As baby boomers begin to retire, look for more product innovations that combine investments with insurance and offer similar benefits to a defined benefit pension plan.

While that may describe the standard annuity or segregated fund, York University associate professor of finance Moshe Milevsky says those products are only the beginning.

“These are products that are attempting to create systematic withdrawal plans that last for the rest of your life,” Milevesky told attendees of a Morningstar conference on retirement income planning on Wednesday.

Long-term care insurance merged with an annuity is an example of a product coming down the pipeline. So, if a policyholder has to go into a nursing home prematurely, the expense is covered. However, if the policyholder doesn’t have to go to a nursing home and is healthy for the rest of her life, the policy will still pay out. Milevsky notes this product has already made headways in the U.S. “It basically combines two risks that independently would be much expensive than when combined together.”

Another product development is what Milevsky calls advanced life longevity insurance, which only pays out if you exceed life expectancy. So if you purchase this policy in your forties, it won’t pay out until you reach age 85. “If you don’t make it to age 85, you get nothing,” he says.

More Conference Collection:

  • It’s the stories that sell CI
  • Retirement boom fuels new investment strategies
  • Insurance advisors want more from their MGAs
  • MGAs put tech on the front burner
  • Ottawa sends “clear signal” on insurance sales in banks
  • Stepping up to the HNW plate
  • IDA trade association unveils new name
  • Investment dealers enjoying record profits
    • Back to Conference collection mainpage

    So why bother paying for a policy that you either won’t receive for 40 years or not at all? Milevsky says the monthly premium will be so trivial — around $30 — and if you do make it to age 85, you will end up with an enormous payout.

    To prepare for smoother retirement income planning, advisors need to help their clients understand all the risks, Milevsky adds. They include:

    • Inflation: Over the long run, the purchasing power of income is eroded. “Too many people think of income in nominal terms,” explains Milevsky. “We have to pay more attention to real income and, in some sense, income that’s after inflation for retirees as opposed to for the population as a whole. Over a 30-year period, inflation can slice a half to three quarters off your income.” Jamie Golombek, vice-president, tax and estate planning, at AIM Trimark Investments, agrees. He notes that seniors tend to like GICs because they are deemed “risk free” but an AIM Trimark study of one-year GIC returns for the years 2002 to 2005 showed negative rates of return after inflation and tax (assuming a 35% tax rate).

      Golombek recommends clients consider insured annuities as part of their portfolios because they are likely to end up with more of after-tax monthly income with the insured annuity than with a GIC—for the same amount of investment. Annuities may also bring more peace of mind to certain clients. “When you buy a GIC, you are subject to reinvestment rates. You have no idea five years down the line what your reinvestment interest rate might be,” he said at the conference. “But if you buy that annuity today, you know forever. You’re guaranteed to know how much money you will get for the rest of your life.” He only recommends a portion since once an annuity is purchased, it’s an irreversible decision.

    • Longevity: Many advisors underestimate the lifecycle of a person, so consider mortality rate averages to ensure retirement income lasts as long as clients do. Then, advisors need to consider whether annuities should form part of their clients’ portfolios. As a tenured university professor, Milevsky wouldn’t be a good candidate for annuities since he will receive a substantial amount of his income for the rest of his life through his DB plan. Someone who isn’t in that situation won’t be as lucky.

    • Timing of withdrawal: When a client retires affects how long his money will last, even though he has the same asset allocation, investments and advisor as someone else who retires three years earlier or later. “While proper asset allocation reduces risk and improves the sustainability of a portfolio, there is a certain amount of financial risk that cannot be removed by asset allocation alone,” Milevsky says.

    “When I’m sitting at retirement on this enormous amount of wealth and I’m starting to withdraw, I’m taking a risk here that the asset allocation isn’t going to be able to help me with. It’s not a matter of ‘OK, let’s move to bonds’ because it’s not about asset allocation anymore, it’s about protection and risk management.”

    Filed by Deanne Gage, Advisor’s Edge, deanne.gage@advisor.rogers.com

    (06/08/06)