Allianz.com: On average, people are now living three decades longer than they were at the beginning of the last century. How has that affected retirement planning?
Theo Bouts: Today’s life expectancies are truly amazing. They are increasing by about six hours every day and we still haven’t hit a ceiling. But as astounding as this is, it does present challenges to retirement planning. Until recently, retirees in developed countries could expect to enjoy a financially secure old age protected by a safety net of state pensions. Many could even count on an employer-sponsored pension as well as on their own accumulated savings, which benefitted from high interest rates. Insurance companies offered further security by providing a long-term promise of payment in the form of guaranteed returns.
But sovereign debt is increasing as quickly as the number of retirees and it is becoming difficult for governments to fund the old-age provision promises of the past. Compounding this is the astoundingly low interest rate environment we are seeing today and may see for years to come. That means neither capital markets nor their actors can afford to offer the type of guarantees we have grown accustomed to. In effect, future retirees and companies that pledged to provide them with benefits are being hit by a double whammy of unsustainable government debt and low interest rates. Most people haven’t yet realized that this shift is putting the burden of responsibility for ensuring a financially secure retirement on them.
So what can people do?
It makes no sense to lock assets into negligible returns during the accumulation phase, the working years when people save. People who still have some forty years of work ahead of them may be better served by creating a savings strategy that supports long-term growth. Even if the guaranteed products of the past were still available, in the current low interest environment, they would only generate about one percent. That’s a poor return on a retirement timeframe that could stretch over three decades or even more. Another disadvantage of guarantees is that they tie up money over a long period of time. That’s money that can’t be used to take advantage of future interest rate movements or develop income-generating strategies that would better provide for them.
Life-cycle funds are a good option for people who aren’t knowledgeable about investing or who don’t want to be bothered by having to actively manage their portfolios over time. Like its name, life-cycle funds are set up to accompany an investor throughout their different stages of life. For instance, as the client nears retirement, the investment management team rebalances the portfolio towards less risky investments because, at this point of the “life cycle”, savings don’t have time to recoup from market volatility.
Where does insurance come in?
Despite the low return on guarantees we are seeing right now, insurance still has a fundamental and essential place in achieving the type of income needed for a comfortable, and long, retirement. Those extra six hours of life expectancy recorded every day over the last few decades – as much as they should be celebrated – also represent the very real risk that a person could outlive their savings. One of the great values of insurance is the ability to address this risk by providing an efficient “longevity put” for people who join its collective pooling of clients.
Insurers are increasingly offering alternative products that provide policyholders with an element of security, while also allowing them to tap into the upside of continued market exposure. Deferred annuities, for example, which start paying out at a later stage of retirement. Combining them with fixed-term income drawdown accounts that begin to pay out at the beginning of retirement could give people the peace of mind of knowing they will have a stable income over increasingly long lifetimes.
The bottom line is that the earlier you start thinking about retirement planning, the better. Finding a good way of balancing and combining upside products with products containing guarantees can still result in an adequate pension for a lot of people.