Broker World September, 2006
Taking this a step further, the companies and advisors who “get it” – meaning they seize the income distribution opportunity to its maximum potential – are those who will have the greatest success in the future. Demographics virtually assure this. The growth rate of the number of people age 65 and older is accelerating, and the retirement assets held by those people who are age 60 or older will reach an estimated $19.5 trillion by the year 2012 – literally the greatest movement of money that has ever occurred.
What does this tell us? We know where the money is, but we need to better understand the challenges associated with deploying it properly. Moreover, life insurance and annuity professionals are obliged to approach clients and customers with solutions that truly meet their needs.
RISK MANAGEMENT IS ALL IMPORTANT
So what are the major challenges for our industry, our clients and prospects? The truth is that the baby boomers will experience retirements very different from their parents’. Fewer boomers are covered by the guarantees and security of defined benefit pension plans. Healthcare premiums, copayments and out-of-pocket expenses will consume a growing percentage of income. And baby boomers – both middle class and wealthier families – will enter retirement with more debt such as mortgages and credit cards than financial assets.
With the prospect of spending 30 years in retirement, risk management becomes all important. We’ll need to help our clients manage longevity risk (they could outlive their assets) as well as inflation risk, because a client’s retirement income will need to more than double to keep up with inflation over a 30-year time span. Healthcare expenses will continue to escalate at a time when individuals will consume more medical services and bear a larger percentage of the costs.
ACCUMULATION VERSUS DISTRIBUTION
As a result of these challenges, we need to think differently. The economic logic of the accumulation phase is yesterday’s news. We need to shift to “income distribution” logic. The key difference in thinking is that in the accumulation phase of retirement planning, say age 35 to 65, even frequent investment mistakes can be managed because we have time on our side. But, in the distribution phase, from age 65 to 95, time no longer works to our advantage. There is no margin for error, but we still need room for growth.
Here’s a chilling example of a distribution strategy that is not in tune with the right logic. If someone had $100,000 invested in a hypothetical large-cap stock portfolio averaging growth of 12 percent per year, and he withdrew $12,000 per year, what would his balance be after 10 years? Most people would intuitively answer $100,000, because they rely on the “logic” that the 12 percent annualized rate of return is enough to satisfy a 12 percent annual withdrawal. The reality, however, could be quite different, because the situation will depend upon two questions: Were there any years which showed a loss, and when did the loss occur?
| YEAR | RATE OF RETURN | WITHDRAWAL | BALANCE |
|---|---|---|---|
| 1 | -10.5% | $12,000 | $78,760 |
| 2 | 14.5% | $12,000 | $76,440 |
| 3 | 14.5% | $12,000 | $73,784 |
| 4 | 14.5% | $12,000 | $70,742 |
| 5 | -10.5% | $12,000 | $67,260 |
| 6 | 14.5% | $12,000 | $63,273 |
| 7 | 14.5% | $12,000 | $58,707 |
| 8 | 14.5% | $12,000 | $53,480 |
| 9 | 14.5% | $12,000 | $47,495 |
| 10 | 14.5% | $12,000 | $40,641 |
This chart shows that a single loss in the first year – even with nine consecutive years of double-digit gains – causes a loss of nearly 60 percent of that $100,000 asset. In the real world, you might expect at least one more year with a loss sometime during the 10-year period, not to mention what could happen over 30 years. Using this seemingly “safe” retirement distribution strategy doesn’t work because it is based on taking withdrawals for income from a growth/accumulation vehicle – large cap stocks.
Clearly then, the accumulation logic will not work in the distribution phase. While the rules for accumulation focus on dollarcost-averaging and tax-deferred growth, the economic attributes of the distribution phase are: guaranteed income streams, longevity risk management, upside growth opportunity, downside protection for life, and principal protection.
STRATEGIES FOR THE FUTURE
What role will life insurance and annuities play in this unprecedented opportunity? Potentially, a huge role because the core competencies of life insurers reflect the necessary economic attributes for distribution planning. Fixed annuities, guaranteed protection products, and longevity risk hedging are just what conservative clients will be looking for in an income strategy. In fact, a creative safe money strategy utilizing laddered fi xed annuities in specific time frames is an example of a solution offering a high probability of creating monthly income streams which adjust upward at a pre-determined inflation rate.
Such a solution plays to the heart of what insurance companies are terrific at providing: guaranteed “paychecks” and principal protection combined with upside growth potential. Further, retirement income strategies based on accumulation thinking and systematic withdrawals, which are often the recommendations of investment managers, do not address the elimination of investment risk, income guarantees and principal protection factors which will be important to a significant slice of the boomer population.
The key to success will be for the fixed annuity industry to start a revolution in education, communications and marketing focused on retirement income distribution for advisors and their clients. While there has been a great deal written and discussed about retirement income distribution over recent years, the likely inaccurate perception of the “golden years” will need to be overcome by new, creative and innovative messages and marketing support.
The communications should be hopeful, educational and compliant. We all agree that there are huge challenges facing Americans nearing retirement and already in retirement, but there are strategies to create a guaranteed retirement paycheck, and we are the ones who can help put those plans into place.
The critical questions for the fixed annuity industry and advisors are:
- Are you ready to play a robust role in the greatest movement of money to ever occur?
- Are you committed to taking back market share from investment management companies?
- Will you recognize that your inherent advantages and attributes are in harmony with retirees’ needs?
- Will you seize the opportunity to develop consumer-oriented solutions that deliver the results retirees seek?
- Will you communicate with customersand prospects in a frank and honest manner?
- Will you embrace the marketing tools and technologies that advisors need to be successful?
- Will you commit to advisor education and training on income distribution strategies and solutions?
If the answer is “yes” to these questions, then the future holds the opportunity for the life and annuity industry to be in the forefront of defining America’s future retirement security.
Reproduced with permission from Broker World.