How Intuitive Should Retirement Income Products Be?
François Gadenne has written extensively at this blog on retirement income issues including essays addressing the present and future activities of the Retirement Income Industry Association (RIIA).
In terms of today’s essay Francois wears a different hat. He writes from the perspective of his role as President & CEO of Retirement Engineering, Inc., where he is involved with developing next-generation retirement income products. Given that a significant percentage of my readers have a keen interest in retirement product development, I felt that it would be appropriate to share François’ essay with you:
What are the generic investment approaches available to investors today and how well do they fit the evolving needs of the retiring retail investor?
The financial industry, thus far, has focused primarily on diversification-based investment approaches. These were particularly appropriate during the Accumulation phase.
However, influential academics such as Professor Zvi Bodie will point out that insurance and hedging are important approaches to consider as well. These additional approaches become increasingly relevant as one’s focus moves from Accumulation to Retirement Income. To paraphrase, the three pillars of Finance include – diversification, insurance, hedging and it is better to use all three, rather than just one.
The purpose of this post is to present a high-level inventory of investment approaches, past and present, in order to see what the future may bring.
So what are the diversification-focused, products and processes that we have seen for some time? At a generic packaging level, these include:
- Diversification with Risky Assets resulting in probabilistic growth and income potential (i.e. actively managed mutual funds, index funds, etc.), and
- Probability-based income projection and illustration processes for asset allocation among risky assets, primarily differentiated by how well they disclose the variances of outcomes.
Since the turn of the century, the industry has moved incrementally to respond to both the slow demographic change caused by the Baby Boomers as well as to the more rapid volatility in risky asset values. These changes in product and process development include:
- Addition of Principal Protection features with a focus on the process of accumulation rather than the result of income,
- Marketing of guarantees (life as well as income) as optional riders in insurance contracts,
- Patented as well as non-patented extensions of earlier Accumulation advice processes such as Systematic Withdrawal Plans, using probability-based returns projections for asset allocation between risky assets and guaranteed products.
- Asset allocation processes turned into products, first in the form of target-risk funds and later in the form of target-date funds (for a recent discussion on this topic see http://audioevent.mshow.com/time/ ), and
- Distribution advice approaches such as Ladders using income illustrations for asset allocation between risky assets and guaranteed products.
What may be the next wave of product and process development?
At Retirement Engineering, Inc. (REI), our view is that it is time to bring to market products that combine the three pillars of finance (diversification, hedging and insurance) in a series of intuitively understandable retail packages that provide explicit floors under the investor’s retirement income risk. It is time to focus on products that talk to outcomes rather than only to inputs.
The time has come, because both the consumer and the industry have evolved sufficiently over the last five years and appear increasingly ready for it. We also believe that the time has come because REI was recently allowed the first of several pending patents with regards to Future-Income Denominated™ products and other inventions.
The development of new, consumer-focused and intuitive products that combine diversification, options and insurance solutions in one offering may start with smaller, process-focused steps including:
- Adding Income on the Statement – quantification of retirement income on the investment account statement, and
- Adding Impact-of-Consequences-based projection and illustration to probability-based processes/software to integrate risky asset diversification, hedging and insurance guarantees in investment management for retirement income.
At REI, we have a name for this next wave of product development. We call it “Future-Income Denomination™” and we develop Future-Income Denominated™ products and their matching processes.
Future-Income Denominated products and processes have intuitive appeal at the investor’s level because they distill the problem from complexity and intractability to letting the investor’s tolerance for retirement income variance set their allocation between less-risky and more-risky investment vehicles.
In addition to its Future-Income Denominated™ products including the Genuine Retirement Income Security (GRInS®) family of products, REI’s inventory of processes includes specific implementations of the initial process-focused steps, including:
- Future-Income Denominated approaches to allow the presentation of income on the statement, and the
- IncomeAtRisk™ Framework for planning software and income benchmarks.
Our clients are the financial institutions that manufacture and distribute products and processes. Information about REI’s products and processes is provided under mutual non-disclosure agreements. The mutual non-disclosure agreement is available here .