Rethinking Investment Strategies For VL And VAs After Retirement

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Well, your client has finally done it. She has walked through the door marked “Retirement” and is now ready to enjoy the hard-earned fruits of many years of labor.

Assume for a moment that she had previously purchased a variable annuity or variable universal life contract with a long-term focus on retirement needs. One of the decisions that must be made is how to allocate the assets in the contract for the golden years. Should you recommend that she maintain her exposure to equities? Should you recommend moving everything into bond accounts or the fixed account option in the contract?

Now that she is no longer working, it may seem that the asset-allocation stakes have gone up–after all, your clients investment horizon is shorter now than it was during the pre-retirement years, and her thoughts are turning from “accumulation” to “conservation.” Also, the recent persistent weakness in the equities markets may have taken a psychological toll; severe market volatility may have tempted your client to migrate into “safer” investments, such as bond funds.

This situation presents an excellent opportunity to review some basic tenets of investing with your clients who have retired or are approaching retirement. The fundamentals that have served them well for the past 20, 30, or 40 years are still valid. Portfolio diversification can still help soften market declines. Staying fully invested can sometimes take extraordinary discipline, but it sure beats trying to time the market successfully.

Systematic investing may be more difficult to achieve during retirement years, and while it can neither assure a profit nor protect against losses in declining markets, it is still a good way to take advantage of market volatility by buying more units when unit prices are down.

Perhaps most important of all, this may be a good time to remind your clients that the greatest threat to their financial health over the long term may not be market risk, but rather inflation risk. A 65-year-old client is quite likely to live another 20 years or even more. For a couple aged 65, the odds that at least one will live to age 85 are even higher. Even a modest 3% percent to 4% percent rate of inflation over that time frame can cut the purchasing power of a fixed income by half.

Historically, investments in equities have outpaced inflation by a significantly greater amount than have fixed income investments; consequently, stocks have been the asset class of choice for those concerned with maintaining purchasing power over time.

Beginning most recently in the first quarter of 2000 and continuing today, the stock market has consistently provided us with reminders that volatility, or market risk, is the price one pays to mitigate the risk of inflation. The stomach-churning losses in many sectors of the financial markets during the last 18 months have seriously tested investors ability to withstand short-term volatility and thus stay invested for the long haul. This has been a particularly trying period for older investors who have less time to overcome market losses.

Nonetheless, you would do well to remind your clients that even though inflation doesnt grab the headlines that market fluctuations do, it remains an insidious threat to their long-term financial well-being. Their main focus during this time of market uncertainty should be to stay the course and resist the urge to bail out of the markets.

There is a long-standing industry rule of thumb that calls for having the percentage of your overall portfolio that is invested in stocks be equal to 100 minus your current age. Using this formula, our 65-year-old retiree should have 35% of his or her portfolio in stocks, the balance in bonds and cash. The “100 minus your age” guideline may not be entirely appropriate; it may be somewhat conservative for many investors, but it is a good place to start.

From that point you should look for an asset allocation program to either validate or modify the rule of thumb. There are a number of programs available to the financial professional, both on the Web and also from various insurance carriers. These programs can do an effective job of gauging your clients risk tolerance and investment time horizon, and they are generally easy to use.

Using such programs to support allocation choices inside a variable contract can help the rep who may not consider himself to be an investment expert, and also enable the client to establish more realistic expectations about market risks and returns.

There are a number of things to remember about the asset allocation process for a post-retiree. It provides a “snapshot” of your clients situation at a point in time. This snapshot should not be viewed in a vacuum, but in consideration with all of your clients assets. Many of the proprietary asset-allocation programs available are designed for use in conjunction with a single product or product family. Consequently, the “universe” of investment choices is limited only to those available for a particular product.

It would be prudent to consider the big picture; examine all the assets your client owns and all of the choices available. Ensure that the allocation for a variable contract is congruent with your clients overall situation.

If your client owns a variable universal life policy, it is imperative that you continue to manage the contract properly to meet their needs after retirement. The internal cost of insurance, on a unit basis, will continue to increase over time. It may be necessary, therefore, to change the death benefit option to “level” (usually known as “option A”), so that the net amount at risk in the contract can be minimized, particularly if your client is no longer paying premiums. Otherwise, the rising unit cost of the insurance may outstrip the growth in the policys accumulated value account, causing the policy to lapse prematurely.

Many VUL contracts contain a provision allowing your client to select a single subaccount from which all the monthly charges are deducted. By allocating sufficient values into a relatively stable fund option or even a fixed account option, you can insulate the policy from market fluctuations to some extent. This type of provision can add a measure of comfort for the aging client who may be increasingly concerned about volatility while trying to strike a balance between market risk and inflation protection.

By way of contrast with most VUL policies, many modern variable annuity contracts have a more liberal definition of death benefit than in previous years. Many contracts now allow for ratcheted death benefits or similar mechanisms that protect against downside market risk. This type of feature should allow your client to invest a bit more aggressively than would otherwise be the case, particularly if the annuity proceeds are not expected to be needed during lifetime.

The post-retirement investment allocation may or may not be radically different from the one which the client used pre-retirement. The ultimate goal is to help your client find the proper balance between the risk of inflation versus the risk of market volatility.

Fortunately, there are many tools at your disposal to help you lead your clients to a comfortable balance between their need for returns that have the long-term potential to beat inflation versus their tolerance for short-term market risk.

is assistant vice president of variable product sales at Jefferson Pilot Financial, Greensboro, N.C. He may be reached via e-mail at stephen.barrett@jpfinancial.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 13, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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