Longevity has become front-of-mind for many advisers whose clients are at this stage and demand for income certainty in retirement has exploded. The market is teetering on the edge of a new era as new products look poised to expand into the area.
Classic annuities continue to play a major role, but do they offer enough variety in a growing market? Competing and complementing strategies appear to be progressing as concerns about longevity issues become more prevalent.
But how long will it take for new players to catch up?
This new concern about living too long and surpassing life expectancy highlights the need for investors to adjust their portfolios accordingly.
"Generally, people are starting to realise that yes, on average, you will die at 85, but you might live to 97, so budgeting to 85 is not enough. People have to realise that longevity is a real risk," PIMCO senior vice president Tony Hildyard told ifa.
There is more than $600 billion worth of assets held by people over the age of 50, half of which is held by people in the 60-plus age bracket. This represents over 60 per cent of all fund assets that could be exiting the accumulation phase in the near future.
Annuity shift
As the dominant longevity solution, annuities continue to play a vital role in portfolio construction when planning for retirement by providing certainty of both income and return of capital, regardless of market performance and economic conditions.
Both CommInsure and Challenger have noted demand growth for annuity products as the focus shifts to retirement.
CommInsure general manager of super and investments Greg Ballard told ifa he noted a 50 per cent increase in inflows for annuity products from the 2011 to 2012 financial year.
Although annuities seem to be booming, there is a clear shift in investor and adviser focus from chasing capital gains to simply retaining wealth.
Investment Trends found in its "December 2011 Retirement Planner Report" that the proportion of planners who regard maximising capital growth as the top priority for annuities has diminished from 77 per cent to 1 per cent for retirees.
Instead, planners have increased priority to maximising income (from 3 per cent to 48 per cent) and focusing on minimising risk (from 4 per cent to 33 per cent).
Investment Trends senior analyst Recep Peker cites volatility in the market for the shift and, as a result, annuities are enjoying a resurgence in the market with good growth.
"Investors are also quite worried about the situation in highly indebted countries, with 66 per cent agreeing that they will trigger a second wave of the GFC (global financial crisis)," he said.
Challenger chief executive of life Richard Howes also notes a trend for advisers to reprioritise annuities with an increased focus on income certainty.
"We are not seeing that advisers are forgetting about wealth accumulation or creation, instead what we are seeing is a reprioritisation of things," he says.
"We're seeing a layered approach where advisers first say 'I must ensure my client can meet his basic living needs under all circumstances, then on top of that I can use the balance of the assets to chase more aspirational outcomes'."
Although the sentiment shift is encouraging when it comes to protecting against longevity risk, there is concern in the market that annuities do not offer enough variety to a market that is going to continue to focus on retirement.
Alternatives poised
For the past 20 years, Australians have been incredibly focused on accumulation. Now there is a change in that approach, it has opened the door for new players and products to enter the market.
The swarm of baby boomers hitting retirement is causing an increased demand for income certainty and a push for alternative income products to aid a more holistic solution to building a portfolio.
If there is no one single product that can affectively protect each investor type against longevity risk, then it seems logical that an investment strategy including a number of asset classes or products would be the next alternative.
"[Retirees want] a steady income and protection from market risk and living too long. They want flexibility to control their capital and payments as their income changes in different phases of their retirement. They also want to be able to get out of products at will," Actuaries Institute chief executive Melinda Howes says.
"So when you put all of those together, it's quite difficult to find any one product that will give them all of that. Any strategy an adviser is putting in is probably going to be a combination of products."
BT Financial Group head of retirement Rodney Greenhalgh explains that the approach to the issue of longevity depends on the client and their accumulated balances.
Those with a smaller accumulated balance during their active retirement generally fall back on their aged pension. Investors with larger sums of money tend to manage longevity through an investment process and a relatively conservative level of income.
"Then you have the people in the middle who don't have so much that they can effectively self-insure for longevity risk and they don't have so little that it almost doesn't matter what they do. That is the sort of area where people are looking for other solutions," Greenhalgh told ifa.
"We're certainly seeing an increase in this [middle group]. We are seeing people looking for capital protection solutions that can be applied to protect them from the worst events so that they can take away some of those risks, but still leave themselves exposed to the kind of returns that markets generally provide."
New products such as reverse mortgages and government annuity bonds are starting to make a bit of noise in the market, but they have not quite caught up to meet demand and still have a long way to go in terms of development.
The boom in demand means it is likely providers will identify this need and start to offer products.
Hildyard expects to see institutions compete in the super fund area, creating demand for more cost-efficient approaches.
