Managing retirement risks


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In the UK, we have seen the 2015 “Freedom & Choice” reforms shake up the retirement market. We have gone from a market dominated by the fixed annuity to one where the onus is now on retirees to manage a complex set of risks to meet their retirement goals. For them and their advisors it is now a tremendous challenge to generate a reliable lifetime income that will survive an unpredictable story line.

Milliman is a risk management and retirement expert and is ideally placed to assist in providing innovative new solutions to help you deliver products that allow your customers to meet this challenge.

Risk management solutions

UK retirees are increasingly investing for longer during retirement. A slow growing economy, low interest rates and the looming threat of inflation are making it difficult to meet both income and risk management needs. Investing too much in stocks and shares may mean too much market risk, while too much in bonds may equate to a lack of growth. An alternative “middle way” to solve this conundrum is to apply a sophisticated risk management technique to greatly reduce the market risk whilst still allowing the investor to remain largely invested when markets are performing well.

Milliman Managed Risk Strategy

The Milliman Managed Risk Strategy uses hedge assets (typically exchange-traded futures contracts) that act independently of an underlying portfolio, which allows investors to remain invested in current assets. The Strategy consists of two risk management processes that actively account for changing market conditions. Following are brief descriptions of these processes, which are designed to help foster growth in bull markets while defending against losses in down markets:

  • A volatility management process designed to keep the risk level of the portfolio from increasing significantly during periods of market turbulence. This is accomplished by continuously monitoring and reacting to specific changes in the market, allowing the overall portfolio to effectively target a predetermined volatility level and accurately maintain it over time.
  • A capital preservation process, which adjusts futures positions on a daily basis subject to market-based thresholds, with the goal of maintaining the capital of the portfolio on a rolling five-year basis. In a severely declining market, futures gains are generally harvested and reinvested in growth assets in an effort to maximise long-term returns.

Key benefits

The Milliman Managed Risk Strategy:

  • Helps address sequencing risk. Market downturns in the early years can be devastating to the sustainability of an income drawdown portfolio, or as we were quoted in NEST’s retirement income blueprint1: “market declines combine with portfolio withdrawals in a toxic way.” The pay-offs from this strategy are specifically designed to cushion the investor from large market downturns.
  • Cost-effective downside protection. Whilst the Strategy does not provide a hard guarantee, it aims to provide a significant cushioning of downside risk, and at the same time, also avoids the cost of paying for “over-insurance”. For example, for a retiree who plans for a multi-year horizon, there is a question as to whether the overnight gap protection provided by some alternative products is money well spent.
  • Low-cost and liquid instruments. The only derivative that the Strategy employs is the futures contract, which is at the low-cost and highly liquid end of the derivative spectrum and traded in a market which was proven to remain open during the worst of the 2008 global financial crisis. It avoids the need to expose the investor to counterparty risk, and the additional premium and complexity associated with other derivatives.
  • Requires little movement of underlying portfolio assets. The Milliman Managed Risk Strategy acts as a basket of hedge assets and operates independently of the underlying portfolio, allowing investors to remain invested in current assets. Therefore, it has the flexibility to be overlaid on to existing fund structures and so offer the investor a choice between a fund with and without the risk management as well as different intensities of risk management.
  • Term-independent risk management. The Strategy itself has a rolling time horizon. It applies the downside risk management as the risk arises. Thus, for retirees who want to maintain flexibility, this approach allows them to avoid their spending plans being dictated by the market or their product structure.
  • Offers institutional-quality access to a global risk management authority. Milliman Financial Risk Management provides investment advisory, hedging and consulting services on £115 billion in global assets (through its regulated entities Milliman FRM LLC, Milliman Financial Strategies Ltd. and Milliman Pty Ltd. as of 31 December, 2016).

Managing retirement guarantees

The persistently low interest rate environment in recent years has meant a challenging environment to offer new guarantees and manage existing ones. Relatively benign market volatility in recent years has helped keep the cost of hedging down. But there are some significant causes for uncertainty on the horizon, both in the Brexit-bound UK and globally as central banks begin to wean the markets off the financial stimulus of recent years. If volatility starts to re-surface while interest rates remain low, guarantee writers face a new challenge to make guarantees attractive.

Milliman FRM is a financial risk management expert and pioneered techniques used by many of the top global retirement guarantee writers today. Contrary to many risk management strategies now available, Milliman FRM’s approach relies on the simplest, most liquid hedge assets available, and the firm insists on complete transparency with all of its clients. Milliman FRM’s risk management strategies have been tested for more than 16 years and through two market crises (the 2000 Internet bubble and the 2008 global financial crisis). We are continually redefining the investment industry’s modus operandi through our team of trading, risk management, portfolio management, quantitative finance and actuarial professionals that develops and implements effective hedging strategies. We have assisted companies with hundreds of guaranteed product development initiatives and have created transformational change in portfolio risk management through the Milliman Managed Risk Strategy to help companies deliver guarantees cost effectively in a challenging market.