Life insurers and asset managers are jointly launching innovative concepts that address the woes of customers in the low-interest rate environment
Years of persistently low interest rates with virtually no prospect of returns have hit security-oriented savers hard. As a result, many are questioning if they can continue to rely on life and pension insurance to finance their capital requirements in old age.
The situation is compounded by market observers who have taken a pessimistic view on the effectiveness of insurance in this world of negative interest rates. We are more optimistic. The need for insurance companies and pension plans to support people’s retirement ambitions has never been greater, and innovative concepts that support savers have been on the market for some time.
Although the great wave of baby boom retirement is well underway in the United States and Australia, it is only about to begin in Austria, Germany and the UK. The first boomers will officially enter retirement in 2021, with public pension systems coming under mounting pressure.
As states grapple with the mounting costs of public pensions, with people living longer than previous generations and spending proportionally more time in retirement, benefits are likely to continue to fall and individuals are going to need to create other sources of retirement income.
The traditional book of financially strong life insurers, typically used for financing long-lasting liabilities, can remain a key element of collective accumulation of old-age provision. With the expertise of major institutional investors behind them, life insurers spread investments over asset classes, using tangible assets like real estate or equity as key investment components. Long-term investments, such as renewable energy or infrastructure projects, also promise stable, attractive returns that match the liabilities of insurers to customers’ needs for secure long-term returns. The central management of policyholder assets can, in addition, save costs. It is clear, however, that the considerable need for old-age provision today cannot be covered by fixed-income investments alone in the current low-interest rate environment. As a result, those saving for retirement must now strike a balance between security and opportunity, and the industry is responding with new solutions.
Traditional Book and Upside Potential
One new type of product class uses modified guarantees to enable people to invest in the traditional insurance book, while providing upside potential. How this functions can be seen in the example of the concept called “Perspektive” from Allianz Leben in Germany. The product guarantees capital on the pension start date of at least 100% of the premiums paid in. In 2016, the credited rate of the policies came to 4%. This is 0.3 percentage points more than for traditional policies. While such products are convenient for people who want to have investment decisions automated, those seeking to be more active can look at index- or unit-linked concepts. The latter invest a portion of the old-age savings in investment funds that customers can select individually.
The extent to which premiums are invested in funds is determined by, among other things, the level of security guaranteed by the policy: customers can opt to adjust the level of minimum capital that is guaranteed on the pension start date. As well as the level of 100% of the premiums paid, the old-age provision concept “InvestFlex” allows customers to select guarantee levels of 80% or 60% of the premiums paid. This can increase the upside potential because a larger portion of the premiums is initially plowed into the fund investment. Depending on the policy terms, this allows initial fund ratios of 70% while maintaining valuable pension start date guarantees.
Investments in opportunity-oriented asset classes such as equities give customers the chance of higher returns compared with conventional policies. This is because with unit-linked insurance the amount of the total capital available on the pension start date depends on the performance of the underlying fund unit that the policy invests in. This means, however, that investments can also be affected by capital market fluctuations.
People who choose unit-linked concepts need to be prepared and able to accept the risk of such fluctuations. Multi-asset concepts can, however, provide a check on potential losses. This is achieved by either offering lifecycle investment profiles that adjust the fund risk during the term to reflect the policyholder’s risk-bearing ability, or by ensuring that, in a given calendar year, a specified maximum loss threshold will most likely not be exceeded.
Cushioning Fluctuation Blows
The intelligent management of the investment split between traditional book and fund investment also helps cushion the blows of fluctuations in value, since the traditional book offers more returns and more stability than other “risk-free assets” commonly used in unit-linked concepts with guarantees (such as CPPI concepts). At the end of the policy term, fluctuations can also be mitigated by optional end-phase management.
In order to secure returns, customers can also opt for guarantee increases during the term when they take the policy out. This means that if the policy shows favorable development, the benefit guaranteed on the pension start date can increase beyond the level originally selected.
Decumulation strategies are also likely to play more of a role in future insurance retirement products. These solutions combine variable or fixed payouts with capital market participation and insurance cover during retirement. With people spending 20 years or more of their lives in retirement, models combining pension payments with high-return investments on the remaining capital could be increasingly attractive.
Finally, the changing regulatory environment in Europe will also give rise to new product generations. Investors will continue to look for strong investments based on flexible, transparent concepts that address their individual requirements and offer good value for money.
Written By: Volker Priebe and Kai Wallbaum
Source: Project M