You’re standing beside a frozen lake. It’s late March — the snow has melted and re-frozen, with the lake surface as clear as glass. You assume it’s safe for skating, even with the heat of spring around the corner. So you put on your skates and step on the ice.

Or do you?

Not likely, unless you really know the lake. Chances are you’ll test your assumption before you skate — either by chopping a hole to determine ice thickness, or edging out slowly to stress test how well the ice holds. Conditions can change quickly, and with something as dangerous as thin ice, you don’t want to get it wrong.

Just as ice conditions change, economic conditions do the same, almost constantly. That’s why so many institutions stress test their economic assumptions. For example:

  • Financial companies go beyond their best projections to look at challenging scenarios — from equity market declines, to oil price shocks, to no or lower economic growth.
  • Defined benefit pension plans stress test changes to interest rates, market declines and factors related to plan liabilities.
  • The investment managers you rely on to provide portfolio solutions for your clients regularly stress test different economic scenarios, and adjust their holdings to manage risk and take advantage of opportunities based on their findings.

These are important tests that ensure our financial system, guaranteed pensions and investment solutions are sound. But what your clients may be missing is something that can have an equal or greater impact on their lives — stress testing the investment and financial plans you’ve helped them put in place.

Stress testing explained

Whether your clients are building their savings or considering the sources of their retirement income, you’ve helped them plan their finances based on a number of assumptions. Stress testing involves placing a “what if” beside these assumptions — and discussing the potential scenarios with your clients.

A good example: portfolio return expectations. Let’s say your client is 10 years from retirement, and they are actively saving and investing to build their retirement savings. You’ve shown them that if their portfolio averages a 6% return over the next 10 years, they will reach their savings goal. Your 6% return assumption is a reasonable one based on the balanced portfolio they hold. But as 2008 showed us, world events can turn reason on its head.

What if you stress test this assumption, and run projections under a “what if returns were 3%” scenario? This could lead to an important discussion with your client. For example, do they want to increase their savings to mitigate the impact of lower returns? Do they want to keep their retirement date options open, in case they need to work a year or two longer? Do they want to adjust their asset mix, to take some market risk off the table?

Even if your stress testing of assumptions leads to no change, you’ve provided your clients with an understanding of how different events could impact their portfolio and their retirement — and provided them with options they may choose to use either now or in the future.

Different needs, different tests

Looking at different market return scenarios is just one example of how stress testing can open a conversation with your clients. Every situation is different, and there are a number of possible factors that may be worth examining and testing, depending on your clients’ needs and goals. Here are a few you may want to consider.

  • Withdrawals: For clients who are post-retirement, regular withdrawals from savings are typically a key part of their retirement income plan. But what if a large lump-sum withdrawal is eventually needed to cover a medical expense or to help an adult child in financial need? By testing a “what if” withdrawal now, before any withdrawals occur, you can show them the impact this would have and talk about strategies they may want to consider, such as building a contingency fund to reduce the impact.

    Stress testing withdrawal scenarios can also be important for your pre-retirement clients, both for showing what a pre-retirement withdrawal will do to their savings, and illustrating the need to build contingencies into the amount they may need in retirement. These discussions can also raise awareness of other solutions — such as long term care insurance or critical illness insurance — that can provide much needed financial resources in difficult situations.

  • Interest rates: Today’s current rock-bottom rates aren’t expected to rise any time soon, but what if they actually rise faster than expected? Stress testing higher rates could show an impact to many parts of a client’s financial plan. For example, if they have a large fixed-income portfolio, these investments may decline in value as rates rise, or the increased mortgage or loan interest they pay may reduce cash flow and their rate of savings.
  • Longevity: Your retired clients may be fine with an income plan that assumes a lifespan to age 90, but what if they live to 95 or 100? By stress testing these scenarios, you open up discussions about their current rate of withdrawals, and the potential need for income guarantees, whether through annuities or other income protection products.
  • Tax rates: For clients who are on the bubble for income-tested government benefits such as Old Age Security, or anticipate they will be when they retire, it’s beneficial to consider higher-than-expected returns within a registered retirement savings plan or registered retirement income fund. Minimum required withdrawals after age 71 could push them into a higher tax bracket — and their higher income could reduce or eliminate the government benefit. Testing for these higher returns now could lead to a change in strategy, perhaps channelling a greater portion of savings into a tax-free savings account or non-registered investment.

While no single client will likely need all of these assumptions tested, these simple “what if” scenarios can be important tools for encouraging and shaping client conversations — and nudging them to consider actions that could increase their comfort level, or improve their financial outcomes.

Change is constant: stress test different scenarios

Life isn’t static — and financial planning assumptions shouldn’t be either. By stress testing different scenarios for your clients, and updating these scenarios over time, their financial plans become dynamic, and allow for change when change is needed. It also encourages conversations with your clients that can uncover hidden needs and expand the financial planning relationship you have with them.

Rocco Taglioni, Senior Vice-President, Head of Distribution, Individual Insurance and Wealth, is responsible for the overall leadership of Sun Life Financial’s distribution organizations across its Retail business in Canada. His role encompasses the leadership of the distribution company, as President Sun Life Financial Distributors Inc., as well as the Insurance and Wealth wholesaling sales organizations. Through the various leadership teams he oversees the development, direction, and execution of the Distribution strategies centered on wealth management, protection, retirement, and estate and financial planning.

Since joining Sun Life in 2004, Rocco has held various executive leadership roles, including Vice-President Business Development, Group Benefits; Head of Individual Wealth Management; Senior-Vice-President, Client Solutions; and most recently Senior Vice-President, Distribution and Marketing, Individual Insurance and Wealth. Throughout his tenure at Sun Life, Rocco has led various business strategies centered on building, transforming, and evolving organizations and teams to drive higher levels of performance and success.

Rocco has 36 years of experience in strategic leadership in the insurance and investment industries. He has served on and is a member of a number of boards. Rocco is currently President and Chair, Sun Life Financial Distributors (Canada) Inc. and is a member of the Sun Life Financial Investment Services (Canada) Inc. board. He is a member of various industry associations, including Advocis, GAMA Canada, the Canadian Pension and Benefits Institute, and the Association of Canadian Pension Management.

Rocco holds a Bachelor of Arts in Economics from York University.