The following is an article that appeared in http://www.structuredretailproducts.com/news/latest
The Rules of the Retirement Solutions Game Need to Change
30 Jan 2013
Karl Strobl, the former global head of structured products and retirement solutions in Deutsche Bank’s asset management division, provides independent advice on defined-contributions pensions to financial institutions and policymakers. He talked to SRP about the challenges and opportunities of the retirement market.
“There are many problems and opportunities at a global level in the defined-contributions market, and governments, financial institutions and plan sponsors have rightly started to worry about the long-term consequences of getting things wrong,” he said. “We have seen the massive shift from defined benefit [DB] to defined contributions [DC], and of course this will continue. What is often under-appreciated is that, going forward, DC money held by retired persons rather than working savers will be the source of new growth and new problems for the industry and policymakers.”
The driver, said Strobl, is the demographic trend in the West: as a wave of baby boomers hit retirement age, many have substantial DC savings and not much else they can, or want to, rely on in retirement.
“While this means that where DC has been in place for a long time, things are to a large extent playing out as planned, we are nonetheless faced with a shortage of retirement income products and imperfections in guarantee hedges as well as government finances. Seeing people running out of money and income before they die is not an acceptable option, so the bill for getting this wrong will be picked up by all of us,” he said.
“It is no longer just an issue of creating better products, it’s a question of the socio-political sustainability of the rules of the game, and of the way it is played.”
He said that in the coming decade many more DC assets will enter the “spending” phase, as people retire, than there are assets held today by those who are already in retirement. “Products and guarantees that are required are typically insurance-based, substantially more exotic and hybrid than what many structured products specialists in the banking sector usually deal with. And regulation often emphasises risks differently and inconsistently, leading to perverse incentives”, Strobl said.
This can hurt savers through higher premiums, and insurance companies through lower returns on capital. But given that the market will be increasingly under-supplied in terms of product and risk capacity, it will be the savers who bear the brunt of the damage. “When the majority of people are under-insured against risks they cannot bear, it benefits no one,” Strobl added.
There is already a perfect storm in terms of government finances, long-term interest rates and low growth. “But the real crunch comes from demographics: the number of people of working age, the major taxpaying cohort of the population, is shrinking everywhere in the West, as well as in Japan and China.”
This, he explained, will dampen growth with mathematical certainty. When the workforce is shrinking, you need a certain amount of productivity growth just to tread water. “When you plan a retirement system for the next 30 or 40 years, you have to contend with the incredible unpredictability of demographics, which is really not in your favour,” he said.
“In 40 years’ time, we won’t be able to give birth to 40-year-old people. They are born now or never, and they will be the high-value taxpayers and growth drivers. With birth rates some 40% below replacement rates, and people enjoying much longer retirements than they did even a decade ago, this has got to be reflected in your long-term strategy.”
Strobl believes there are certain ways in which retirement systems must respond, and that countries have not done enough to learn from each other’s successes and failures. The issue of how to insure “the 99%” with limited capital in the financial system, he said, is far from solved.
“We need to structure and design products in a way that is not intensive in the use of existing capital, and that is a lot simpler to model, hedge and regulate than what we find today in some markets. And we need to ensure that the political and regulatory debate does not create a time-bomb while concentrating too much on solving yesterday’s problems.”