"If you look at the big super funds, the bulk of their assets are owned by over-50s. If they don't [look to offer] something else, then they're going to see their clients take a lump sum of their money and go to an adviser because they want more certainty and less volatility," he says.
"In 10 years' time, I think we'll have as much money in retirement as in the accumulation phase and this means that generally there is going to be a pretty balanced focus."
Advisers should err on the upside
As the market is in a state of progressive shift, the largest move is likely to be in advisers' approach to longevity and how to address it with their clients.
Now that wealth accumulation is no longer the singular approach for financial advice, advisers will be forced into taking a more layered approach to retirement.
"If we look ahead, I think its going to be very much [about] increasing tools to tailor portfolios to deliver to those retirees' needs. Rather than retirees demand, I think there is an acceptance from many retirees that ... the outlook is more conservative than they might have thought," Greenhalgh says.
Obviously advisers need to have a thorough understanding of the client's position and understand the interplay between different investment options, but they also need to educate themselves as new products arise and investment options shift.
"There is no silver bullet to address longevity issues. As always, advisers need to understand the client's circumstances, goals and expectations in retirement. They then need to overlay expenditure that may be required for any fluctuations in the client's life," Ballard says.
He explains that in trying to calculate future income needs of clients, advisers also need to bear in mind people are living longer than previously. There is also a significant risk life expectancy could become even longer due to continual medical advancements.
At present, a male aged 65 has a 50 per cent chance of living to 86 and a 25 per cent chance of reaching 93. A woman aged 65 has a 50 per cent chance of living to 90 and a 25 per cent chance of reaching 97.
"What I'd be saying to advisers is to err on the upside when they're working out how long their clients are going to need income for. The current generation of retirees, there is a very strong possibility they will live well into their 90s. That's what they should be looking at, and how to provide an income until then," Melinda Howes says.
However, it is clear the lack of guaranteed products and variety to suit these needs are likely to hamper adviser success at the moment.
"The government is doing some consultation on this now and there is an appetite to change that. So we're very hopeful that will happen and advisers will have more options for their clients," Melinda Howes says.
Once more options are available, advisers would add some value to the emergence of a bucket-type strategy, where a portion is allocated to income and another bucket is allocated to growth assets.
"Then as you get older you'll probably allocate more to your income bucket and less to your growth bucket. I think that's where advisers are going to be adding some value, by helping construct those types of portfolios," Hildyard says.
Innovation outlook
Most predict it is going to take another two to five years before there is a significant change in the number of new products entering the market.
"There has been limited innovation in the annuities space to date, with investors predominantly focused on accumulation of assets," Ballard says.
"However, this will likely change as a growing proportion of the population enter the decumulation phase."
Although the market is unlikely to experience much change in the immediate future, as advisers and their clients come to terms with the fact they are likely to live far past the current life expectancy, demand, and then new products to meet the demand, is expected to rocket.
But this is not only limited to Australia. The anticipation is providers overseas will see the demand and start to make their move into the market.
"I know that some [product] providers [from overseas] are sniffing around the Australian market, so it would be really interesting to see what happens," Melinda Howes says.
"I think we'll see a lot more product providers out there, I think we'll see a broader range of annuity and deferred annuity products and we'll see some more innovative things, [such as] where advisers can put a customer into a product that starts out as a really flexible account-based annuity and morphs into a more guaranteed secure product as they get older."
NSW waratah annuity bond
The New South Wales government has launched annuity bonds to add value to the pre-retirement space and complement investors' existing investment strategies.
NSW Treasury Corporation head of funding Tim Hext says the Waratah Annuity Bonds are a retail version of the indexed annuity bonds on offer to the wholesale market and are aimed at the self-managed superannuation fund and retail markets.
"This is just an option that will suit some people and not others. [It] complements different things for different people. It is [not meant] to be a competitive product [against annuities]," he told ifa.
Hext says the Waratah Annuity Bonds will appeal to risk-averse retirees.
He likens the Waratah bonds to a fixed-interest home mortgage in which the principal and interest are paid over a set time, at the end of which the mortgage is discharged.
"If in retirement your risk/reward outlook is conservative, then this is the ideal product because the credit risk is very small, being a government bond. The cash-flow risk in a purchasing-power sense is protected, and you have certainty of payment," he says.
He explains that because the investments are used to build NSW infrastructure, flexibility is limited.
"The Challengers of the world provide a lot more flexibility. We offer the highest level or security [rather than flexibility]. I do think it's important to offer investors the choice," he says.
"I do think in five to 10 years you will see a lot broader range of instruments and a lot more focus on what suits different people.
"Over time you will see more of these products, probably from the private sector and maybe also from the governments."
