Evaluating Retirement Income Solutions

Long-term financial security is an ultimate goal of any retirement plan and account. And as average lifespans grow, the term “long-term” takes on heightened importance. Thus the rise of retirement income solutions that seek to help provide financial resources for a lifetime. But a retirement plan professional needs to be able to evaluate the effectiveness and worth of those solutions. A recent paper offers suggestions on doing just that.

In the Institutional Retirement Income Council paper “Evaluation Scorecard for Retirement Income Products,” the Newport Group’s Sr. Investment Research Analyst Julie Leinenbach and Chief Investment Officer Mendel A. Melzer call the benefits of such lifetime income strategies “clear,” but add that they come “with a cost and with restrictions.” Further, they note, the solutions are adopted and monitored by people “subject to the rigorous demands of ERISA,” and therein lies at least part of the rub — they posit that “While there is a large body of knowledge that has been developed regarding selecting and monitoring traditional investment options within participant directed retirement plans, the new lifetime income options don’t easily fit within existing frameworks.”

Accordingly, Leinenbach and Melzer propose metrics by which retirement income solutions can be assessed regarding how suitable they are for a particular plan and participant. They argue that there are five main aspects that must be evaluated.

Efficacy of the Underlying Process. Leinenbach and Melzer contend that it is important to understand how well the underlying investments have done when measured against “appropriate benchmarks.” In addition, they advocate determining how much flexibility participants have in choosing the risk entailed in those investments.

Nature of the Lifetime Guarantee. “The objective in selecting a lifetime income guarantee strategy for a participant investment menu is to offer the participant an income stream that s/he cannot outlive,” say Leinenbach and Melzer. They note that there are many variations regarding this guarantee, from managed payout fnds to guaranteed minimum withdrawal benefit (GMWB) strategies with annual increases, as well as annual guaranteed increases.

Strength of Counterparties. Leinenbach and Melzer say that most retirement income products have the benefit of a single insurer. When there are multiple insurers, they say, they are not jointly and severally liable and are responsible for only part of the guarantee. And this puts at least a portion of an investor’s funds at risk of being frozen. In addition, they say, an at-risk insurance company will make offering the benefit more expensive. They suggests working with “counterparties that maintain ratings in the top third of financial strength rankings.”

Product Cost. Insurance and management fees directly affect performance, Leinenbach and Melzer note. They argue that “Investment management fees should not exceed typical expense ratios for similar risked asset allocation strategies outside of the retirement income guarantee products arena.” Another area to consider, they say, is the cost of the guarantee.

Operational Flexibility. There are two factors to consider in this regard, say Leinenbach and Melzer: (1) if a participant leaves the plan, there must be an available vehicle for retaining the product‘s guarantee; and (2) a plan sponsor’s flexibility to adopt an alternate platform if it is dissatisfied with its existing recordkeeper. “A plan sponsor has a fiduciary responsibility to evaluate its recordkeeper based on service, cost, and investment option availability,” they argue.