Fund firms enlist insurers to craft retirement income products

Several money managers are scrambling to design investment options embedded with annuities or income guarantees in what they hope will be the next major evolution in defined-contribution plans.

So far, though, they are having a tough time winning over clients. But the timing should be perfect.

With 401(k) and other DC plans now the main retirement vehicle for U.S. workers, the industry has been shifting away from focusing on asset accumulation to retirement income and the distribution phase. Last year’s market collapse further highlighted the need for plans to better protect assets, particularly for those participants at or near retirement.

As a result, several investment-only DC service providers — including AllianceBernstein LP, Barclays Global Investors, Putnam Investments and UBS Global Asset Management — have launched or are developing strategies within investment plan options such as target date funds that annuitize or guarantee a portion of participants’ assets to provide steady income.

For several years, insurers have offered annuities as a stand-alone investment option, but few plans bought what the insurers were selling. Now, investment-only service providers are trying to crack the market by teaming up with insurers to offer guaranteed income embedded in another investment option.

But industry experts say that DC plan executives, along with their consultants and some large record keepers, are reluctant to get behind such solutions, citing legal and fiduciary hurdles and cost concerns. Some even wonder if there is participant demand for such strategies.

“Adding income solutions to DC plans makes perfect sense, but the details are the biggest challenge,” said Sue Walton, a senior investment consultant at Watson Wyatt Worldwide.

“What are the fees? How do you solve the portability issue? Are we comfortable as fiduciaries signing off on long-term guarantees with one insurer? It’s the topic du jour right now, but the industry needs to answer some of these questions before it will go anywhere,” Ms. Walton said.

The idea of adding a guaranteed- income option to target date funds or other investment options is “good in theory,” said Keith Overly, executive director of the $6.8 billion Ohio Public Employees Deferred Compensation Program.

“There are certainly many details to consider, including fees, how the product is structured, and whatever terms and conditions apply if a plan wishes to terminate a manager and discontinue the guaranteed-income product.”

Tobi Davis, the retirement plans and cash manager at Playboy Enterprises Inc., which has an $87 million 401(k) plan, said “it’s a bit early” for DC plan sponsors to adopt guaranteed-income solutions.

“There aren’t enough products in the marketplace and we don’t yet have a good feel for the cost structure,” she said. “Time will tell.”

TWO STRATEGIES

There are two basic strategies for offering income guarantees.

In one approach, an investment manager designs a target date fund (or other qualified-default option) that includes an income guarantee from one or more insurers. The participant begins accumulating future income by buying slivers of a traditional deferred fixed annuity as he or she approaches retirement.

At retirement, the participant receives income from the annuity, and the rest of the plan’s assets are invested.

In the second strategy, the investment manager and the insurer design a “guaranteed-lifetime-withdrawal benefit,” which is offered as part of a target date fund or balanced fund.

The participant chooses to transfer assets in that fund to the guaranteed benefit, or is automatically enrolled in the feature as he or she nears retirement. The design allows participants to remain invested in a balanced portfolio “wrapped” by an insurance guarantee, permitting the participant to withdraw a set percentage of the “high-water” value of the account each year in retirement, even if the market value of the account is tapped out.

The complexity of such investments could initially put off some plan executives and participants, said Philip Suess, a principal at the consulting firm Mercer. “But I think there is a place for these types of solutions,” he said.

“There continues to be a progression toward greater guarantees, and outsourcing of risk, in DC plans. The challenge will be the implementation and the willingness of people to move ahead,” Mr. Suess said.

One major hurdle, said David L. Wray, president of the Profit Sharing/401(k) Council of America, is that such solutions “currently don’t have the blessing of the federal government.” Congress, he said, would have to repeal the joint and survivor annuity laws, which give a non-employee spouse the right to choose a survivorship annuity as the way in which benefits are distributed from the plan.

The problem with the law, Mr. Wray said, is that when such an option is offered, men are at a disadvantage because of the requirement of using gender-neutral annuitization.

Another issue, said Tom Idzorek, chief investment officer and director of research and product development with Ibbotson Associates Inc., is that plan sponsors are worried about the fiduciary risk of choosing a new, untested strategy.

“This is something all plan sponsors are talking about, but very few want to be the first movers,” he said. “Plan sponsors have a very strong desire to not be sued.”

However, Mr. Idzorek does predict that a couple of megaplans will adopt guaranteed-income or guaranteed-annuity options within the next year or two. That would “break the egg open” and encourage adoption by other plans, he said.

Pamela Hess, director of retirement research at Hewitt Associates LLC, agrees. “We’ll see a few companies adopt in-plan annuities next year, but most companies will wait and see how this all comes out,” she said.

Plan executives might receive a nudge from Washington. Late last month, Assistant Labor Secretary Phyllis C. Borzi said at the Profit Sharing/401k Council of America’s annual conference that she is planning to ask plan executives, consultants and vendors what regulatory or statutory changes will “encourage” employers to offer a lifetime-income-stream option, such as an annuity, in their DC plans.

SAFE HARBOR

If Washington were to classify DC investment options with lifetime-income guarantees as “safe harbor” investments, “it would ignite the adoption” of such investments, said Thomas J. Fontaine, the global head of DC investments at Alliance-Bernstein LP.

“Nothing changed quicker than the adoption of target date funds after it was designated a safe harbor, thus protecting plan sponsors from lawsuits,” he said.

Mr. Fontaine said that his firm is still developing a lifetime-income-stream option.

“We’re at the latter stages of development,” he said.

“Our goal, in studying the largest DC plans in the country, is designing something that makes it the default investment of their plan. We want to make it simple to understand, but designed in a way that’s industrial strength,” Mr. Fontaine said.

In May, Putnam Investments chief executive Robert Reynolds said in an interview that the firm was testing a lifetime-income-guarantee product — with the annuity provided by parent Great-West Lifeco Inc.

“Work continues on that front,” said Putnam spokesman Jon Goldstein, who declined to comment further. He said that Mr. Reynolds was unavailable for comment.

Last year, Barclays Global Investors introduced SponsorMatch, a strategy that combines a target date fund with a managed annuity.

When a SponsorMatch fund matures, participants get annuity payments from 65 until death. The annuity allocation starts at 5% at 25 and grows to 53% at retirement.

BGI spokesman Lance Berg said that the company hasn’t “quantified” the success of the program yet but that company officials have had “hundreds” of meetings with plan sponsors about it.

Drew Carrington, UBS Global Asset Management’s managing director and head of DC and retirement solutions, said that officials there are working on “several guaranteed-income designs with multiple insurance company partners, at various levels of development.”

He said that record keepers and consultants have been reluctant to recommend these products to plan sponsor clients. Fidelity Investments, for example, has no plans to add a guaranteed-income option to its life cycle funds, said spokeswoman Sophie Launay.

“Record keepers are concerned about record keeping these investments and portability,” Mr. Carrington said.

“Consultants tend to stick to traditional, marketable investments,” he said. “It’s really important that we get both consultants and large record keepers on our side on this one.”

Jeff Nash is a reporter for sister publication Pensions & Investments.