Global Lessons in Developing Post-Retirement Solutions
Blending growth, income and protection for DC retirees
We have researched many post-retirement systems around the world. No market has fully solved the puzzle of a successful post-retirement strategy. The long-term nature and degrees of uncertainty involved often lead to conflicting objectives, apparently impossible to achieve simultaneously.
The move from Defined Benefit (DB) to Defined Contribution (DC) has transferred the longevity and investment risks from the plan sponsor to the individual plan member. Without the actuarial cross-subsidies implied by pooling these risks, the danger of outliving one’s savings is significant. We need to find a better solution to this problem than an early grave.
There are lots of variables in retirement; how long people will live for, the costs of goods and services they will need, interest rates available on their accumulated savings, and so on. Faced with this amount of long-term uncertainty, people tend to suffer behavioral biases and often make poor decisions. We believe that retirees need help about what constitutes a good quality retirement solution to help nudge them in the right direction.
Politics plays a significant, and often unhelpful, role. Due to election cycles and partisanship, politicians often have far shorter time horizons than retirement savers, and the most popular, vote-winning policies are not always the most suitable in the long term. The merry-go-round of post-retirement systems around the world, demonstrating ‘progress’ by politicians, does not help retirees in the long term. Any solution must have long-term cross-party support or, even better, complete isolation from political interference.
We observe that there have been insufficient contributions made into DC plans in the majority of countries we have researched. Our key conclusions are that, in addition to sufficiency of pre-retirement savings, a successful post-retirement strategy requires:
- Stable, real investment returns, net of costs
- Reliable protection against longevity risk, particularly later in life
- Flexibility to adapt to changing requirements
- Simplicity in implementation and communication of outcomes.
A successful solution will inevitably be a blend of investment and insurance components in a balanced manner. With lengthening life expectancies, we anticipate strategies will blend a growth and income account-based approach for the first 15-20 years after retirement with longevity protection engaging in later life. However, an over-arching solution is far broader than simply a fund or insurance product.
We found that the majority of systems currently in place do not achieve satisfactory results on these key requirements. We suggest that solutions could be ‘approved’ as meeting a set of specific ‘needs’ criteria, therefore enabling better guidance for individuals at this difficult decision point.
Where a fiduciary is involved, for example in a corporate plan, an individual could be given a short-list of suitable investment funds and a short-list of suitable longevity protection options from which to choose. The individual would also choose the proportion to allocate to the investment component and the remainder to the protection component. A minimum proportion could be imposed on each. If permitted and tax-efficient, a partial cash lump sum might also be taken at point of retirement. For retirees where no fiduciary is involved at retirement, providing guidance about the need to have both investment and insurance components and having approved choices should help retirees with this difficult decision and improve outcomes for them. Asset managers and insurers should take some responsibility for the thoughtful design of these strategies.
Not all retirees can afford a Ferrari, but most would prefer their retirements to be slow and comfortable, rather than quick and costly. Our suggested approach succeeds in shifting the starting point of the post-retirement conversation towards a healthier long-term solution, giving retirees the deserved opportunity to maximize their financial longevity.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.