Often the question that weighs most on older Australians is, ‘what happens if I outlive my money?’ The risk of living too long can be a serious one, and with volatility returning to markets in the wake of the UK’s Brexit referendum, this fear is likely to again be at the forefront of investors’ minds. But when it comes to selecting the right retirement and life insurance products, investors must keep a cool head.

According to Milliman, one of the world’s largest providers of actuarial products and services, Australians investing for retirement and beyond are turning to risk pooling products, which offer increasingly innovative ways of dealing with longevity risk. Solutions such as pooled mortality vehicles and mortality credits, which effectively transfer benefits from shorter-lived to longer-lived investors, can be an effective way of helping to ensure that investors have sufficient income to support themselves until death.

However, such products vary in complexity, and the benefits received by individual participants are often based on a number of assumptions. Investors considering pooling their mortality risk should look carefully at how individual products work to ensure that they are suitable for them.

“Mortality credits are a potentially valuable source of return for longer-lived retirees,” said Craig McCulloch, Head of Analytics at Milliman. “However, the value of mortality credits is heavily affected by product design, and can vary depending on whether an insurer provides an explicit guarantee or whether these credits depend on actual pooled mortality experience. They can also be materially impacted by the extent of product features, such as access to full liquidity on lapse or surrender.”

While pooled mortality products come in varying degrees of sophistication and complexity, the two main factors affecting value for individual investors are product design and life expectancy. With Australians living longer (see table below), investors must have a clear understanding of the product to ensure it is suitable for them. For those unfortunate enough to die early, a simple annuity product offers a very poor investment return as all capital is lost on death, and this loss is used to cross-subsidise those who live longer. Likewise, a contract design with 100% death benefits provides for a more significant benefit payable to those who die or surrender their contract early, but it also significantly reduces the mortality credits receivable by those who live longer.

Given the debate surrounding the proposed Life Insurance Framework (LIF) legislation, there has been renewed focus on consumers’ understanding of life insurance and related products, as well as the fear of underinsurance. While underinsurance is a valid fear, investors also need to ensure that the insurance they choose is appropriate for them and their life circumstances.

According to Lonsec Research, while mortality credits can be an effective means of mitigating longevity risk and avoiding underinsurance, it is essential that the investor feels comfortable with the product structure and understands the trade-offs involved.

“Mortality credits are an innovative way of dealing with longevity risk, or the risk of running out of income before you die,” said Eleanor Menniti, Senior Investment Consultant at Lonsec Research. “But you need to understand how the mortality credits are generated and what assumptions are being made. More generous liquidity and death benefits will generally mean reduced mortality credits for those who are longer-lived. There will always be uncertainties, and as investors we cannot plan for everything, but we can ensure that the insurance product we choose is suitable for us and caters to our requirements.”

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New reviews highlight portfolio changes needed to maximise portfolio outcomes

Eleanor Menniti

Investment research house Lonsec Research (Lonsec) has announced key changes to its portfolios following the latest Strategic Asset Allocation (SAA) Review and Model Portfolio Review.

Lonsec leverages its research capability to provide advisers portfolio management guidance through a range of Core Model Portfolios. SAA recommendations are reviewed biennially and Lonsec’s model portfolios are reviewed semi-annually as part of the portfolio rebalancing process. It considers key market and product themes affecting the risk profiles of the portfolios which range from secure to high growth.

Lonsec has announced a series of changes to its own portfolios to reflect broader market trends:

• A reduction in overall total return targets due to lower long term expected return forecasts for most asset classes including global listed property, global bonds and cash
• A more balanced allocation between global and Australian equities, which reflects narrowing long term expected returns for the two asset classes
• Increased allocation to alternative assets to help investors achieve portfolio diversification and provide protection in market downturns
• Inclusion of conservative alternatives – in conjunction with growth alternatives – to provide more defensive returns, as the product offerings within this space increases.

Lonsec’s Investment Consultant Eleanor Menniti noted investors’ ongoing proactive hunt for yield in this low return environment, but warns against specifically targeting asset classes that provides tangible income at an attractive rate without taking into account the need for diversification.

“Being solely focused on income return could lead to portfolio overexposure in certain sectors – a prime example of this is current investor concentration in bank stocks. This strategy increased sensitivity to a few factors, meaning that while the market might behave well most of the time, the portfolio would suffer if those specific factors were reversed,” Ms Menniti said.

“Investors are also ignoring the impact of capital volatility on total returns as they look at yield in isolation to other market factors.”

The research house has also made a number of changes to the manager line-up within the Core Model Portfolios, mostly within global equities and alternatives. A number of these changes were made in recognition of new strategies that have recently become available to Australian retail investors, which Lonsec believes provide a differentiated approach and aligns to the underlying philosophy supporting the portfolios.

Lonsec’s investment approach is based on the SAA framework that strong returns are achieved through diversified asset classes and investment approaches over a long term investment horizon. The review notes alternatives will play a vital role for investors to achieve their objectives, allowing them to diversify their risk exposure for traditional assets.

“A common view is that alternatives are return boosters in a low return environment, when improved performance is linked to the diversification benefits this asset class provides rather than the inherent nature of the assets or the investment style used,” Ms Menniti said.

“Lonsec has positioned the portfolio with exposure across a range of approaches to ensure portfolio performance is not tied to one specific market environment,” she concluded.

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