The "great unbundling" comes to retirement

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By Jeff Gebler | 31 October 2016

Technology has radically reshaped the business world in the last decade. The pace of change is staggering with hundreds of firms, from start-ups to mature businesses, attacking traditional ways of doing business.

But while this disruption is exciting, the effect many of these companies are having on the broader business ecosystem is even more intriguing.

Consumers– emboldened by a mix of smartphones, internet connectivity, open information and new technology– are no longer blindly accepting packages that include some unwanted products and services. Instead, they are demanding greater choice and flexibility.

The result has been dubbed “the great unbundling” and it has reshaped industries as widespread as entertainment, utilities and travel– and increasingly, financial services.

Unbundling everywhere

At its worst, bundling raises prices by forcing consumers to buy products or services they don’t really want with those that they do.

For example, pay TV or cable packages often include programs and channels that consumers don’t want. The rise of the Internet-powered Netflix (which started out as a DVD-by-mail service when I was in college in the U.S.) and other services such as Hulu, HBO Go, Apple’s iTunes and Amazon has changed that.

This content has been carved out from cable providers’ higher cost content delivery mechanisms and allows consumers to make bespoke choices.

Similarly, travel agencies no longer have exclusive access to pricing data and booking platforms that allows them to package dream holidays. Now consumers can book holidays themselves with online websites such as Expedia. Travel agents now focus on planning and recommending the perfect holiday for consumers too busy to do it on their own.

While financial services may be a more complex area, consumers are also beginning to take advantage of the unbundling trend.

Investment platforms act as a portal to invest in managed funds with the benefit of performance/tax reporting. But several new offerings can now be combined to potentially deliver similar results at lower cost for investors.

For example, software-as-a-service providers, such as local firm Sharesight, deliver performance and tax reporting of shares, managed funds and other investments for a fixed monthly fee. The ASX mFund platform allows investors to buy managed funds via their broker while a wide range of low-cost exchange-traded funds (including strategic beta products) offer another investment alternative.

These products and services weren’t launched specifically to disrupt investment platforms– they were instead built to do one thing well. But used together, this broader ecosystem offers an effective alternative.

Can longevity solutions be unbundled?

Longevity risk– the chance that an investor will outlive their retirement savings– poses a growing challenge as improvements in healthcare, living standards and agriculture continue to boost lifespans.

Figure 1: Life expectancy from birth

Source: Clio Infra

However, longevity risk is not just a factor of rising life spans. Other factors include the investment returns generated by a retiree’s portfolio, the level of inflation (and whether returns outpace the areas where retirees are spending their money, such as healthcare), and retirees changing expenditures as they age.

The industry’s current longevity risk solution– lifetime annuities and similar products– lack flexibility and effectively bundle longevity risk with assets not typically associated with extremely long-dated liabilities.

These government bonds and similar assets don’t last the 20 to 30 years that investors are now expected to spend in retirement. In fact, there is a more than a 70% chance that at least one of a male/female couple who retire today at age 65 survives to age 90.

This added risk is built into the pricing structure of lifetime annuities. In addition, fixed income assets which typically underpin lifetime annuities are currently locking investors in at historically low rates.

Figure 2: 10 year Australian government bond yield

Source: Reserve Bank of Australia

But there is a way to unbundle these components and build a better solution with a mix of best-of-breed strategies.

Milliman’s alternative approach to longevity risk is built on our work with funds, asset managers and life insurers, where we regularly unbundle risk management strategies from balance sheets and structured products.

We believe that longevity risk management can be unbundled from the underlying asset allocation found in many current products. Funds can instead give investors a greater choice of higher-returning portfolios and manage greater volatility and potential capital losses with managed risk strategies.

Meanwhile, a separate pooling mechanism, where benefits are transferred to members who live longer than average, directly manages many people’s fear that they will outlive their savings and stops them from overly limiting withdrawals.

This unbundled approach, part of our Retirement Enhancement Trust solution, can reduce costs, boost income through longevity pooling and lead to higher returns with greater investment flexibility.

The benefits of unbundling are being seen far and wide and the retirement industry is no longer immune from its effects. But just as importantly, an unbundled approach is particularly well suited to solve complex challenges such as longevity risk.

Disclaimer

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