to thank their colleagues for their contributions in developing and analyzing the study findings and insights in writing the article, including James le Chevalier, Oliver Whittle, Ralf Baldeweg, Fabien Bez, Peter Munro, Gregory Smith, Brendan Ratter, Stephanie Myers, Marco Bernasconi, Olaf Foschi, Ronnie Ahluwalia and Martin Windle.

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