From the October 2012 issue of Investment Advisor • Subscribe!

Guaranteed Income: A Missed Opportunity for Your Clients?

Clients are willing to pay, but advisors are reluctant. Why?

The appeal and practicality of guaranteed income investments is rising. Your clients are willing to pay significant fees for the peace of mind they provide. Academic research shows that guaranteed income offers the potential for higher returns with less volatility over the long run. Product providers are committed to meeting the needs expressed by you and your clients. These ongoing changes demand your attention as you seek to help your clients live comfortably in retirement.

These trends are discussed in detail in “The Missed Opportunity: Guaranteed Income as an Asset Class,” a white paper based on a survey of 248 independent financial advisors in addition to interviews with two academic thought leaders and 11 leading providers of guaranteed income products. The research was conducted by the Aite Group, an independent research firm, and commissioned by NFP Advisor Services Group.

Your Clients Crave Guarantees

Research shows many Americans would like income guarantees. Almost half—61.5 million—of households said, “I would put most of my assets in an investment providing guaranteed income even if it provides a low return,” in a survey conducted for Strategic Business Insight’s 2010-2011 MacroMonitor. More than two-thirds of those surveyed—45 million households—held enough wealth to be served by a financial advisor.

This included 5.1 million households in the pre-retired (age 50-64) and retired (age 65 and older) wealthy (top 5%) and affluent (next 15%) categories.The pro-guarantee households hold a big chunk of investable assets—$10 trillion. Most of these assets are held by pre-retirees and retirees, the most likely candidates for products promising income guarantees (see Figure 1, left). The bottom line? You’re likely to have some of these security-craving households among your clients, and they may be seeking a new financial advisor who can satisfy their craving.

Guaranteed income products aren’t cheap, so you may wonder if clients will pay for them. The cost of the guarantee alone typically runs about 100 basis points (1%), without factoring in other expenses. Other fees may boost expenses to 3% or more. Advisors often cite fees as a reason to avoid the current generation of guaranteed income products. However, consumers “said they were willing to pay between 4% and 6% of assets to guarantee that they wouldn’t run out of money in retirement,” according to a 2007 survey by Alliance Bernstein. It seems likely that the market downturn of 2008-2009 increased this openness to paying fees to achieve peace of mind.

Despite individuals’ enthusiasm for guaranteed income, advisors—especially independent RIAs—aren’t sold on these products (see Figure 2, above). Roughly half (51%) of independent RIAs do not recommend income guarantees to pre-retirees facing longevity risk, according to the Aite Group survey. There are also some holdouts among advisors of independent broker-dealers and insurance broker-dealers.

The gap between individuals’ interest in these investments and some advisors’ reluctance to use them is striking. We asked Aite Group to examine academic research on the impact of guaranteed income on a portfolio designed for distribution in retirement.

The Academic Case: Higher Returns With Less Risk

Evolving academic research makes a case for incorporating guaranteed income into the portfolios of individuals preparing for retirement. Essentially, it lets retirees live better for longer. This is critical as more Americans face the risk of outliving their assets due to longer lives and volatile markets.

Retirement income increased and risk decreased when guaranteed income replaced the cash or fixed income allocations. This was the conclusion of “Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit,” an Ibbotson study for Nationwide Insurance. 

“Rational Decumulation,” a 2007 study by Professors David Babbel and Craig Merrill, fellows at the Wharton Financial Institutions Center, found that taking advantage of insurers’ economies of scale allowed individuals to gain financial security for retirement using 25% to 40% less money than would be required for a retirement portfolio not using income annuities. Babbel and Merrill also found that annuitizing a large percentage of wealth helped retirees provide bequests for heirs, contrary to the conventional wisdom.

Using guaranteed income also allows you more flexibility in managing your retired clients’ income. For example, with an income guarantee, you can keep a higher percentage of your clients’ portfolios in stocks for a longer time. This permits your clients to potentially benefit from the historically higher long-term returns from stocks.

Based on this evidence, advisors should consider including guaranteed income as an asset class when constructing client portfolios. More than half of the advisors in our survey already view guaranteed income as an asset class.

Products Are Changing for the Better

Aite Group’s research showed product providers are aware of advisors’ challenges in using guaranteed income. These companies are committed to education and product development to overcome those challenges.

Senior executives identified some practical barriers to advisors’ adoption of guaranteed income. For example:

  • Financial planning tools were created without guaranteed income in mind. Questionnaires, models and proposal generation systems need to be redesigned.
  • Inadequate clearing systems require manual processing of guaranteed income products in many cases.
  • Some managed account platforms don’t incorporate guaranteed income products.

These are all challenges that can be addressed. In fact, solutions are in the works.

Getting Ahead of the Curve

To attract and retain clients, you must keep up with the dynamic, ever-changing investment environment. This includes offering innovative solutions that meet your clients’ needs and choosing partners who think ahead of the curve.

Clients are intrigued by guaranteed income, and they’re willing to pay for it. Academic research says their interest is justified.

The right guaranteed income products at the right price in the right portfolio can improve your ability to boost clients’ retirement security.       

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