Presentation Pension Day

Transcription

1 Presentation Pension Day Investment strategies for the pre-retirement and retirement phase of IDC pensions A.W.M. van Ool Master Quantitative Finance & Actuarial Sciences Netspar Track specialization 1 of 20 October 14, 2016

2 Table of contents Introduction Assumptions model analysis Results model analysis: investment policy Results model analysis: pension benefit payment policy Conclusions & recommendations Questions 2 of 20

3 Introduction Individual Defined Contribution (IDC) pension scheme New legislation: Wet verbeterde premieregeling Start date: September 1, 2016 Investment policy Life-cycle Investment after retirement Higher expected pension: accumulation & decumulation phase No guarantee Pension benefit payment policy Assumed interest rate (AIR) Financial smoothing 3 of 20

4 Research questions 1. Which life-cycles are suitable for a participant with certain risk preferences? 2. What is the influence of the assumed interest rate on the development of the pension benefit level during retirement? 3. What is the influence of financial smoothing on the optimal life-cycle design and assumed interest rate? 4 of 20

5 Introduction Assumptions model analysis Results model analysis: investment policy Results model analysis: pension benefit payment policy Conclusions & recommendations Questions 5 of 20

6 Assumptions model analysis Merton model Black-Scholes financial market Risk-free human capital Career pattern + AOW included Starting age 25, retirement age 67, CBS mortality table CRRA utility: constant risk preferences Less risk averse participant (γ = 4) Default participant (γ = 7) More risk averse participant (γ = 12) 3% DC fiscal maximum premium ladder Variable pension payments via PPR ( Personal Pensions with Risk sharing ) mechanism 5 of 20

7 Time periods Age Initial Focus Annuity AIR wealth Period 1: Design life-cycle until retirement Fixed annuity Risk-free rate Accumulation period Period 2: ,000 Design life-cycle around and Fixed annuity and Risk-free rate Conversion period during retirement Variable annuity Period 3: ,000 Distribution pension payments Variable annuity - Risk-free rate Decumulation period over retirement period - Optimal AIR Financial smoothing - Expected return - Maximum AIR 6 of 20

8 Assumed Interest Rate (AIR) 10% 9% 8% 7% Risk-free rate (1) Optimal AIR (2) Expected return (3) Maximum AIR (4) 6% AIR 5% 4% 3% 2% 1% 7 of 20 0% Gamma

9 Life-cycle strategies period 1 100% 90% 80% 70% Equity exposure 60% 50% 40% 8 of 20 30% 20% 10% Scenario 1 optimal Merton OM (0) Scenario 2 optimal Merton OM (0) Median Merton MM (1) Linearly decreasing variable LDV (2) Linearly decreasing fixed LDF (3) Constant-mix CM (4) 0% Age

10 Introduction Assumptions model analysis Results model analysis: investment policy Results model analysis: pension benefit payment policy Conclusions & recommendations Questions 9 of 20

11 Results period 1 Conclusion: a decreasing life-cycle is preferable. Welfare losses life-cycles relative to optimal Merton strategy Life-cycle strategy MM (1) LDV (2) LDF (3) CM (4) Less risk averse (γ = 4) 0.5% 1.1% 2.7% 5.8% Default (γ = 7) 0.5% 1.5% 1.0% 5.0% More risk averse (γ = 12) 0.3% 1.2% 0.7% 3.6% 1. Median Merton strategy (MM) 2. Linear decreasing strategy variable annuity (LDV) 3. Linear decreasing strategy fixed annuity (LDF) 4. Constant-mix (CM) 9 of 20

12 Results period 1 Conclusion: sizes of welfare losses can differ significantly. Welfare losses inadequate equity exposure median Merton strategy relative to optimal Merton strategy Welfare loss Correct Inadequate equity exposure equity exposure Less risk averse (γ = 4) 0.5% 6.8% More risk averse (γ = 12) 0.3% 2.0% 10 of 20

13 Results period 1 Conclusion: sizes of welfare losses can differ significantly. 100% Welfare losses inadequate life-cycles relative to optimal Merton strategy Welfare loss No investment Inadequate life-cycle after retirement before retirement Less risk averse (γ = 4) 8.8% 3.8% Default (γ = 7) 5.5% 0.9% More risk averse (γ = 12) 3.6% -1.0% Equity exposure 90% 80% 70% 60% 50% 40% 30% 20% Median Merton MM (1) Linearly decreasing variable LDV (2) Linearly decreasing fixed LDF (3) 10% 0% Age 11 of 20

14 Results period 2 Conclusion: the dispersion in the average replacement rate is significant. 160% Replacement rate at retirement for each level of risk aversion 160% Average replacement rate for each level of risk aversion 140% 140% Replacement rate at retirement 120% 100% Average replacement rate 120% 100% 80% 80% 60% 60% 12 of 20 gamma=4 gamma=7 gamma=12 gamma=4 gamma=7 gamma=12

15 Introduction Assumptions model analysis Results model analysis: investment policy Results model analysis: pension benefit payment policy Conclusions & recommendations Questions 13 of 20

16 Results period 3 Conclusion: disadvantage of a high AIR becomes visible as of 10 years after retirement. 160% Replacement rate 150% 140% 130% 120% 110% 5% risk-free rate (1) 50% risk-free rate (1) 95% risk-free rate (1) 5% optimal AIR (2) 50% optimal AIR (2) 95% optimal AIR (2) 5% expected return (3) 50% expected return (3) 95% expected return (3) 100% 90% 80% 13 of 20 70% Age

17 Financial smoothing: growth rate approach Pension benefit level No financial shock Financial shock with no smoothing Financial shock with smoothing of Age

18 Results financial smoothing Conclusion: financial smoothing reduces the weighted average year-to-year volatility. Smoothing period 1-year 5-year 10-year Assumed interest rate (AIR) Expected return Equity exposure Constant (21.4%) Volatility change replacement rate Weighted average year-to-year volatility 2.5% 1.4% 1.2% Probability (large) decrease benefit level Average probability decrease 49.9% 51.6% 51.9% Average probability large decrease (>5%) 11.7% 1.4% 0.9% Average relative size decrease 3.3% 1.8% 1.6% 15 of 20

19 Results financial smoothing Conclusion: a decreasing life-cycle during retirement is preferable in case of financial smoothing Volatility year smoothing period constant equity exposure 1-year smoothing period decreasing equity exposure 10-year smoothing period constant equity exposure 10-year smoothing period decreasing equity exposure Age 16 of 20

20 Results financial smoothing Conclusion: the expected replacement rate decreases significantly during the first years after retirement in case of financial smoothing. 95% 94.5% 94% 17 of 20 Replacement rate 93.5% 93% 92.5% 92% 91.5% 91% 90.5% 1-year smoothing period 5-year smoothing period 10-year smoothing period 90% Age

21 Introduction Assumptions model analysis Results model analysis: investment policy Results model analysis: pension benefit payment policy Conclusions & recommendations Questions 18 of 20

22 Conclusions Investment policy Decreasing life-cycle is preferable Sizes of welfare losses can differ significantly Pension benefit payment policy Disadvantage of a high AIR compared to a low AIR becomes visible as of 10 years after retirement In case of financial smoothing a decreasing life-cycle and horizon-dependent AIR are preferable 18 of 20

23 Recommendations for future research Financial market model including interest rate risk and inflation risk Impact of more freedom of choice regarding pension contributions Utility function including habit formation Investigate implementation similarity growth rate approach & money pots approach 19 of 20

24 Questions 20 of 20