Retirement and RVER in Quebec – Withdrawal issues and products
In the context of future Volunteer Retirement Savings plans (RVER) to be implemented by the Government of Quebec, we will see a greater share of individual responsibility in managing financial risks related to retirement . One of these risks is when savings are withdrawn and converted into retirement income. Several options are available. For example: annuities, segregated funds, or hybrid products as the Guaranteed Minimum Withdrawal Benefits (GMWB). This is the theme of the report: « Retirement and RVER in Quebec - Withdrawal issues and products ».
What emerges from this report is the unusual restructuring of GMWB products during the current period of economic crisis, and issues from the point of view of both the investor as well as the insurance company. Reason for the restructuring of the products have been identified and are presented. In addition, the report provides an overview of other retirement products, tracks the development of ideas in other jurisdictions, and offers a quantitative analysis of GMWBs. Finally, the Pension Team at CIRANO provides a preliminary proposal that the Government could consider that would benefit workers participating in a RVER savings structure.
Mandate: Managing withdrawal risk
Our mandate in this second project concerns available options at retirement for workers who saved in a RVER-type account. More specifically, our mandate has been to identify and assess the various risks faced by workers who will withdraw their savings in order to transfer them to the most appropriate vehicle to provide them with adequate retirement income. So we go from one challenge to another; from the challenge of saving enough, we turn to an issue of optimal allocation of amounts saved to generate retirement income. A potentially serious timing risk (a form of market risk) is inherent in the transfer of savings to a retirement vehicle because there is no guarantee that good returns on investment will occur during the savings period, as well as good annuity rates (linked to interest rates) will be available at the time of disbursement.
Overview: Industry and annuity products
First, after the introduction, this report begins with an overview of disbursement products (Section 2) including annuities, segregated funds (mutual funds with guarantees) and a hybrid product known by its acronym GMWB. This section presents the current state of the industry in Quebec and Canada. The products offered by this industry are currently undergoing restructuring as a result of the situation of historically low interest rates and stricter regulations. Therefore, trying to be familiar with all the details of these products (especially products with a lifetime withdrawal guarantee) is tantamount to aiming at a moving target. This will be one of our first observations: the state of the industry being in serious questioning shows that some products do not bear the test of time. This consideration seems very central in the development of recommendations for all future Quebec retirees who will have to make decisions with the savings they have accumulated in a RVER.
International: Precedents observed elsewhere
At the end of Section 2, we present some international approaches limited for the moment to the United States and the United Kingdom. Both American experiences, BlackRock and TIAA-CREF are conceptually related because they both incorporate the use of deferred annuities during the accumulation period. These approaches push to incorporate post-retirement issues during the accumulation period, the two periods being closely linked. The British approach presented is only a brief overview of what the National Employment Savings Trust (NEST) is planning as an approach to disbursement. NEST is a fund established by the British government and that we have referred to in our previous report, « Pensions 4-2 for Quebec: Towards a new partnership ».
Quantitative analysis: The limitations of the GMWB products
The third section of the report provides a detailed technical analysis of GMWB products using stochastic simulations under different financial environments. Contrary to expectations often generated by the financial industry or even in the academic literature, we observe that such a product would not be able to fill in an economic environment such as the one we find ourselves in recent years (2008-2012 ).
Some simulation results:
- The pensioner who lives at least until the age of 80 would have a 50% chance of ending up with the equivalent of an annuity that is not indexed, at a cost that is likely higher.
- The annual income growth rates of GMWBs’ withdrawal base are expected to be relatively modest, most scenarios are below the inflation rate target of 2%.
- The value of the underlying asset, or the pensioner’s portfolio, decreases rapidly, especially by the withdrawals made by the pensioner. The average and median scenarios do not seem to threaten the execution of a guarantee on net capital at the time of death, but more pessimistic scenarios could jeopardize the financial viability of a guaranteed product from the point of view of the insurance company.
CIRANO Proposal: Synthetic Annuity through laddered bonds
Finally, this report contains a proposal put together by the CIRANO team and consists of laddered zero-coupon bonds, spread to generate a retirement income. We believe this proposal deserves some attention in regards to future projects. This proposal goes in the usual actuarial model of the insurance industry to use traditional tools of financial markets standards: government bonds. Allocating a portion of its portfolio of fixed income securities with government zero-coupon bonds, and with a specific maturity, the investor can create a 'synthetic' pension annuity, that is to say with characteristics of an annuity without a total lifetime guarantee. Considering the current high cost structure for annuities, institutional aspects, marketing, and others, it seems that another approach may be more beneficial for investors in the RVER.
In addition, this approach must be analyzed in a broader context than the mere post-retirement withdrawal phase; it could also allow a dynamic life cycle approach during the accumulation phase, that is to say link the withdrawal phase to the accumulation phase. The reason these two phases are intimately linked is that an investor contributes to its RVER with one goal in mind: to provide a retirement income. This way it is an Asset-Liability Management (ALM) type of approach rather than using a (‘static’) portfolio strictly based on the age of the investor and that may not be directly related to the purpose of retirement income, or even to market conditions.
Moreover, an approach that rebalances the portfolio by age rather than by market conditions could generate more risk than a portfolio with fixed ratios (which is not a recommendation, but a point of comparison). The reason for this additional risk is closely linked to the financial context, an investor who begins its life cycle in unfavorable market conditions and being more exposed to equity markets than bond markets will have difficult time to catch up these losses in the future as its exposure to provide a positive stock market shock will decline over time in favor of more conservative investments. Therefore, an initial negative shock will be crystallized in the portfolio as the investor gradually moves away from shares to fixed-income products.
These reflections and proposals are developed as a conclusion to the report.
download the executive summary