New Developments in Mortality Risk Pooling - SOA · PDF fileSession 132 L - New Developments...
Transcript of New Developments in Mortality Risk Pooling - SOA · PDF fileSession 132 L - New Developments...
Session 132 L - New Developments in Mortality Risk Pooling
Moderator:
Deborah A. Tully, FSA, EA, FCA, MAAA
Presenter: Rowland Davis, FSA
SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer
SOA Annual Meeting: October 17, 2017
Session 132: New Developments in Mortality Risk Pooling
Presenter: Rowland Davis, FSA
Moderator: Deborah Tully, FSA
Overview
Three key questions- What is the value of mortality risk pooling?- Why do retirees usually choose non-pooled options?- What are the best ways to build product packages that include pooling?
Agenda- Traditional economic analysis- Insights from behavioral economics- Analysis of real-world options- Proposal for a collective risk-sharing payout plan
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Traditional Economic Analysis
Based on life-cycle utility framework- Posits a rational desire to smooth consumption across entire lifetime- Optimization problem for measured utility, with key parameter = individual’s “rate
of time preference” (we will call this parameter the “gamma” factor) Numerous academic studies/papers
- Starts with seminal paper by Yarri (1965) showing significant value to using annuities (if “fairly priced”), leading to “annuity puzzle”
- Concept that developed is the “Annuity Equivalent Wealth” metric: the additional amount of wealth that a rational consumer would require/demand to be as well-off (in measured utility) without access to fairly priced annuities (see Brown, Mitchell, Poterba, Warshawsky papers and book)
- Attempts by academics to work in other factors: need for liquidity to deal with health care spending; bequest motives; Social Security and pension income
Recent SOA project: Value of mortality risk pooling (“VoMoP”)- Georgia State professor Dani Bauer: refined the sensitivity of results to the need
for liquidity for unexpected health care expenses- Excel worksheet to calculate VoMoP / AEW (based on algorithm from “Annuity
Equivalent Wealth is the Value of Longevity Pooling: Some Analytic Approximations” by Huaxiong Huang and Moshe A. Milevsky, Working Paper, Schulich School of Business, York University, Fall 2017)
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Excel Workbook
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These calculations reflect the value of mortality pooling for retirement at age 65, based on the assumptions listed below, and using standard life-cycle methodologywith a Constant Relative Risk Aversion function. The calculations include the ability to recognize that Social Security benefits automatically provide mortality pooling, so that the risk aversion adjustments only apply to the non-SS benefits. The resulting value of mortality pooling results are therefore lower, representing the marginal utility for the pooling of non-SS benefits. For this purpose, the calculations assume that the non-SS benefits will be in the amount required to achieve a total specified final pay replacement ratio, inclusive of the specified level of SS replacement ratio.
The "value of mortality pooling" should be interpreted as the utility value gained by pooling the mortality risk for non-SS benefits through an actuarially fair annuity without any loading for expenses, profits, etc. For example, if $100,000 is the required amount to annuitize the non-SS benefits, and the "value of mortality pooling" result is +15.0%, this means that the annuity is equivalent in utility value to a lump sum amount of $115,000 -- based on all the assumptions used.
Basis for calculations
Results
Without recognition of Social Security (or other pension income)
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Assumptions
Inflation 2.00%Ben COLA 2.00%Real risk-free interest 2.00%Risk aversion (gamma) 1.00 SS repl ratio 0%
Target repl ratio 80%
Value of Mortality Pooling (retirement at 65)
Single Male
Single Female
Single Unisex
Married Couple
36.5% 32.6% 34.6% 29.4%
Results, contd.
