Professional research and advisory firms have developed an impressive array of benchmarking tools over the years, which soundly provide guidance to plan fiduciaries on the selection and monitoring of pooled investment funds. Often using a rigorous combination qualitative and quantitative measures, fiduciaries rely heavily upon these tools to (among other things) demonstrate their compliance with fiduciary standards. The really good ones effectively integrate judgement with the use of number. This includes, for example, inclusion in their benchmarking practices a measure of qualitative assessment such as changes in management and the managers’ adherence to their own published investment goals in establishing their “scorecards.” Central to the use of most of these arrangements is the benchmarking of fees and their impact on the total performance of those funds.
There are substantial efforts underway in many parts of the industry to develop similar sorts of benchmarking tools for assessing, comparing and monitoring the growing variety of lifetime income programs for defined contribution plans. A very real challenge these developers face arises from the fundamental difference in the nature of the investments involved: existing equity based assessment tools translate poorly into critiquing programs where decumulation risks are the critical factor. Even the language used to produce these new tools is demanding a new mind set.
I attribute Matt Gray, an actuary with Allianz Life, with suggesting a new and viable route to addressing this challenge. He outlined it in the Retirement Income Consortium’s July 18 Webinar on “How to Analyze Fees Associated with Retirement Income Solutions.” I invite you to take a look at the last few slides of that presentation, as Matt succinctly lays out the case that effective benchmarking of lifetime income programs is all about “outcomes,” not fees.
Just looking at fees doesn’t tell you a lot with regard to these programs, where annuity products are a key element of the design. This is not to understate the importance of knowing where the “stated” (or “explicit”) fees lie, and who is getting compensated. However, their role in the benchmarking process is much different than it is for scoring equity investment products. The actual “costs” related to covering the variety of lifetime risks within an annuity are imbedded into the products themselves, and cannot be meaningfully compared in the same manner as we have always approached “fees.” What you really are looking at in order to conduct a comprehensive review of any product’s relative reasonableness are the “outcomes” which are being provided (which CAN be quantified) for the premiums being paid.
I would suggest that the benchmark developer’s next step, once building out the “outcomes analysis,” is then to develop and weave into these outcomes a new set of relevant qualitative tools.
Relevancy is important in the qualitative analysis. I take note that at least a few elements of the “conventional wisdom” being proposed by a number of professionals really don’t seem to pass muster. A prime example is an often misstated notion that the type of annuity used in a program does not really matter, and that each type simply provides an actuarial restatement of the same priced risk. This is not true, as each type of type of annuity provides much different “efficiencies.” A variable annuity is, structurally (because of the way insurance rules apply to them), one of the most efficient platforms under which to accumulate wealth in a plan (see, for example my blog on this point); where the fixed indexed annuity (again, because of the way in which insurance rules apply to them) appears to be very efficient at providing certain income benefits.
Another example is the use of the “spread” an insurer realizes on its general account investments in any given year, a question now often being asked by a number of advisers. Though collecting this factoid may be an interesting exercise, it has little relevance (for a number of reasons, including state reporting protocols) to a fiduciary’s quantitative or qualitative assessment of a lifetime income program.
I also wonder if an outcomes based approach may not actually help address the concerns many have expressed as to whether or not insurance products should be used in these programs, or whether even these programs should be offered in a DC plan. I suspect it will.
It also well makes my point from my previous blog that we all need to become accustomed to a whole new use of technical language.