An Idea Whose Time Has Come

Laurence Siegel et al of his ilk have really thrown a gauntlet to the financial services industry.

But first: I don't like Laurence's close ties and basic advocacy of insurance products and insurance companies - because I don't trust them (they are run by actuaries with ROI hurdle rates on products). Because insurance companies can't control market returns they control their shareholder returns by embedding high costs into their products to cover their business and market risk.

Having said that, Laurence has outlined a simple, robust way for the industry to meet and support the post retirement needs of retirees. To this end he advocates the creation of new low cost annuity companies insulated from corporate default risk structured as follows:

• Separate corporate structure insulated from financial exposure to affiliated companies.
• All reserves held in default-free Treasury bonds and TIPS and properly hedged to the liability as closely as possible at all times.
• “Participating” policies, so that any longevity surprises are used to reduce annuity benefits proportionally instead of forcing the insurer to default entirely on some of the benefits (after going bankrupt)
  Advocate for setting up a 20 year TIPS ladder based on expected withdrawal rate complemented by a deferred income life annuity to protect against longevity risk.
  
• Very broad participation so there is little adverse selection.
  Withdrawal rate or spending rate based upon an annually recalculated variable annuity (ARVA).
   

The retirement investment structure that we’ve been describing doesn’t need teams of “quants” or financial engineers to create it. Mostly it involves a lot of effort in changing the culture of the investment business, refocusing it on doing what’s best for the consumer. The needed changes are not only cultural but also institutional, legal and regulatory. And, once the products are built, an incentive structure needs to be developed that motivates advisors and salespeople to place investors in these products. (and therein lies the problem)

These ideas are something the industry should, and can easily do, but won't because it can't make money from it. Someone will no doubt have a go at it but are likely to struggle. It will be a number of years before the industry mutates toward this model.