Session 167 PD, Decumulation Strategies for Retirement: Individual, Advisor and Plan Sponsor Roles Moderator: Cynthia J. Levering, ASA, MAAA Presenters: Carol A. Bogosian, ASA Kailan Shang, FSA, ACIA Paul Yakoboski, Ph.D. SOA Antitrust Disclaimer SOA Presentation Disclaimer
Moderator: Cindy Levering, ASA Speakers: Kailan Shang, FSA, CFA, PRM, SCJP Paul Yakoboski, Ph.D. Carol A. Bogosian, ASA Session 167 PD Decumulation Strategies for Retirement: Individual, Advisor and Plan Sponsor Roles October 26, 2016
Diverse Risks in Retirement SOA s Committee on Post Retirement Needs and Risks call for essays in late 2015, linked to DC environment: 1. defined contribution plan risk management strategies; 2. decumulation strategies for retirement; and 3. long-term care financing. 18 essays published See more https://www.soa.org/news-and- Publications/Publications/Essays/2016-diverse-riskessays.aspx as well as various recent and forthcoming issues of the Pension Section News. 2
Multiple Objective Asset Allocation for Retirees Using Simulation By Kailan Shang, FSA, CFA, PRM, SCJP Managing Director & Co-Founder Swin Solutions Inc. 3
Agenda 1. Multiple Objectives 2. Current Asset Allocation Methods 3. Simulation-Based Multiple Objective Method Business Intelligence & Risk Management www.swinsolutions.com 4
Multiple Objectives Current Income Liquidity Wealth Growth Purchasing Power Relative Importance Tax Minimization Longevity Risk Estate Business Intelligence & Risk Management www.swinsolutions.com 5
(100 Age) % Business Intelligence & Risk Management www.swinsolutions.com 6
Modern Portfolio Theory Mean-variance optimization Asset Class Expected Return Risk free rate: 3% Correlation between bond return and equity return: 20% Required return: 8.5% Risk (Vol) Bond 4.5% 8% Equity 9% 25% Return Efficient Frontier 14% 12% CML 10% 8% 6% 4% 2% 0% 0% 5% 10% 15% 20% 25% Risk - Volatility Business Intelligence & Risk Management www.swinsolutions.com 7
Risk Pyramid Pinnacle Middle Bottom Investment Types Speculative investment Equity and real estate Bonds and savings Objectives Substantial return Estate, vacation home, etc. Living cost, medical cost, etc. Business Intelligence & Risk Management www.swinsolutions.com 8
Analytic Hierarchy Process (AHP) Goal Objective 1 Weight: 62% Objective 2 Weight: 24% Objective 3 Weight: 12% Plan A Plan B Plan C Plan A Plan B Plan C Plan A Plan B Plan C Relative Preference Objective 1 Objective 2 Objective 3 Objective 1 1 5 3 Objective 2 1/5 1 3 Objective 3 1/3 1/3 1 Weight Objective 1 62% Objective 2 24% Objective 3 14% Business Intelligence & Risk Management www.swinsolutions.com 9
Simulation-Based Multiple Objective Asset Allocation Business Intelligence & Risk Management www.swinsolutions.com 10
Example Five Objectives 1. High current income no less than 2 percent of the asset value (CI) 2. Maintain the purchase power of the portfolio (PP) 3. Maintain sufficient liquidity to cover living costs and unexpected medical costs (AL) 4. Minimize longevity risk (LR) 5. Leave an estate of $100,000 for his children (ES) Relative Preference CI PP AL LR ES CI 1 5 3 1 7 PP 1/5 1 3 1/2 5 AL 1/3 1/3 1 3 5 LR 1 2 1/3 1 7 ES 1/7 1/5 1/5 1/7 1 CI PP AL LR ES Weight 36% 18% 21% 22% 3% Business Intelligence & Risk Management www.swinsolutions.com 11
Example Measurement Objective CI PP AL LR ES Measure Type of measure Performance measurement (current income rate 2%)/2% (investment return inflation rate)/2% (AL living cost unexpected medical cost)/(living cost + unexpected medical cost) (age at which assets are outlived age @ life expectancy)/ (99th percentile of the age age @ life expectancy) (estate @ life expectancy 100,000)/ 100,000 Average Average Worst Average Average 1.5 2 0.9 0.75 0.8 Business Intelligence & Risk Management www.swinsolutions.com 12
Example Asset Class Profile Retiree Financial Information Stochastic Scenarios (Economic, Mortality, etc.) Risk Tolerance Business Intelligence & Risk Management www.swinsolutions.com 13
Example The investor needs to have a minimum expected weighted performance of 0.5 with less than a 1 percent chance of having a performance less than 0.1. Optimal Asset Allocation Savings Bond Equity Real estate Annuity (monthly payment with 2% annual increase) Weighted performance Risk Sharpe ratio 10% 90% 0% 0% 500 1.94 1.96 0.99 Sharpe Ratio = (Weighted Performance 0*) / Risk 0 means minimum requirements are met. Business Intelligence & Risk Management www.swinsolutions.com 14
Additional Information The essay written by Lingyan Jiang and Kailan Shang can be downloaded at https://www.soa.org/library/essays/2016/diverse-risk/2016-diverse-risksessay-shang-jiang.pdf. A free online tool that implements the new method can be accessed at http://www.wiseallocation.com/naa.php. The presenter can be contacted at kailan.shang@swinsolutions.com. The opinions expressed and conclusions reached by the presenter are his own and do not represent any official position or opinion of Swin Solutions Inc. Swin Solutions Inc. disclaims responsibility for any private publication or statement by any of its employees. Business Intelligence & Risk Management www.swinsolutions.com 15
