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On the Lookout for Guaranteed Income Streams

Controlling longevity risk is achievable, but clients have to decide what they're willing to give up to get it.

Christine Benz, 12/21/2010

This article first appeared in the December 2010/January 2011 issue of Morningstar Advisor magazine. Get your free subscription here.

Choosing an approach that ensures clients won't outlive their retirement savings is no easy task. To manage longevity risk, advisors and their clients must weigh an incredible number of factors, including, ultimately, one that is unknowable: how long a person is going to live. The financial industry, however, is on the case, rolling out products and innovations every year that offer new ways to guarantee investors a steady stream of retirement income.

To get a handle on longevity risk and the best ways to control it, we asked three leading experts in the field to discuss the challenges advisors face in finding an optimal solution. Moshe Milevsky is a finance professor at the Schulich School of Business at York University in Toronto and author of Are You a Stock or a Bond? Create Your Own Pension Plan for a Secure Financial Future (FT Press, 2008). John Ameriks is a leading researcher at Vanguard, where he heads the firm's Investment Counseling & Research group. Thomas Idzorek is chief investment officer and director of research at Ibbotson Associates. Our conversation took place Oct. 18 and has been edited for clarity and length.

Christine Benz: I'd like to start by talking about what you think belongs in investors' tool kits when it comes to managing the risk that retirees will outlive their assets.

Moshe Milevsky: When you're accumulating wealth toward retirement, mortality as an asset class doesn't really come into play. Insurance is something you purchase to protect your family. Nobody really thinks of it as an integrated asset-allocation decision. The same thing happens with downside protection. I don't really view put options as something that I'd use on a regular basis to grow my wealth as I'm getting closer to retirement.

But once I start to withdraw money from a portfolio, both of those product classes--downside protection in the form of put options and synthesized puts and longevity insurance, which is essentially a short position on mortality rates--start to play a role in asset allocation. In other words, your health and mortality become an asset class that you can invest, leverage, and perhaps even arbitrage. So, I would start with traditional linear instruments that we're all familiar with, plus an augmented set that essentially consists of derivatives on mortality and other asset classes.

John Ameriks: I think standard asset classes are going to serve people well throughout both accumulation and distribution. Once people get a little older, once they stop thinking about how much life insurance they need and begin to worry about outliving their money, then they need to think about what kind of instruments might be appropriate.

I want to point out that most people start off in retirement with a pretty big annuitized chunk of wealth in the form of Social Security. So, it's not really about needing to do things that are new. It's just thinking about what you have, and whether it's sufficient to meet your needs, and then trying to decide whether additional longevity protection--an immediate annuity or a company pension plan--is something that makes sense in your situation.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.
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