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Post-Retirement Risks 1.Longevity 2.Family issues 3.Health and long-term care 4.Business and public policy 5.Investment.

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Presentation on theme: "Post-Retirement Risks 1.Longevity 2.Family issues 3.Health and long-term care 4.Business and public policy 5.Investment."— Presentation transcript:


2 Post-Retirement Risks 1.Longevity 2.Family issues 3.Health and long-term care 4.Business and public policy 5.Investment

3 1. Longevity Risk Outliving your resources Problems created when death occurs Death of a spouse –First-to-die life insurance

4 One Way to Plan? Use life expectancy to plan –Many expect to outlive average –Many underestimate what is average Add 5 or 10 years to the average life expectancy Annuitize certain assets to provide lifetime income

5 Longevity Risk Age Life Expectancy Age Life Expectancy 60 61 62 63 64 65 24.2 23.3 22.5 21.6 20.8 20.0 66 67 68 69 70 Etc. 19.2 18.4 17.6 16.8 16.0 Etc. Source: Unisex Table V

6 Annual Percentage of Deaths Population of 65 Year Olds Source: 2000 Individual Annuity Mortality table Life Expectancy

7 Life Probabilities at Age 65 Source: Society of Actuaries RP-2000 Table Age %

8 The Uncertainty of Life Highly uncertain variable Consider probabilities based on certain ages –Not: “20 years at age 65” –But rather: “a 63% chance at age 65 that one spouse will live to 90”

9 Implications for Longevity Risk More uncertainty –Order of death for a couple –Women tend to outlive men –Changes in life expectancy of survivor Immediate financial needs Overall capital needs Flexibility: update longevity estimates as time passes

10 Managing Longevity Risk Social Security Annuities Reverse mortgages

11 2. Family Issues Divorce and remarriage Unexpected death of the retiree or an adult child with dependents Job loss of the retiree, a spouse, or an adult child

12 Other Family Matters Care of a grandchild or other dependent Elder care for retiree parents Paying for college while in retirement

13 Costs –Medicare, insurance premiums and coverage, prescription drugs, LTC Geographic resources –Caregivers, facilities –Ability to live alone COBRA Advance directives –POAs, living wills 3. Healthcare and Long-Term Care Risks

14 LTC Needs & Issues Assisted living facilities –Average yearly cost: $28,548 Nursing home facilities –Average yearly cost: $57,000 to $66,000 Home health care –Average hourly cost: $18.12 Trading premiums for expected benefits Source: MetLife 2003 Survey

15 Types of LTC Insurance Indemnity policy – pays fixed benefit amount Expense-incurred – reimburses for actual expenses up to a fixed amount Integrated policy offers a total dollar amount toward different types of LTC services Daily benefit amounts for nursing home care: $50 to $300 per day

16 LTC Policy Features Definition of benefit triggers Inflation protection Coverages –ADLs –Adult day care –Assisted living –Nursing home coverage: at least 1 year of coverage –Coverage for Alzheimer’s –Respite care for the caregiver Tax treatment: premiums qualify for 7.5% medical expense deduction

17 Housing Needs Downsizing for early retirees Relocation issues Retiree expectations Home as an asset –Natural disasters (e.g., earthquake or flood)

18 4. Business & Public Policy Risk Employer bankruptcy Employee benefits reduced or eliminated Insurer solvency Employment risk –Physical ability –Job availability Diversification –Employer stock concentrations –Annuity insurer diversification

19 Legislative Changes Social Security –Later start ages for boomers Medicare

20 Tax Rate Change Risk Rate/rule changes –Income tax –Estate tax Imagine making a retirement income plan in 2000 –Then EGTRRA 2001 –Sunset provisions Need to monitor proposals

21 Historical Income Tax Rates Year % 2004 top rate: 35%

22 Historical Income Brackets Year $ 2004 top rate: 35%

23 More Income Tax Rate Variables “Assumed” lower tax rate in retirement –Match the tax bracket to the retiree’s income need Bracket change due to death of a spouse –Lower expenses for the surviving spouse –From married filing joint to single

24 Change in Filing Status Married filing joint (MFJ) $70,000 = 25% income tax bracket If the surviving spouse needs only $50,000, then would be 15% bracket Single $70,000 = 28% income tax bracket If the surviving spouse needs only $50,000, then would be 25% bracket

25 The Best Tax Income Capital gains Which spends better: $1 of ordinary income or $1 of capital gain income? The challenge: overcoming the “I don’t want to spend principal” mindset

26 An “Ordinary” Illustration Ordinary income tax $142,857 1% interest annually ($1,428.57) Lose 30% ($428.57) to ordinary income tax $1,000 left after taxes Capital Gain Tax Same $142,857 grows by 1% to $144,286 Sell $1,428.57 after one year Lose 15% ($214.29) to capital gain tax $1,214.28 left after taxes

27 5. Investment Risk Inflation risk Interest rate risk Market risk

28 Inflation Risk Not of major concern right now How you define it matters Any fixed income stream is exposed Interest in products with cost of living adjustments is low at present

29 Historical Inflation Rates by Year Source: Bureau of Labor Statistics

30 Rolling Period Historical Inflation Rates Source: Ibbotson Associates

31 Defining Inflation for a Retiree One rate: CPI By expense type –Healthcare –Food/utility –Home value –College –Others

32 Inflation by Components of CPI Source: Bureau of Labor Statistics

33 When Do You Want Your Risk? Source: Nick Murray, The New Financial Advisor. Used with permission. For broker/dealer use only.

