Guaranteed Minimum Withdrawal Benefit products entered Canada with a bang, twisted through a few snags related to underlying pricing assumptions and now are cruising along as accepted components of client portfolios for those close to retirement.
So, what’s next?
Paul Lorentz, President of Manulife Investments, notes a great deal of research went in to the original planning of GMWB products prior to their introduction in Canada.
So, to get a handle on what the next decade might hold, Manulife returned to the research fold to conduct a study into Canadian attitudes towards income guarantees, and what keeps investors up at night.
The standout numbers show 80% of respondents saying they want some form of guaranteed income upon reaching retirement, and that fewer than half of Canadians surveyed were happy with their current state of their retirement planning.
Lorentz says the research shows a mind shift among people nearing retirement, with Canadians placing less emphasis on trying to outperform the market and capture upside, and more focus on capital preservation and protecting themselves and their families against downside risk.
“It reconfirmed that guaranteed income products resonate with consumers and really fit with where their minds are,” he says.
The commissioned study by Investor Economics, which also looks at how the guaranteed product space can be expected to evolve, places the current market at $65 billion and predicts it could reach $230 billion by 2020.
“This seems like the time for these types of products,” Lorentz says. “It resonates with consumers, and really is an opportunity to grow this market.”
The key drivers of client uptake, of course, are the current state of equity markets and other factors impacting consumers’ perception of risk.
“You’ve got real uncertainty in the equity markets. You’ve got interest rates that have fallen really low, and are expected to stay there for awhile, and you’ve got individuals who are losing access to defined benefit plans,” says Lorentz. “So there really isn’t a good source of guaranteed income available for a lot of individuals in retirement.”
And, in the face of recent market losses, consumers are placing more emphasis on capital preservation. Taken together, those factors virtually ensure products offering predictable income will be around for a long time.
What will change, though, is the range of product offerings. Lorentz expects them to broaden, with more plain vanilla products entering the market for those who are simply looking to protect against long-term downside risk for their post retirement income plans.
Down the road, products will become less bundled and consumers will pay for the features they value. Particularly in today’s markets, certain options come at a price, so customers would be able to make menu choices based on their own weighting of need over cost.
“It’s a question of what the consumer wants,” says Lorentz. “Today you buy a product that has it all, so you might see some variation in that in terms of more selection.”
These structural changes will highlight the value of advice, because clients will need to be walked through the options—creating an opportunity for discussions around planning and future needs. Advisors still need to be in play to ensure allocation is done correctly.
“Every consumer is different in terms of their retirement plan—what they want in income; how much they want,” says Lorentz. “And I think what we’re starting to see is that when the mix of products, or the product allocation, really is tailored to the individual it can help improve that certainty of guaranteed income.”
Expanding the client base
Time in the market has also worked to the advantage of guaranteed products. Lorentz notes advisors now better appreciate what they can do for clients, and where they fit in to the asset mix. The key going forward will be for both manufacturers and advisors to continually simplify the message and clarify the roles GMWBs and traditional annuities should play within portfolios.
Much of that will come down to helping younger advisors explain the value of the products to younger clients. When GMWBs were launched, they were targeted at a cohort nearing retirement and enjoyed huge uptake among clients between 50 and 65 years old. But that home run’s been hit. “Now,” says Lorentz, “your objective is to continue to hit those home runs by dealing with the demographics of what you have going forward.”
A good place to start will be younger clients who no longer have access to defined benefit pension plans. “Hopefully they’re getting access to a defined contribution plan,” says Lorentz, “but aside from the CPP there is no real guaranteed income [for these younger clients].”
Another potential market is the emerging affluent. This group won’t buy GMWBs to cover basic income needs, but will use them to supplement income and ensure they’re able to support a desired level of lifestyle.
“You get to a point where they’ve saved a lot and decide, ‘I don’t really want [my income] ever to be less than this,’ and these products provide some of that protection for them,” says Lorentz
The new retirement
GMWBs can also let advisors build tiers of income for clients through the spending stages that accompany 21st century retirement—increased spending immediately after retirement, when physical energy levels are high; followed by a decrease when mobility declines; and a spending increase to cover rising health care costs late in life.
Built in flexibility lets clients decide when, and how much, to take out of the product. “If we look at our block, most people don’t take the full amount,” says Lorentz. “They actually take something less, so they have some flexibility and then that stays in there to accumulate and continue to grow.”
If clients start investing in guaranteed income products when they’re younger, it will allow them to accumulate more and take an income at the earliest stage of retirement, deferring CPP until they’re in their early 70s. GMWBs can also provide access to emergency liquidity, although it must be made clear to clients that those draw-downs will decrease income amounts post-retirement.
Such access can also have tax consequences and Lorentz notes advisors should get details about whether clients think they’ll want to use some of the capital before making the decision to put funds into a registered or non-registered instrument. Withdrawing from a registered account has far greater tax consequences, so it’s better to leave that money in the retirement pot.
Flexibility will become increasingly important because clients are actively redefining what it will mean to be retired. Lorentz says this will spur more people to take advantage of product features that allow them to choose when they start taking income.
If a client waits, future income is bulked up. So the ability to evaluate the decision to stop working on a year-to-year basis also needs to include consideration of what it means to the client’s eventual income stream.
“They may decide to do something else or work four days a week instead of five. But every year they can have that option of deferring, having a higher payout,” Lorentz says. “The flexibility that this brings allows that knowledge-based worker more options.”
In that sense, it’s very different from a defined benefit plan, which is focused on a specific stop work date and everything in the plan is built around that date. The ability to choose when to take income makes retirement, to an extent, customizable.
Longevity, mortality, and inflation
From a product manufacturer perspective, Lorentz notes careful attention is being paid to rising life expectancies and the need to price product correctly to account for long-term demographic shifts.
“What provides a natural hedge for most insurance companies is the fact that we also write insurance,” he says. “Longevity risk is reduced, because those that are buying insurance are going to live longer, versus [our having to pay] out benefits.
“That’s the comfort we have as a company in terms of the expertise we have to really look at these products and understand the risks.”
There are also safeguards aimed at the current interest rate environment. “There is a regulatory framework for these particular products,” Lorentz says. “[It] requires companies, today, for all the products they sell, to hold a certain amount of reserves and capital to support those. In addition, for all new business we hedge both equity and interest rate risk to minimize the impact of the change in the economic environment.”
The important thing for advisors to manage going forward is client uptake. Clients have caught on to the fact that GMWBs aren’t intended to be a sole source of retirement income and, Lorentz says, advisors have come to view them as an additional asset class that they’re comfortable allocating into the product mix.
He adds there have been two good lessons since the product was introduced. First, the 2008 market downturn allowed the product to show buyers who opted-in prior to the crisis that it was capable of doing as promised. “I think that solidified the value,” says Lorentz.
Secondly, advisors have learned that a large client base is pursuing peace of mind, a trend which has continued even after markets settled. People realized they couldn’t afford for volatility to rear its head at the wrong time; some even delayed retirement for a year.
“Years ago I don’t know if we would have talked about 40% drops, or 30% drops, or 10%, [but now] 10% swings [are] happening all the time,” Lorentz says. “So it’s highlighted that the odds of this stuff happening are a lot higher than people maybe originally thought. And I think you’ve seen that, with the whole industry re-examining the product portfolio and making sure there’s a balance.”