Decisions Misaligned With Priorities By Paul Yakoboski, Ph.D. Senior Economist, TIAA Institute 16
About the survey 1,000 retired TIAA participants surveyed (2014) Age 60 or older Retired with at least $400,000 in defined contribution and/or IRA assets No defined benefit pension income 500 receiving annuitized payments (annuitants) 500 not receiving annuitized payments (non-annuitants) 17
Top priorities for personal finances in retirement Ensuring the financial security of your spouse if you die first Not outliving savings and financial assets Having a guaranteed income stream to cover basic expenses 18
Bottom priorities Having professionals manage your financial assets Leaving an inheritance Earning a high rate of return Having the flexibility to adjust your income as needed 19
Mid-level priorities Maintaining direct control of your financial assets Preserving your financial assets Maintaining the same standard of living throughout retirement 20
Reasons for annuitizing 21
Reasons for not annuitizing 22
Impact of advice Worked with a financial advisor in deciding how to manage and draw income from retirement savings Annuitants 54% Non-annuitants 58% Advice received about annuitizing retirement savings Do Don t No advice Annuitants 60% 9% 30% Non-annuitants 21 37 42
Impact of plan design Annuitants Nonannuitants Participated in a DC plan that offered a deferred annuity in the investment menu Invested in the deferred annuity (if available) 29% 24% 45 25 Source: TIAA Institute (2010). 24
In retirement 25
Dealing With Multiple Post-Retirement Risks in the Middle Market By Charles S. Yanikoski, President of RetirementWORKS, Inc. Presented by Carol A. Bogosian, ASA 26
Focusing the Discussion Principal focus is on middle market retirees Affluent retirees are at less financial risk, and typically have adequate means to cover all of the most significant risks. Low-income people have few options, and therefore their decisions are less complex (not that this is a consolation to them). 27
Key Retirement Financial Risks Longevity: living too long; premature death of the primary income recipient Health: medical expenses; long-term care expenses; inability to earn income; need to pay for home maintenance and other chores; need to be a caregiver instead of earning income Investment: low interest rates; poor market performance; opportunity costs of conservatism Expense control: inflation, property value fluctuations, casualty losses Guarantee impairments: pension underfunding; Social security underfunding Family: divorce; remarriage; other family crises Other: fraud; poor advice; poor personal decision-making 28
Three Ways to Address Risk Purchasing insurance products Life insurance, annuities, health insurance, long-term care insurance, investment return guarantees, or combinations of these Self-insuring Personal cash, savings, investments, home equity, other assets Reducing exposure Frugality, earned income, benefits claiming strategy, healthier lifestyle, etc. 29
Limitations of Insurance Not available for many risks Middle income people cannot afford to insure against every risk Purchases reduce cash, which is already limited, therefore increasing exposure to other risks 30
Opportunities and Limitations of Self-Insurance Available virtually for free: self-insurance is another word for "personal wealth" Wealth (even modest wealth) provides some insurance against any financial risk Consumers do not have to guess correctly which risk will strike them Any "claim" against the self-insurance fund increases subsequent exposure to all risks Middle income wealth is usually such that even one severe adverse outcome might not be fully covered 31
Opportunities to Reduce Exposure Rigorous, on-going budgeting to keep expenses low, and thereby increase wealth (or at least not deplete) wealth Part-time employment or other income-generating opportunities Smart decisions about Social Security claiming, and choice of a DB plan retirement option Prudence about other financial and life decisions Healthy lifestyle choices Strengthening of social relationships (family, community, church, etc.), so that help is available if needed Attitudinal adjustments -- e.g., learning to love simple living, or accepting Medicaid as a long-term care strategy 32
Optimizing These Strategies in the Middle Market Step 1: Assessing risk exposure What risks do not apply (or don't matter much)? What is the likelihood and impact of those that do apply? Step 2: Assessing risk abatement capacity How much wealth (assets, income) is needed for normal needs? (Consider various levels of lifestyle) How much is left for risk abatement, under each lifestyle scenario? 33
Optimizing These Strategies in the Middle Market (continued) Step 3: Assessing financial risk-reduction products For which remaining risks is insurance available? For each, does the risks it reduces outweigh the increased exposure to other risks (caused by reduction in wealth) Step 4: Reality test Evaluate, and repeat the process as necessary 34
