The retirement product gap

This article appears in the November 2022 issue of Advisor’s Edge magazine — our second last print issue. If you’re a print-only subscriber, learn more about our digital transition and how to continue to receive all the best news and features on Advisor.ca.

Canadians have saved for retirement to the tune of $1.5 trillion nationwide but experts say there are inadequate options for converting those savings into reliable lifetime income.

With retirees living longer and the number of defined-benefit pension plans declining, Canadians are “unknowingly facing a perfect storm” when it comes to long-term financial security, said Bonnie-Jeanne MacDonald, the director of financial security research at the National Institute on Ageing at Toronto Metropolitan University.

“We’ve really got to think of ways to help people have more automated income as they get older, because many just don’t have the cognitive abilities to make good financial decisions,” MacDonald said.

There’s a huge gap waiting to be filled with new products that MacDonald said are necessary not just for a retiree’s financial stability but their mental health as well.

What should those products look like?

Variable payment life annuities (VPLAs), also known as dynamic pension pools, are one option that’s gaining traction.

Based on 17th-century tontines — longevity-based collective investment pools — these products offer regular income for life but with variable payments based on the mortality pool and return on investments. They differ from annuities because they are not guaranteed and, therefore, incur lower costs.

The Liberal government passed federal legislation last year approving VPLAs and advanced life deferred annuities (ALDAs). However, insurers so far haven’t jumped to offer new products.

Kevin Dorse, assistant vice-president for strategic communications and public affairs with the Canadian Life and Health Insurance Association (CLHIA), said some insurers are designing ALDAs, which would allow a client to move part of their savings from their registered retirement accounts to an annuity deferred until age 85.

“An increasing interest rate environment is expected to be helpful in regard to the development of ALDAs,” he said.

VPLAs, though, are limited to members of large plans. The CLHIA and others are lobbying the federal government to expand access by permitting standalone VPLAs.

Noeline Simon, the CLHIA’s vice-president of taxation, pension and reporting, said the discussions “are going well” and she’s hopeful the changes will be announced in the next budget. That would open the market to more tontine-like products for a wider range of people.

Recognizing the need for innovative products like VPLAs, Purpose Investments last year launched the Longevity Pension Fund, which issues monthly lifetime distributions when investors turn 65.

“This product behaves somewhat like a pension plan, somewhat like an annuity and somewhat like a mutual fund, but it sits within a mutual fund wrapper,” said Simon Barcelon, vice-president of products at Purpose Investments.

The fund is designed to optimize income during the investor’s lifetime, he said, with the trade-off that “you have to give up some of the assets when you pass away.”

Moshe Milevsky, a finance professor at the Schulich School of Business at York University in Toronto, said Purpose’s product is “part of a trend of developing funds that are partially insurance and partially investment funds. It’s a great trend, because it’s opening up a conversation about how to manage longevity risk and how to merge these [product types].”

In September, Guardian Capital released its own longevity products after partnering with Milevsky on retirement income solutions. The GuardPath Modern Tontine 2042 Trust, restricted to investors in a specific age range, is designed to provide a lump-sum payout in 20 years based on compound growth and the pooling of survivorship credits. The GuardPath Managed Decumulation 2042 Fund targets 8% cash flow in the form of monthly distributions over 20 years, with the assets depleted by 2042. There’s also a hybrid option combining the two products.

These new types of products may be attractive to financial advisors in a way that annuities aren’t because the money is still “owned” by the advisor’s client and advisors will continue to assist in the management of the funds, said Richard Fullmer, a U.S.-based pension researcher and entrepreneur. “I think it removes that disincentive for advisors,” he said.

Asset managers may also look to develop products around another asset that’s traditionally been beyond the domain of managed money: real estate.

Milevsky said many Canadians have “raided” their RRSPs and “short-changed” their TFSAs to dump money into their houses with the hope that the increase in value will allow them to live off those funds in retirement. The predicament is that it’s not easy to monetize that value and turn it into life-long income. (See article, right.)

With Canadians’ asset allocation heavily lopsided to housing, Milevsky said real estate is the next frontier for investment product innovation. “I think that’s going to be the real estate industry working together with the fund industry — and perhaps with the tax authorities — to innovate and say, ‘Look, we have a problem.’”

He said fund companies could develop a product where a client sells part of their house in the forward market to a pension fund. The client gets to live in the house while receiving an annuity, and when they die the house’s value is split between the beneficiary and the fund.

Innovative funds may need time to catch on in the retail market, though. More than a year in, Barcelon said the Purpose longevity fund has only about 400 investors and $10 million in assets under management. Fund managers must be willing to do the “heavy lifting” to get their products added to dealer shelves and get advisors comfortable enough to offer them to clients, he said.

What about a robo-tontine?

If tontines are making a comeback, why not make this centuries-old solution truly modern with a robo version? That’s what Richard Fullmer, a U.S.-based pensions researcher and entrepreneur, and co-author John Turner of the Pension Policy Center asked in a paper published this year in the Journal of Retirement.

Robo-advisors have a large client pool and experience managing investment products, but some are lacking when it comes to the decumulation phase of investing, the paper argued. Tontines, meanwhile, could be automated to provide personalized investment strategies and payout options.