With recognition of Social Security- Calculation methodology still under development for Excel workbook- For estimated impact, we use results from “New Evidence on the Money’s Worth
of Individual Annuities” by Olivia Mitchell, James Poterba, Mark Warshawsky and Jeffrey Brown; American Economic Review (1999) which showed that if half of the retirement wealth is “pre-annuitized” (e.g. Social Security) then the VoMoP is reduced by a factor of about x0.7
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Assumptions
Inflation 2.00%Ben COLA 2.00%Real risk-free interest 2.00%Risk aversion (gamma) 1.00 SS repl ratio 40%
Target repl ratio 80%
Value of Mortality Pooling (retirement at 65)
Single Male
Single Female
Single Unisex
Married Couple
25.5% 22.8% 24.2% 20.6%
Sensitivity to “Gamma”
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Gamma = 0.5
Gamma = 1.0
Gamma = 2.0
Assumptions
Inflation 2.00%Ben COLA 2.00%Real risk-free interest 2.00%Risk aversion (gamma) XSS repl ratio 40%
Target repl ratio 80%
Value of Mortality Pooling (retirement at 65)
Single Male
Single Female
Single Unisex
Married Couple
18.9% 17.0% 18.0% 15.3%
Value of Mortality Pooling (retirement at 65)
Single Male
Single Female
Single Unisex
Married Couple
25.5% 22.8% 24.2% 20.6%
Value of Mortality Pooling (retirement at 65)
Single Male
Single Female
Single Unisex
Married Couple
33.4% 29.6% 31.6% 26.9%
Insights from Behavioral Economics
“Rational economic agents” ≠ real human beings Overview of behavioral issues: “Annuitization Puzzles”; by Shlomo Benartzi,
Alessandro Previtero and Richard Thaler; Journal of Economic Perspectives (2011) Actual decisions heavily influenced by embedded psychological factors:
- Mental accounting- Prospect theory
• Reference point• Value function with loss aversion• Decision weights different from true probabilities
- Availability heuristic- Hyperbolic discounting- Framing effects: investment vs consumption
• Investment frame – potential loss of principal• Consumption frame – insurance against out-living assets
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“Behavioral Obstacles in the Annuity Market”; by Wei-Yin Hu and Jason S. Scott;Financial Analyst Journal (2007)
“Why Don’t People Insure Late Life Consumption: A Framing Explanation of the Under-annuitization Puzzle”; by Jeffrey Brown, et al;NBER Working Paper (2008)
Framing Experiments
Practical work to potentially improve up-take of pooling products Ongoing series of on-line surveys, and papers reporting results, by Jeffrey Brown
(Univ. of Illinois) and collaborators- Participants (over age 50) provided some background information- Then presented with a series of choices made by two fictitious people- Must answer who they think made the better choice
Let’s give it a try….- Read over the page of background information you have- Then enter the version number shown at the top of the page- Then on each of the following slides, enter the person who you think made the
better choice
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Question #1
Mr. Green / consul bondor
Mr. White / savings account
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Question #2
Mr. Red / life annuityor
Mr. White / savings account
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Question #3
Mr. Orange / 20-yr. period annuityor
Mr. Blue / 35-yr. period annuity
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Question #4
Mr. Blue / 35-yr. period annuityor
Mr. Red / life annuity
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Question #5
Mr. Red / life annuityor
Mr. Orange / 20-yr. period annuity
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Results
The background papers present different “frames”- Version 1 is an investment frame- Version 2 is a consumption frame
In the survey done for the paper, the life annuity was considered the better choice as follows:
In our survey, here are the results (% where Mr. Red / life annuity was selected as better choice):
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Investment Frame
Consumption Frame
Savings account 21% 68%
20-yr. period annuity 48% 79%
35-yr period annuity 40% 73%
Consul bond 27% 70%
Investment Frame (V1)
Consumption Frame (V2)
Savings account (Q #2)
20-yr. period annuity (Q #5)
35-yr period annuity (Q #4)
Analysis of Real World Options
SOA research project: Quantitative Evaluation Framework (QE Framework)- Nearing completion- Based on stochastic modelling of various risk and reward metrics- Goal is to provide a consistent basis for comparing the outcomes of various
retirement systems- Two separate, but connected, models
• For the accumulation phase• For the payout phase
Trying to expand beyond the academic “utility models” to cover a much broader range of metrics