Advantages A holistic approach -- all risks are taken into account, not just one or two Mind over math -- the focus is on maximizing happiness, not money Preserving wealth as a form of "universal insurance" -- making careful decisions about risk-abatement trade-offs 35
Enhancing the Model Fully developed and automated model should include Evaluation of financial impact and likelihood of each significant risk including effect of combining risks Education of consumer on meaning and likelihood of the risks, their consequences and nonfinancial options to reduce risks Weighting strategy to evaluate immediate financial costs, long-term financial costs, and psychological effect of each alternative 36
Decumulation Strategy for Retirees: Which Assets to Liquidate By Charles S. Yanikoski, President of RetirementWORKS, Inc. Presented by Cindy Levering, ASA 37
Which assets should go first? Making poor choices can be harmful Most consumers know little about the subject Most professionals do not have a well-considered and well-organized methodology Wrong guesses can result in regret and recrimination 38
Which assets should go first? Difficult with more assets Many factors some cannot be easily quantified Financial and non-financial questions Risk Liquidity Income generation Future growth potential Taxation Timing Liquidation costs Portfolio diversification 39
Which assets should go first? Financial questions Risk Liquidity Income generation Future growth potential Taxation Timing Liquidation costs (including penalties) Portfolio diversification Non-financial questions Personal use Sentimental value 40
Ideal Situation Good software should Be fully informed about assets and concerns Be fully informed about financial situation Recognize financial desires and fears Evaluate assets against financial and non-financial questions Include asset allocation analysis
Asset Disposal Worksheet
Reality Test & Decision
Conclusion Tools can produce prudent but not necessarily optimal decisions Worksheet is simpler than well-designed automated system Should be sufficient for typical middle-class households Improvement over less rigorous processes
A Portfolio Approach to Retirement Income Security By Steve Vernon, FSA Research Scholar - Stanford Center on Longevity Presented by Cindy Levering, ASA 45
Classic Investment Portfolio Theory Pre-retirement: Allocate savings among various asset classes Expect performance to balance in up vs. down markets Challenges to address: keep up with inflation until retirement In retirement: Allocate savings among various retirement income classes and retirement income generators (RIGs). Challenges to address: longevity risk, inflation risk, sequence of returns risk, fraud risk, risk of mistakes and cognitive decline. 46
Typical Retirement Income Goals Generate income for life Maximize expected amount Minimize stock market impact Provide inflation protection Maintain access for unforeseen events Preserve unused funds as legacy Select solutions that minimize adjustment Protect against fraud and mistakes due to cognitive decline
Pros and Cons of Common RIGs
Applying Portfolio Techniques Use savings to delay claiming Social Security Balance investment in stocks, bonds and insured products Understand tradeoffs with systematic withdrawal programs
Putting it all Together Cover basic expenses with guaranteed lifetime income Social Security, pensions, and annuities become the bond part of a retirement income portfolio Cover discretionary expenses with high allocations to stocks, if risk can be tolerated Work longer if possible Cash-poor house-rich retirees may want to explore appropriate use of home equity
Medical & LTC Expenses Address through insurance Consider current and future premiums and copayments Uninsured long-term care events can drain savings used to produce retirement income Leave home equity intact as possible resource if don t purchase long-term care insurance
Decumulation for a New Generation By Elizabeth Bauer, FSA Consulting Actuary at Aon Hewitt Presented by Cindy Levering, ASA 52
Why Don t Retirees Annuitize? Annuities are perceived to be expensive Consumers distrust annuities and insurance providers Employees want to get full value from their DC money There is more fear of dying too soon than too late 53
The Price of Annuities $100,000 => Monthly SLA for age 65 female of: $498 from USAA $553 using Moody s Aa bond rate 90% MWR 100 basis points for expenses and margins Does not include inflation or bequest protection
Is this too expensive? 4% rule buys $333 a month Includes inflation and bequest protection Looks like a good deal
Pick a Life Expectancy 30 years => $485 using bond rate 5% or 6% return => $535 or $600 Eliminates most longevity risk Does not eliminate investment risk
Live off the Interest Current rates are low Reassurance of no capital loss Not locked in if rates rise in future
How to Make Annuities a Better Value Government subsidies Pooled retirement fund Counter consumer distrust Transform Social Security to longevity annuity Cover age 85 expenses with annuity
??? Questions??? 59