When it comes to the complex area of retirement income, the key to success for advisors and investors alike has everything to do with outcome.
That is the message of Achaean Financial executive Mike Henkel, who in an interview with AdvisorOne said his firm’s retirement advice software, Retirement Outcome, will be incorporating ideas from behavioral finance in the product design. To that end, Achaean has hired noted behavioral finance expert Shlomo Benartzi as the firm’s first academic advisor.
Henkel (left), a top executive at Ibbotson for the nine years leading to its sale to Morningstar, says at Ibbotson he worked closely with Benartzi and his academic colleagues Dick Thaler and Daniel Kahnemann, where the three behavioral finance experts “drove it into my head: outcome, outcome, outcome. Shlomo was always coming up with clever ideas,” Henkel says.
Benartzi has agreed to advise Achaean periodically on the development of their software. His role will be twofold. The first is as a source of ideas. For example, they agreed that decisions about when to take Social Security should be made at the same time as decisions about whether and when to take annuities, since Social Security is also a pension.
Second, Benartzi will also “help me orchestrate involvement by the academic community with other things we need to do with the software.” That is, Benartzi, with his global understanding of behavioral finance research, will make introductions to other academic advisors.
Benartzi (right), a professor at UCLA, is also known in the financial services industry as the chief behavioral economist for Allianz Global Investors’ Center for Behavioral Finance.
Henkel believes that the way decisions are framed and phrased can improve retirement outcomes for investors, but also have a significant commercial impact for financial advisors and insurance companies. “You’re going to undersell the product unless you can help investors…who have been left to their own devices with their DC plans [with advice and guidance].”
Henkel credits Thaler with a key insight that has informed his product design: “It should be a lot like going to the ophthalmologist. ‘Do you see better with this one or with that one?’ We’re finally getting something that does that,” he says.
“It’s really a system designed to have an advisor sit down with an investor and help them understand: If you take more risk, this is what happens; if you save more, this is what happens. It’s not going to be enough to show them a slice of a pie chart.” The objective, he adds, is to offer a “personalized outcome perspective” fully reflecting the impact of saving, spending, investing and taxes on retirement wealth.
Henkel says there are other systems that incorporate some of the elements of his program, but most are insufficiently outcome-based. “There’s very little out there: a lot of smoke, but very little fire,” he said. “There are very few…effective products in the hands of advisors.”
Another significant contemporary problem Achaean seeks to address—in this case, with its Income Plus+ software product —is the remediation of liabilities associated with in-force variable annuities. The problem is that today’s market environment squeezes everyone relying on variable annuities for guaranteed income.
“We’ve got one of the only effective ways for underwriters to [address] sold policies sitting on their books [which] they really have no way to fix.”
“If [an insurance company has] sold a bunch of VA policies, they’ve got a book of business. They’re not happy with that. Capital costs are very high.
“If you’re an advisor, you’re not real happy. The high-water mark is way above the account value. You’ll never get someone to convert to something new.
“If you’re an investor, you realize a lot of what’s been sold has little chance of an increase in payment.
“With the income product design that we have, we can actually help insurance companies convert some of these policies,” he says.
The situation is somewhat analogous to refinancing a mortgage today. Most homeowners have difficulty meeting the requirements. But IncomePlus+ runs an analysis that determines who can benefit from conversion of an existing annuity policy.
“We can literally go through the entire book of policies and run a Monte Carlo forecast for every one of those policy holders and determine the cash each can receive,” Henkel says. “We can do all sorts of fancy quantitative calculations.”
For those deemed better off with a conversion, the advisor can use the software to lay it all out: “You may like this option. Here’s why. Now it’s your choice whether to do it or not.
“Ultimately, if the conversion is not good for the investor, it shouldn’t get done.”
But, “if [the conversion would] free up a lot of capital, [the clients] may decide, ‘We’re happy to pay the advisor a commission.’” Doing so may be the only way clients will realistically see annuity payments rise in their lifetime; it will give advisors a basis to convert and earn commission income; and the result for the insurance company will “look a whole lot more reasonable from a capital cost perspective,” Henkel says. “There is limited capacity for new business unless there are products that insurance companies can afford to underwrite.”
Henkel warns that under increased capital requirements that are already affecting insurance companies domiciled in Europe and Canada and which are coming down the pike for U.S.-domiciled companies in 2014, a failure to convert policies will hurt carriers, driving more insurance companies away from a marketplace that retirees depend on.