This article does not claim to see the future of retirement products in a clear crystal ball, nor will it reveal dark secrets. It seeks to achieve three goals: (1) set our expectations with regard to the pace of change; (2) map the demographic tipping point just ahead of us; and (3) highlight the potential paths that new product developments may take.
Change Is AcceleratingOur first instinct is to look at our future in light of our past. Our memories and behavioral proclivities are readily available to create a first-order approximation. During his keynote presentation for RIIA's 2007 MRI conference, Terry Burnham clearly showed the limits of such instinctive memory and behavioral proclivities. Human nature evolved in an environment that is not the environment that we currently live in. We live in abundance when human nature was forged in scarcity. For instance, we live in a world where food can be preserved and stored in great quantity.
Contrast this with our evolving in a world where the currency of the day, food, lost its value quickly as it spoiled. As a result, many of us instinctively prefer to consume now rather than to save for later. This may no longer be the proper behavior to have in a world of plenty and readily available refrigeration. This may also not be the optimum behavior when it comes to finance.
On the other hand, during his keynote speech for RIIA's 2006 Managing Retirement Income (MRI) conference, Ray Kurzweil presented another idea: The Law of Accelerating Returns. The Law of Accelerating Returns applies to businesses that are subject to the economics of information. It states that the power of information technologies doubles every 18 months. This doubling of power can be measured in a variety of ways and is plainly visible in the world of electronics. This also accounts for a large amount of our unusual productivity increases over the last few decades.
It is interesting to note that this doubling of power is the equivalent of a large deflation rate. This is why we are used to seeing many important electronic devices such as computers and TVs, become cheaper over time.
As we can see from our increasing use of computers and models, the financial industry is fast becoming subjected to the economics of information. This observation helps us calibrate the pace of change that we are likely to see in the future: If Ray is right, we may see the equivalent of the last 30 years worth of change, not in the next 30 years but in the next 6 years. If Terry is right, we are not naturally prepared to handle it well.
Demographic Tipping PointNot only are we living through accelerating change created by the impact of information economics on our lives, but the economies of the developed world in general and the U.S. in particular are also moving towards a demographic tipping point as the boomers prepare to retire.
Over the last few decades, the lifecycle of boomers has had a well-documented center-of-gravity-shifting impact on business. As illustrated in Chart 1 below, boomers nearing retirement are shifting their interest from accumulation to distribution in a predictable way. This chart maps the investor's life cycle on the X-axis ranging from early accumulation to late retirement against the Y-axis where we show the generic types of products that can be provided ranging from best-efforts to those that are guaranteed.
Interestingly, as shown on the chart, there is an in-between transition phase that is worth exploring in more detail. This phase is often called the "transition management" phase.
The identification of the transition management phase arises from observations of the particular needs of investors as they move into retirement. To quote from RIIA's 2006 white paper: "In the late accumulation phase, or pre-retirement, the investor is completing an accumulation career that may have spanned 30 or 40 years. Due to the compounding nature of accumulation, half of the dollar accumulation is achieved in the last 8 to 10 years of the typical accumulation career. This highlights the risk that investment returns on retirement assets may fall below expectations."
What that means, the paper continues, is that "there may be a shift in investor psychology from what is usually a superficial intellectual understanding of risk in the context of probabilities, the odds of success and percentage-based evaluation, to an intuitive, common sense understanding of income and dollars. Such a change may move investors from being somewhat risk-averse to becoming more clearly loss-averse."
As Elvin Turner explains, summarizing the paper's academic flavor into money quotes for financial advisors, the bottom line is that investors need downside protection during the final 8 to 10 years of the accumulation phase because so much of their total retirement dollar accumulation is at stake.
Investors moving through this life-stage grow more concerned as they are finally able to connect the actual amount of money that they can expect in their retirement years to the illustrations of the odds of success and probable investment returns (in percentage terms) that they will receive on their investments. For the first time in investors' lives, risk feels real in terms of the life that they will be able to live rather than just the assets they are accumulating. The investor's changing metric for risk may be shifting from focusing on the odds that "returns may vary" to the actual dollar amount of the "mountain of cash" and the sustainable dollar income it may provide.
As we try to change in sync with the investor's lifecycle, we need to master the provision of advice across a larger number of risk factors. This can move us from traditional investment management to more holistic retirement management roles. Financial advisors evolving from investment management to retirement management need to acquire new individual professional skills as well as new practice management methods.
This expanding focus, from financial capital to human capital and social capital, is a key step on the road to mapping future retirement income products. Retirement-focused investors create new tasks for financial advisors. These tasks are becoming more numerous and more complex and seem to have reached the point where it is important and urgent to create new professional job descriptions. These tasks include not only investment management but also retirement planning, implementation and ultimately management.
Can you see that a new type of financial advice professional is emerging from this complexity: the retirement management professional?
The Next Six (or 30) YearsGiven this accelerating pace of change resulting from information economics and our looming demographic tipping point, we can reasonably expect that our products and services will have to evolve as well. Since much of the value that we take for granted is created by increased productivity and innovation, what innovative products will improve the productivity of retirement-focused financial advisory jobs?
The winning products and services may come from one or more generic categories shown in Chart 2.
Using this framework systematically, we can identify 11 potential retirement-income-focused innovations. These include six pair-wise combinations (such as insurance/hedges, insurance/advice, insurance/investment, etc.), four triple combinations (e.g., insurance/hedges/advice, etc.), and one combination including all categories. We can also expect innovations in each individual business silo (investment, insurance, hedges and advice processes). Which among these 15 in-silo and cross-silo potential combinations are likely to be successfully selected by the market?
Would the product-packaged ("productized") vs. process-packaged ("processized") distinction prove to be an important differentiator for market success in the retirement income space? If so, we could be tracing many more than 15 possible paths. It seems reasonable to believe additional relevant distinctions could be made, further increasing the number of potential paths. The future of the retirement income industry is likely to become quite busy.
Which of these product development paths will be the roads less traveled? Which of these product development paths will lead to the successful retirement income products? It is likely that these questions will be answered faster than most of us expect. Let's look forward to celebrating our next 30th anniversary -- say, six years from now?
Francois Gadenne is chairman and executive director of the Retirement Income Industry Association in Boston; see www.riia-usa.org