Guarantees not worth the cost

Australian financial services companies and superannuation funds looking to offer post-retirement products may be well-advised dropping the notion of a guarantee, according to new research released by Milliman.

The research, contained in a paper titled ‘Life-cycle investing for the post-retirement segment’, argues that the global financial crisis (GFC) raised many questions about such products with the steep market downturn exposing “many flaws in traditional asset-allocation principles and risk management techniques.

It said the lack of balance sheet and capital within many retirement funds made it difficult for a guarantee to be offered without significant support from a third-party institution.

The report said the GFC had shaken many people’s confidence in the institutions that traditionally provided guarantees or insurance against such events, with the high profile corporate failures of institutions such as Lehman Brothers and American International Group having brought counterparty risk to the forefront.

However, it noted that opportunities might exist for funds to replicate some of the accepted investment strategies without a guarantee, resulting in a sustainable and lower-cost solution while providing much of the benefit of the original product but without a guarantee label.

The Milliman research concludes that strategies delivering protection rather than an absolute guarantee may prove attractive and cost-effective in the Australian defined contributions market because it will entail lower costs and minimal counterparty risk.

It said guarantees often carried with them a number of restrictions that could be avoided through the use of protection strategies without sacrificing the value proposition.