34 Strategies for Handling Inflation Risk Control expenses over time Certain resources are/can be protected –Social Security –I bonds –Variable annuities –COLA annuities –Real estate and/or REITs –Stocks

35 Interest Rate Risk Fixed income assets exposed Interest rates are currently low by historical standards Reinvestment rate risk –Call risk But low rates are good news and good timing for some income products

36 Historical Interest Rates Source: Federal Reserve

37 Market Risk Retirees have a high degree of concern with short-term volatility Investment return variability –Ibbotson 5-, 10-, 15- and 20-year rolling periods

38 5-year holding periods 1-year holding periods Each bar shows the range of compound annual returns for each asset class over the period 1926–2002. Small company stocks Large company stocks Government bonds Treasury bills -75% -50% -25% 0% 25% 50% 75% 100% 125% 150% 20-year holding periods 10.2%12.1%5.5%3.8% Compound annual return Reduction of Risk Over Time 1926–2002 This is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. 3/1/2003. © 2003 Ibbotson Associates, Inc.

39 Spot the Pattern

40 Market Risk Going Forward Future expectations –Equity risk premium Predictions & debates

41 A Deterministic Quiz Q. If you had $100,000 averaging 6% per year, and you withdrew 6% per year, what would your balance be at the end of 10 years? a. $100,000 b. $71,531 c. $0 A. Depends on two factors: 1. Are there any years with negative returns? 2. When do the losses occur?

42 $100,000 in Hypothetical Investment with 1 st Year Loss YearRate of ReturnWithdrawalEnding Balance 1-15%6,00079,900 2-10%6,00066,510 310.636,00066,939 410.636,00067,414 510.636,00067,939 610.636,00068,520 710.636,00069,163 810.636,00069,874 910.636,00070,661 1010.636,00071,531 Average RoR6%

43 Recovery Returns Average RoR required to get back to $100,000 (while still making withdrawals) is 50% in 1 year 14.1% in 8 years 11% in 18 years

44 Lessons Learned Returns aren’t linear in the securities markets Major asset allocation changes (more price/market risk) may be necessary to make up for a bad year early in the distribution years

45 Retiring in Different Decades Retiree has $500,000 portfolio in either –All stocks, or –All bonds, or –60/40 stocks/bonds 5% withdrawal first year, indexed for actual inflation Some years are better than others…

46 1960

47 1970

48 1980

49 1990

50 More Lessons Learned The sequence of returns matters—a lot! Linear assumptions (x% per year for 25 years) are unrealistic and dangerous to a portfolio’s health We can know the past with precision, but the future is unknown Monte Carlo simulations

51 Asset Allocation The accumulation years are different from the distribution years. –Conventional wisdom: go more conservative –For a “die broke” mentality, go conservative –For an inheritance mentality, go more aggressive More time Multigenerational investment policy

52 Investor Characteristics Age Investment experience Risk tolerance Personal financial factors Risk capacity

53 Managing Portfolio Risk Rebalancing Diversification

54 Techniques for Measuring Risk: Pros and Cons Deterministic: single outcome; linear Scenario: changes in some variables = what if? Stochastic: range of outcomes; Monte Carlo simulation GIGO

55 Monte Carlo Basics Considers multiple risk variables at one time –Returns, volatility, correlation, return order, longevity –Roll the dice Produces portfolio values and probabilities Monte Carlo illustrated: The iMulator game (courtesy of Financeware)

56 The iMulator Game Get into small groups of six One person is the scorekeeper, aka the financial advisor, who uses the Scorecard Another person is the mortician, who uses the Mortality Table Another person is the market, who uses the Growth Factor Table Two people are the dice; you will be choosing numbers between 1 and 6 randomly and independently One person is the client!

57 Wealth Forecasting With Cashflows: MC Simulation Portfolio Balance $10,000 $100,000 $1,000,000 $10,000,000 $100,000,000 65707580859095100 Age 75% 90% 50% 25% 10%

58 Monte Carlo Pros & Cons Pros Uses multiple variables Shows probabilities Attempts to deal with the unexpected Easy to see results of variable changes Cons Can be interpreted as certainty Historical assumptions Differences in probabilities are difficult to grasp Can’t predict very unusual events

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