Investing December 10, 2015

Providers Respond to Participants’ Call for Lifetime Income

 

Ongoing product innovation among insurance providers and asset managers is slowly improving choice for investors hoping to convert DC plan assets to guaranteed income streams.

 

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The preponderance of new lifetime income products is very much a positive development given anticipated demand for lifetime income options in the years ahead, according to the Insured Retirement Institute (IRI), especially options hardwired directly into employer sponsored defined contribution (DC) plans. 

This has been a particular area of strong provider focus, IRI finds, but regulatory challenges remain and plan sponsors are still somewhat wary of the amount of fiduciary liability that might come along with in-plan lifetime income.

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Heading into 2016, a vast majority of individuals investing in the DC system say they are open to the idea of in-plan lifetime income options, but only about one in five plan sponsors feel their company would be interested in offering these features. IRI notes that ongoing product development is creating “a wide array of consumer choice regarding lifetime income products, allowing advisers to create retirement plans that better meet the needs of their clients,” both participants and sponsors.

IRI finds product providers delivered a variety of new lifetime income approaches during 2015, with strongest development in the categories of investment-oriented variable annuities (IOVAs), fixed indexed annuities (FIAs), and deferred income annuities (DIAs) that meet qualifying longevity annuity contract (QLAC) criteria.

NEXT: The demographic trends are clear 

IRI President and CEO Cathy Weatherford says the demographic case for lifetime income, whether inside or outside the plan, “has never been more pronounced.” Put simply, there is a huge cohort of Americans who control substantial wealth who are all closing in on retirement and looking for ways to control their spending and insure against longevity risk.

“These Americans will live longer in retirement than any generation before, and will be more responsible for their financial security,” Weatherford says. “This is a tremendous opportunity for the retirement income industry, and we are seeing market participants expand and fill out their product shelves to meet this growing need.”

IRI says annuity providers are encouraged by the current market forces and most feel “well-positioned headed into 2016, with strong liquidity and balance sheet fundamentals.”

“In addition to healthy financials, the expectation that interest rates may soon begin to rise should ease macroeconomic headwinds bearing on the lifetime income market,” the report explains. If interest rates reach or exceed 3% by the end of 2016—which is admittedly on the higher end of economists’ current predictions—IRI says income-oriented annuity sales will likely increase significantly.

From a public policy perspective, IRI cautions that the Department of Labor’s forthcoming final fiduciary rule is a “wildcard that all eyes across the industry will be watching.” IRI believes the final form of the rule will determine the level of disruption to the lifetime income industry and the consumers it serves.

NEXT: Other key findings 

While lifetime income product providers are optimistic heading into 2016, the investors they hope to service are feeling anything but. A rather dismal 27% of Baby Boomers are confident their savings will last throughout retirement, for example. While this group represents “a large pool of consumers who can benefit from lifetime income strategies,” it’s less clear that they will have enough assets on average to shape a livable guaranteed retirement income plan.

Looking to particular product lines, IRI finds sales of investment-oriented variable annuities have increased 94% during the past five years, and they now make up 16% of total variable annuity sales. Fixed income annuities also are “experiencing strong sales as a fixed-income substitute and on the attractiveness of optional guaranteed lifetime income benefits.” Sales of FIAs have increased 50% since 2011, IRI explains, further predicting sales of FIAs “should continue to experience growth with the introduction of new products, including those that offer ‘uncapped’ growth on the portion of the contract participating in the index.”

Additional findings show the number of companies offering deferred income annuities has doubled since 2012. As of mid-year 2015, sales of DIAs were tracking near 2014 sales of $2.6 billion. As recently as 2012, sales of DIAs were only $1 billion, IRI says.

Perhaps most impressive: “While only one QLAC product was available at this time in 2014, there are now 11 companies offering QLAC products that are available for use in either [individual retirement accounts] or workplace retirement plans.”

The full report is available for download here.

Investing December 10, 2015

A Shift in DB Investing Strategies Expected in 2016

Market and regulatory factors will lead defined benefit plan sponsors to pursue more active strategies and different asset classes.
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In the past couple of years, a big focus for defined benefit (DB) plan sponsors has been the interest rate environment. Rising interest rates may be a reality for 2016, says Michael A. Moran, senior pension strategist at Goldman Sachs Asset Management (GSAM) in New York City.

