Finding the Retirement Income Sweet Spot for Your Business
Asset managers and insurers are looking for new solutions for retirement portfolio decumulation. With literally trillions of dollars, euros, pounds, pesos, yen, etcetera in retirement assets, the stakes couldn’t be higher.
Portfolio decumulation is challenging for everyone. The problem is longevity risk. Trying to manage longevity risk individually could hardly be more inefficient. To outlive one’s savings is a disaster. To live an unnecessarily frugal lifestyle out of fear is almost as bad. The solution is to pool longevity risk, diversifying and minimizing it.
Until now, asset managers have lacked to ability to pool longevity risk. Pooling has been the realm of insurers offering guaranteed annuities. But insurers are mindful that the high cost to maintain their guarantees reduces their attractiveness.
Fortunately, there is another way – Modern Fair Tontines. Modern tontines pool longevity risk in the most efficient way possible, and they do so inexpensively. They involve no insurance because they make no guarantees and involve no risk transfer. Instead, they simply pool risk and make payouts in a formulaic manner based on the requirement of being fully funded. The combination of omitting guarantee costs and adherence to fully funded status maximizes the efficiency of the arrangement.
The Retiree’s Dilemma
At the 10,000 foot level, retirees have been given two choices, each with pros and cons:
- Drawdown your retirement portfolio on your own (perhaps with help from an advisor), or
- Buy a guaranteed income annuity product from an insurance company.
Guaranteed annuities are great because they pool longevity risk, which economists have shown to be optimal (“utility maximizing”) for most investors. But they typically are opaquely priced, and their guarantee costs have to be passed on to the buyer, which reduces the amount they can payout. The these and other reasons, annuities are unpopular in most countries of the world.
Let’s give people a middle choice
Doesn’t it make sense to also offer retirees the high-value benefit of risk pooling without the high cost guarantees? And even better, to offer it all transparently?
With modern tontines, this is now possible. Although they are irrevocable like annuities, they offer the benefit of risk pooling, longevity (i.e., mortality) credits, assured lifetime income, transparency, upside potential, and at least partial control (for example, investors can select their own portfolios and change these portfolios as they wish).
Modern tontines are sticky assets. They make payouts for life, but otherwise the assets always remain in the pool. Even at death, investor balances remain in the pool.
The key to modern tontine design lies in actuarial fairness, which opens up a world of design possibilities. Perhaps most importantly, it allows tontines to operate in perpetuity as open-ended pools with heterogeneous membership, rather than only as closed-end pools with homogeneous membership. Closed-end pools are certainly possible, but suffer from the fact that the membership size falls over time as the investors die, which reduces the effectiveness of the risk pooling over time. In addition, providers of closed-end pools must continually create new pools to offer to new sets of retirees, and multiple pools are more expensive to operate. Open-end pools do not suffer these problems.
Nuovalo is a pioneer of fair tontine design and your trusted partner in the design and development of portfolio longevity risk pooling.