There’s been a lot of chatter lately in the retirement industry about guaranteed retirement income products in defined contribution (DC) plans. While the challenge these products address is valid, and some of these products show considerable promise, guaranteed retirement income products are hardly a retirement plan panacea.

A guaranteed retirement income product is intended to provide asset protection up to and through retirement in the face of market volatility and painful economic swings. However, these products also incorporate a new set of risks for plan fiduciaries and participants. Sponsors may very well want to help retired employees manage their retirement incomes, but they typically want to do so with vehicles that involve limited fiduciary liability. By adding an in-plan guaranteed retirement income product, such as a suite of annuitized target-date funds, plan sponsors take on a new set of risks:

• Who’s providing the income guarantee? Plan sponsors who consider adopting an in-plan guaranteed retirement income solution need to understand who’s on the hook to make the eventual payout, and make an informed decision about whether the insurance provider(s) backing the annuity are stable enough to deliver on these contracts that may need to endure at least 35 years.
• Are these products a good fit with the investment policy of the plan? The end value of the product is going to be based, in large part, on the investment returns of the product, so it’s important that these products be benchmarked and analyzed appropriately.
• How much does it cost? These products typically carry a hefty fee, in the form of a high operating expense ratio, which eats investment returns over the applicable period of market gains (and may or may not be less than the cost of purchasing an annuity upon retirement).
• What about administrative burdens on plan sponsors? For years, market trends have been moving away from in-plan annuitized retirement income and defined benefit (DB) plans toward more flexible and efficient plan administration and delivery of benefits. Reintroducing joint and survivor requirements would have implications for plan administration.
• What about portability issues? It is highly unusual for plan sponsors to stay with the same recordkeeper for the “life of the plan”; or for a participant to spend an entire career in just one plan. Unlike mutual funds trading through the National Securities Clearing Corporation (NSCC), which have seen a large movement towards open architecture, guaranteed retirement income products are not universally available on multiple platforms.

Until these issues are thoroughly addressed, we are unlikely to see the pace of adoption increase for guaranteed retirement income products. If the vendors of these products are serious about mitigating risk and enhancing the retirement outcomes of a significant chunk of the population, they need to get serious about making guaranteed retirement income products work within the structure of the current retirement plan marketplace—namely, they must be portable between platforms; they must be competitive investment options; they must be priced appropriately; and they must be “guaranteed.”

Investor Daily picks up on the following story out of Australia:

Structured product providers are likely to develop products that offer the same level of capital protection as products with an investment guarantee, but at a much lower cost.

They would be able to do this by not actually guaranteeing a minimum investment amount, but by giving investors access to the same hedging strategies that have traditionally been used by investment banks to make guaranteed products viable.

“In the short term, there will certainly be a shift towards these non-guaranteed structured products,” Milliman financial risk management practice leader Wade Matterson said.

These types of products are not yet available in the Australian market, but Milliman runs financial risk management strategies for providers of these types of structured products overseas.

“We are currently in discussions with an institution about bringing these products to the Australian market,” Matterson said.

The increasing popularity over the past decade of all kinds of financial products that guaranteed a return—variable annuities with investment guarantees, equity-indexed annuities, structured notes, and the like—was based on the idea that they could offer investors upside participation when equities rally while limiting downside losses when markets decline.

Well, along comes the global financial crisis and providers of these products discovered their promises were unsustainable—they were trapped between record low interest rates and historically high volatility.

That conundrum, according to Ghalid Bagus, a principal and financial risk management consultant in the Chicago office of Milliman, brought to the fore issues most investors tended to gloss over in better times—illiquid guarantees, exposure to the provider’s credit risk, and lack of transparency.

Bagus believes that it’s possible to design sustainable guarantee products if investors, not providers, own the hedge assets. The investor can liquidate the hedges they own at any time, credit risk can be mitigated through use of exchange-traded hedges (where margin requirements can help restrain risk), and investors can see the hedges they own as well as the risks being hedged.