Ken Mungan, Milliman’s Financial Risk Management practice leader, is quoted extensively in an article about Milliman’s customized hedging strategies for individual accounts, in the March 16 edition of Retirement Income Journal (access to the entire article requires login).
“We’re seeing the emergence of a client account on a platform with a protection strategy that would contain hedge aspects,” according to Mungan. “So many people have withdrawn from the market. This would give them protection.”
Milliman’s new service is driven by three factors: the failure of diversification during the recent global financial crisis, low bond returns, and the need for Baby Boomers to invest in equities in order to make up for their failure to save enough for retirement.
Mungan explains that Milliman’s approach offers investors a middle path—between advisory services with unprotected portfolios and complete market exposure, on one hand, and variable annuities with living benefits, on the other. Individual investors can participate in uncomplicated hedges that protect against severe downturns without abandoning gains if markets rise. It’s an approach uniquely suited to investors with anxieties about entering a volatile equities markets still feeling the effects of the recent financial crisis.
Does this service compete with some of Milliman’s traditional clients, such as insurers offering VA products?
Not really. In fact, Mungan thinks Milliman’s approach will actually create new business for insurance companies—by increasing the demand for unbundled living benefit riders, aka stand-alone living benefits (SALBs).
More details on the approach can be found at “Overcoming challenges through portfolio protection” on the Milliman website, an article Mungan co-authored with his Chicago colleagues Ghalid Bagus and Matt Zimmerman (who is also quoted in the RIJ article).
Even before things went sour in the financial markets, individuals were having to take on more responsibility for planning and funding their own retirements.
The decline of defined benefit (DB) pensions over the past two decades—and corresponding rise in 401(k)-type retirement savings programs—has been accompanied by an explosion of financial planners, planning tools, and products, all aimed at helping individual investors navigate an increasingly complex financial marketplace.
Ken Mungan, Ghalid Bagus, and Matt Zimmerman, from Milliman’s Financial Risk Management practice, discuss new approaches to risk management that help overcome challenges for portfolio protection in the post-global financial crisis environment.
Risk management based on asset diversification has been central to these innovations.
However, as the authors point out, traditional asset diversification failed to mitigate the effects of a financial marketplace where most asset classes declined simultaneously. Clearly, financial advisors need new risk management protection strategies that “involve assembling and managing a portfolio of hedge assets tailored to each client’s investments.”
Such an approach seeks to counteract the natural tendency of the average investor to buy high, when the market is strong, and to sell low, after significant market decline, which, of course, plays havoc with investment returns.
The authors detail a strategy that reduces risk and enhances the overall value of an investment portfolio by locking in gains from underlying investments and harvesting gains from the hedge portfolio during severe market corrections.
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.