Here is a guest post by Dr Wade Pfau on his blog (his bio on his blog page) of a segment of a longer email conversation he and I had about the possibility the big push to “solve” the retirement issues exposed by the Great Recession may be a setup for insurance companies to become too big to fail.
The problem is the financial industry’s desire to want to guarantee retirement income based on consumer sentiment (which is sometimes counter to what may be good for them). The tendency is to think that the risk goes away when you invest in an annuity or pension. Risk simply gets shifted to the pension or insurance company, but it doesn’t go away. ALL markets are variable and everyone, including the pension plan and insurance company, invest in the same markets.
Also, when was income guaranteed during your working years? If you look at your Social Security statement earnings history, I suspect it will show you that your income was variable over your working lifetime too. We tend to forget that we had variable income during our working years.
Thus I proposed (not in the linked blog snippet) in our email conversation that retirement income should also be variable, just a little over the years as necessary, to sustain the asset base (i.e., your money) as long as you may live.
In summary, at present pensions, annuities and the first generation of safe withdrawal research, tend to disconnect the benefits paid from the money that needs to sustain that income. With more and more assets encouraged to go into annuities through 401k proposals, this may be a set up where insurance companies get too big to fail. Why? Pensions and annuities are required to pay promised benefits … but if the money isn’t there to pay those benefits, benefits that are now too high because assumed market returns didn’t pan out, the money runs out.
The dynamic approach developed in our second generation research, is designed to keep benefits paid for retirement income connected to your current retirement account balance which is required to prudently sustain your income for the rest of your life.
PS. See my blog post, “Two schools of retirement income thought,” currently scheduled for posting 22 Feb 2013.