Support for guarantee proposal
There’s support for a call from the Financial Services Council for capital guarantees to be introduced for KiwiSaver.
Monday, July 21st 2014, 6:00AM 
6 Comments
by Susan Edmunds
The FSC wants them as an option for people who are close to withdrawing money for a home, or retirement, to allow them to move out of conservative funds.
“We asked Infometrics to calculate the cost of guarantees that would ensure someone who was defaulted into a balanced or growth fund was protected against a major financial market downturn, especially when close to either retiring or withdrawing funds to buy their first home,” chief executive Peter Neilson said.
The Infometrics report said that if someone knew in advance that they wanted to buy a house in their 12th year of savings, they could pay a single premium in the 11th year to insure against a negative return.
“That premium would be 1% of the balance in year 11. For someone on the mean wage the corresponding dollar amount fee would be about $700. Expressed in relation to the contribution rate the proportionate increase would be about 15%, raising the contribution rate from 7.60% to 8.74% in the case of a balanced portfolio for that one year.”
It said another option would be to spread the premium over 20 years, the period over which most KiwiSavers would purchase a house.
“For someone in a balanced portfolio who purchases a house in year 12, their contribution rate would need to rise from 7.60% to 7.65%, an additional 0.05% contribution each year for 20 years, to protect themselves against the possibility of one to three years of negative returns prior to house purchase.”
Ralph Stewart, managing director, of NZ Income Guarantee said the FSC’s comments were a welcome contribution to the retirement savings debate. “Little attention has been given to the systemic risks associated with retirement savings being eroded by unknown investment returns and retirement savings lasting over an unknown life expectancy.”
He said the FSC approach could be compared to products offered overseas, called guaranteed minimum accumulation benefits (GMAB).
“The costs quoted in the report are low in our experience. They do not factor the cost of capital to the provider or any additional volatility created by aggressive investment strategies. The annual cost of a GMAB in the US in the fourth quarter of 2011 was 0.25% to 1.95%.”
John Berry, of Pathfinder Asset Management, said guarantee products were often structured so they de-risked in years when markets turned.
“One way to look at it is the average return on a growth fund is 6.6% compared to a conservative 4%, that’s 2.6% difference. If someone offered a guarantee for 1% per annum, that when they fall you won’t lose money, that would seem like a good idea.”
He said innovation that offered KiwiSavers more choice should be supported.
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Comments from our readers
The main issue I have with the FSC proposal is they seem to be wanting the govt to provide the guarantee. The govt balance sheet should not get tied up in this - any solution should be offered by the private sector and properly regulated.
I am not disagreeing just for the sake of it although that is tempting. According to the GIRY portfolio insurance doesn’t make sense in that it is too expensive. I would have thought that a better option and certainly a cheaper option would be for someone to take their money out of KiwiSaver as soon as they knew they needed it or, if that wasn’t possible because of some fundamental problem with KiwiSaver, they should shift to a conservative asset allocation.
I have been in business since 1984 and, although it’s tempting to maximise funds under management, whenever a client rings me and says ”I need the money” I don’t tell them to take out portfolio insurance, I tell them “take the money, it’s yours”. Maybe I am naïve but I think minimising fees is fundamental to putting clients’ interests first. This is an interesting issue and I intend to write about it because I suspect there is more to this story in terms of cost than meets the eye.
12 bp for protection does seem pretty high especially when no doubt it is based on synthetic instruments which either fail under extreme event conditions or their provider goes belly up aka during the early stages of the GFC.
A post retirement income / capital guarantee could also be a useful option - but like you say, the pricing needs to be right.
Your key point is when considering a product advisers must act in their client's best interests - no argument from me on that!
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Several commentators are on record in saying that the only “innovation” that bankers ever came up with that offered genuine value was compound interest and we all know greater complexity equals higher fees. Also the authors of the GIRY are on record as saying portfolio insurance is stupid … a conclusion you arrive at with common-sense as well. Regards Brent