Jeff Coons, president of Manning & Napier in Rochester, New York, agrees: “We’ve been talking a long time about what happens when the bond market gets more volatile. We will now see plan sponsors forced to address it.”

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Since DB plans have a natural time horizon and duration of liabilities, fixed-income investing is to some extent in bonds, but plan sponsors must consider asset return assumptions, and a rising bond environment can be a drag on absolute returns, according to Coons. “We’ve bee talking about what can happen for a few years, but translating it into mandates for portfolios hasn’t occurred. With bond market risk more front and center, plan sponsors will have to address allocations to fixed income.”

The benefit of long-duration bonds in a falling rate environment is important to keep up with liabilities, but it will turn the other way with rising rates, Coons says. He contends there will be more focus on a Barclays-type benchmark. “We will see more active mandates and nontraditional and unconstrained bonds. As an analogy, over time equity allocations have moved from hiring managers whose performance looked a lot like their benchmarks and turned out little value to managers performing above their benchmarks. The same trend will happen with bond allocations,” he tells PLANSPONSOR.

Moran says preparing for a higher rate environment will be a catalyst for a shift to more fixed income. GSAM is seeing continued interest in unconstrained fixed-income strategies that give managers more room to address duration. In addition, they are adding one or two more fixed-income managers to their portfolios to increase fixed-income holdings from, for example, 40% today to 50% next year and 60% thereafter.

NEXT: Need for more returns

With rising rates, it will probably be a tougher return environment in the next couple of years, Moran says. For many plans, this is a risk management exercise; he notes that on an aggregate basis, DB plans are about 83% funded, same as last year, so plan sponsors need return. Plan sponsors should look to shifting equity exposure to protect from downside risk; hedging and smart beta strategies are being used.

Many corporate and public DB plans have reduced their long-term return assumptions, but it may still be a challenge to hit those, Moran predicts. He says passive management has worked for corporate plans the past couple of years, but now they need active management, or to use asset classes such as real estate, private equity or emerging market debt.

Public plans, in general, have always been more return-focused than corporate plans, as more corporate plans are closed or frozen, Moran notes. With a longer term time horizon, and many public plans not well funded, as well as the expectation of a more muted return environment, GSAM has seen them expand their use of alternative investments. 

With the divergence of performance in the developing world, Coons expects plan sponsors will rebalance their portfolios to take advantage of what is growing. He notes that before and shortly after the credit crisis, there was a big push to make emerging markets a larger percentage of DB plan holdings, since that was where growth was expected to be. However, since 2011 and 2012 emerging markets have shown a dramatic underperformance, and now there are lower allocations to emerging markets across the pension universe.

“My guess is that there will be a need to rebalance to bring back some of these allocations, but the focus will be on more active mandates,” he says. Coons also notes that growth is coming from the consumer and sciences sectors, so it’s likely mandates will take advantage of emerging markets and consumer-oriented growth.

NEXT: Risk transfer prompts changes in portfolios

Changes in the regulatory environment—funding relief and higher Pension Benefit Guaranty Corporation (PBGC) premiums—are enhancing risk transfer activity, either lump-sum offerings or annuitization, Moran tells PLANSPONSOR. Investment strategies can help prepare portfolios for risk transfer, and after risk transfer, liabilities will be different so portfolios will have to change.

If preparing to purchase an annuity to transfer some pension liabilities, how the plan sponsor pays for the contract will affect pricing, according to Moran. “Typically plan sponsors are paying out of plan assets, so they need to look at what securities in the portfolio are more attractive,” he says. After the transfer, since usually plan sponsors only transfer part of the plan to an annuity, plan sponsors need to change their asset allocations to match the different liability.

When offering lump sums to a group of DB plan participants, plan sponsors will be liquidating a substantial portion of their portfolios. Moran says they need to anticipate from where they will withdraw assets. “They will want to draw from the most liquid assets, so they are not paying a spread. They need to consider how this will affect the remaining portfolio after the lump-sum window.”

Moran concludes that there is always something going on in the markets, but a confluence of factors, particularly on the regulatory front, means we will see DB plan sponsors doing some different things in 2016.

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