According to the forthcoming report US Baby Boomers and the Financial Crisis, to be released at the end of September, the US pension landscape had $17.92 trillion in assets at the end of 2007.

However, in 2008, those poised to retire watched as the value of US retirement assets dropped more than $4 trillion – approximately 20% – to $14 trillion from 2007 to 2008. A significant plunge in housing values and other financial assets was also experienced, making this downturn, the second this decade, far worse than the first.

About 78 million baby boomers are expected to retire over the next two decades. When they do, they will enter a phase where their focus will shift from mere asset accumulation to carefully considered decumulation of their retirement nest eggs – a nest egg that may have to support them for up to 30 more years.

Will it be enough? Individuals entering retirement are relying more and more on personal retirement in order to maintain their living standards. In addition, mistakes in investing may be irreparable. Unfortunately, research shows that many elderly have low financial literacy with little understanding of inflation and diversification.* The upcoming challenge of the US financial services industry is to provide products and services that are focused on payout solutions. As consequences from this crisis show, risk management is a key feature of any such solutions.

The current retirement income product landscape varies widely. The key distinguishing features of products are the level of capital protection regarding shortfall risks, the flexibility and liquidity in terms of accessibility, the potential for growth, and the predictability of payouts. Additionally, both longevity insurance and health coverage are important aspects.

The latest downturn revealed significant weak spots in product design. For example, the soon-to-mature target date funds were heavily invested in the stock market. Variable annuities have significantly hurt insurance companies at a time when the prices for risk hedging have exploded.

Likewise, the fallout from losses like those incurred in 2008 mostly affects retirees dependent on supplementary pension coverage to maintain a reasonable standard of living. The recent drop in retirement assets will also force many employees nearing retirement to postpone or defer this date indefinitely. And these developments are likely to accelerate longer-term trends evident in the general pension system and in terms of occupational pension design.

The role of Social Security as a general pension safety net will come under increasing pressure. Decreasing generosity seems inevitable – and this from a system that already provides a relatively low level of financial support. As a result, occupational and private pension assets will play increasing roles as sources of retirement income, evolving from being only complementary sources to being integral parts of old-age income.

Unfortunately, for employees the ongoing shift from DB to DC pensions plans means they can no longer expect to enjoy lifetime payments from occupational pension plans. Instead, lump-sum payments prevail, and this means individuals need to assume greater responsibility for retirement income. Given the trends toward individual responsibility and the complexity of the product spectrum, financial advisors may play an ever more important role in guiding people in their investment and retirement decisions.

Other issues need to be considered as well when developing new products. For example, retirement income solutions are predominantly determined by household wealth. High-net-worth individuals are primarily concerned with asset preservation while the less affluent need assets to cover required spending needs. In addition, less affluent households have most of their assets in nonliquid assets such as their primary residence. Consequently, retirement planning strategies differ to a substantial degree.

Greater focus on the fiduciary responsibility on the part of the adviser and changes in product design are most likely to be two of the most immediate responses to the current market turmoil. If boomers are to sustain their wealth over lengthy retirements, product providers must develop new solutions to meet the changing requirements of this generation. 

* Presentation by Annamaria Lusardi and Olivia S. Mitchell at the Conference on Financial Literacy in Times of Turmoil and Retirement Insecurity, March 2009.

Published by PROJECT M in September 2009

(Photo: Bela Borsodi/trunkarchive.com)