The United States will have to come up with new risk-management mechanisms if it wants many more workers to annuitize their retirement assets, according to financial risk management specialists at Milliman Inc.

Kenneth Mungan, the financial risk management practice leader at Milliman, Seattle, and Tamara Burden, the managing director of Milliman’s Retirement Guarantee Network program, write about lifetime income option guarantees in a response to an income planning request for information issued by the U.S. Treasury Department and the U.S. Labor Department.

Federal regulators asked for advice about use of annuitization and other mechanisms for converting retirement savings into lifetime income streams.

Milliman has found that, in its experience, successful retirement income programs have been backed by strong hedging programs, Mungan and Burden write.

“The fair value of the guarantee should be fully funded through a collateralized separate account,” and “market risk should be neutralized through industry standard hedging techniques,” the risk management specialists write.

In 2008, the retirement specialists write, individual retirement accounts and defined contribution retirement plans held about $7.1 trillion in assets, while annuities held only $1.4 trillion in assets.

In September 2008 and October 2008, derivatives-based hedging programs saved the insurers offering large guaranteed retirement income products about $40 billion, and, if the insurers had not had the hedging programs in place, rapidly increasing income guarantee liabilities could have “brought down the biggest company,” Mungan and Burden write.

“The potential impact of an insurer failing to fulfill their obligations is enormous, particularly given the potential scale of this business, when these liabilities are part of the general account obligations of the insurance company,” Mungan and Burden write.

The best solution is to put the assets backing the guarantees, including the hedge instruments, in a separate collateralized trust account, Mungan and Burden write.

“This simply draws the line in the sand clarifying that the assets are specifically earmarked for the guarantee and thereby clarifies the place where the participants sit in the creditor chain in the event of a default,” Mungan and Burden write. “Make this trust account an asset of the plan, and plan sponsors have a viable option for replacing defaulting insurers, or simply continuing to manage the risk on their own.”

A consortium of insurers should back the trust account, and have the Pension Benefit Guaranty Corp. act as the backstop for the consortium, Mungan and Burden write.