ITDFs: A Formula To End Retirement Blues?

All over the world, the financial industry is grappling with the ‘ideal’ post retirement investment strategy and with how best to pay out income in retirement. There is an arms race and the question is the following: who will win the retirement agenda? 

There is a great deal at stake. For many providers it could be a life-or-death proposition on whether they retain customers and members. On the other hand, there are huge opportunities for those who get it right, including opportunities for asset consolidation and for attracting a greater number of older investors.

That said, managing money in the decumulation phase is harder than in the accumulation phase. Prof Wade Pfau of the New York Life Center for Retirement Income expressed this in 2017 as: “The ultimate goal of climbing a mountain is not just to make it to the top. It is also necessary to get back down. Going up is easier than coming down.”

The pension industry’s key weakness  is that “the design of good DC pension plans is considerably more complicated – to say the least – than the design of commercial airliners or even rockets to the moon”, as David Blake, Andrew Cairns and Kevin Dowd put it in 2008.

Looking to the future 

The powerful mathematical law of gravity laid the foundation for rockets to the moon. Similarly, we need to discover a mathematical law of retirement income investing that can lay the foundation for creating a breakthrough in retirement income products and investment strategies.

That is why we are proposing our mathematical law of retirement income investing including formulae for retirement income and capital investment strategies. The formulae are the foundation of an emerging product category from Denmark, which is called iTDFs.

Only two (multi-asset) funds are needed; the iTDFs’ algorithms and technology do the rest of the work by varying the asset mix in the investors account over time in an intelligent way. The iTDFs framework is sophisticated and based on a few objective, robust and surprisingly simple mathematical formulae that explain everything. The formulae can keep on working in the real world for the benefit of millions of retirement savers and retirees around the world.

iTDFs are modern lifecycle products with or without longevity risk management based on personalised dynamic investment strategies and capital-efficient smoothing of retirement incomes for each individual. The built-in drawdown and investment strategies are interconnected and coordinated by mathematical formulae.

New perspectives

iTDFs open up new perspectives on retirement income. For example, retirees do not have to accept lower expected returns as the price to pay for more stability in retirement incomes. On the contrary, the iTDFs’ smoothing mechanism enables the combination of expected higher returns with lower volatility in retirement incomes. Attractive retiree income outcomes are the priority and, after all, that is the purpose of pensions. 

A choice between payment profiles is offered. A targeted minimum pension benefit may potentially be obtained at retirement and even the subsequent non-decreasing smoothed retirement incomes can be achieved with a high degree of certainty. The participants also have the flexibility to choose a smoothed retirement income profile which is higher during the earlier, more active years of retirement. Unfavourably low interest rates do not have to be locked in when converting retirement savings into retirement income.

iTDFs combine the accumulation (saving) and decumulation (income) phases of a pension seamlessly, providing both a savings vehicle and a smoothed regular retirement income. The iTDF approach is a managed account solution, making decumulation and accumulation easy for the customer. It requires no expensive guarantees or potentially costly derivatives. The manufacturer does not have to assume investment and mortality risks. That said, for those who want guaranteed income in the later part of life, iTDFs can be combined with deferred or immediate income annuities. 

iTDFs may also be designed to produce smooth income during retirement, either for a pre-defined period (for example, between ages 65 and 85) or, if combined with optional longevity pooling, for as long as the account owner lives. It is unique to iTDFs that a seamless transition between the two phases are offered. 

The retirees may maintain flexibility and control of all of the savings during the liquidity period and they do not have to enter the life contingent phase, for instance because of deteriorating health. 

On the other hand, it is expensive to self-insure longevity and there is a compelling case for the benefits of sharing longevity risk between the retirees when they get older. The survivor benefits become more significant the older the retiree gets and the mortality gains for those alive will have more impact than asset returns at older ages. 

The iTDF concept presents a comprehensive and personalised approach to retirement. It offers the opportunity to coordinate investment, distribution, and longevity protection strategies. It can also provide liquidity, flexibility, the possibility of leaving bequests and a range of investment options (for example, low, medium, high investment risk) determined by the desired or default degree of smoothing and stability in retirement incomes. Different versions of iTDFs can be tailored to local market conditions and purposes, and targeted at different groups – including low to medium earners. 

Relying on a robust algorithmic framework, iTDFs will fit easily into an increasingly digitalised and mass-customised world and can be delivered as fully automated solutions. The algorithm-based product design allows scalability, portability and low cost. The concept offers retirement savers and retirees more for the same money and can fill a vacuum in drawdown solutions. 

Finally, the iTDF framework can also provide investment strategies that are designed to enable the account holders to take (part of) their pensions as a ‘smoothed’ lump-sum capital payment at retirement.

Reshaping the landscape

The iTDFs framework provides a platform for developing 21st century personalised dynamic investment strategies and capital-efficient smoothed retirement income solutions which can fulfil the needs of a diverse range of retirement savers and retirees. 

iTDFs have the potential to reshape the investment and retirement income landscape. More importantly, they represent an opportunity to improve the retirement outcomes and the lives of millions of retirement savers and retirees throughout the world by giving guidance to their withdrawal decisions for a smoother retirement journey. 

That said, it is a ‘speed limiter’ for one man with insufficient resources to bring iTDFs to market internationally. Therefore, I am inviting strategic partners to adopt the algorithms and grow the concept at scale. This may lead the way to a new wave of innovation.