- Benefit risks and reward / success measures- Cost risks to sponsor
Provide guidance for researchers and practitioners in the development of newer and better system designs
- Variable and target benefit designs- Guarantees (“hard” or “soft”)- Collective risk sharing designs (investment and/or mortality risks)- New insured products (e.g. longevity annuities)- Efficient risk control features
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QE Framework: Overview of Payout Model
Goal: Create metrics that allow for comparative analysis of payout schemes for retirement accumulations
Measurement of:- Efficiency in creating lifetime income streams
• Mean, or average, levels of income• Range of dispersion / uncertainty around mean• Shortfall and “failure” risks• Year-to-year volatility risks• Sensitivity to initial conditions at time of retirement
- Balance between income benefits and death benefits- Potential cost risks to sponsors
Approach used:- Stochastic simulations, as extensions of the accumulation phase model (i.e. simulation
results for first year of retirement at age 67 are the next year’s values from the age 66 results in the accumulation model)
- Create a baseline set of results- For any payout scheme, calculate the ratio of results in each year to the baseline- Parameterized model to handle combinations of:
• Insured annuities, priced at market rates• Fixed-price annuities• Longevity annuities• Various “Structured Withdrawal Plans” (SWP’s)
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Methodology
Initial conditions- Continuity from the accumulation phase model- Yield rates at age 67 point of retirement (nominal 10-yr. Treasury, 10-yr. TIPS,
expected inflation)- Accumulation balance at retirement
• Default is for DC plan using typical TDF investment structure (10% of pay each year)
• Option to use other balance amounts (DC with different investment structure, or DB)
- Final pay at retirement, based on accumulation model Baseline set of results = “ideal” basis from participant viewpoint to minimize risk /
maximize income- Fixed price annuity (selected 5.45% interest rate, based on expected return from
a fund with 30% risk asset allocation)- Full CPI indexing (priced at average inflation expectation = 2.5%)- No death benefits
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Parameters: General
Asset allocation for non-insured balance (other ages will be interpolated) Percentage allocation to:Risk assets TIPS Bonds
Age 67 60% 0% 40%Age 70 55% 0% 45%Age 75 50% 0% 50%Age 80 45% 0% 55%Age 85+ 40% 0% 60%
Assumed investment expense rate 0.10%
Allocation of distribution (by percent of initial balance)Approx. ben. as %
of final payImmediate annuity -- insurance company 0.0% 0% this provides lifetime income from age 67, priced at market interest ratesImmediate annuity -- fixed rate in-plan 0.0% this provides lifetime income from age 67, but with a fixed price and cost risk for sponsorLongevity insurance 12.0% 17% this provides income from age 85, with COLA; no death benefits (prior to or after age 85)Balance to "Structured Withdrawal Plan" (SWP) 88.0% variable see below for parameters
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Parameters: Annuities
Immediate annuity -- Insurance company
Include 15-yr certain period death benefits? 1 0 = no, 1 = yes; protects against loss of annuity premium (approx.) due to "early" deathCOLA 2.5% enter fixed rate from 0% to 3%, in 0.5% increment, or enter 99% for CPI-based COLALoad for expenses/profits/contingencies 5% generally use 5% for a group annuity or 15% for a retail annuity
Immediate annuity -- Fixed rate in-plan pricing is at a fixed interest rate, producing cost risk for sponsor (e.g. typical DB plan)
Include 15-yr certain period death benefits? 1 0 = no, 1 = yes; protects against loss of annuity premium (approx.) due to "early" deathCOLA 99.0% enter fixed rate from 0% to 3%, in 0.5% increment, or enter 99% for CPI-based COLAAllocation to risk assets for in-plan funding 30% enter 30%, 50% or 70%; pricing will use expected return for this allocation
Longevity insurance -- Insurance company
COLA (applied from age 85) 2.5% enter fixed rate from 0% to 3%, in 0.5% increment, or enter 99% for CPI-based COLALoad for expenses/profits/contingencies 5% generally use 5% for a group annuity or 15% for a retail annuity
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Parameters: SWP’s
Base spend rate definition for SWP, where spend rate at each age = 1 / PV( real return discount, time period,-1,,1)Confidence
factorPV factor time period for each age IRS RMD
Life expectancy? Or fixed period? 0 0 = life expectancy; 1 = fixed periodRP2014 single life 50%
If life expectancy, choose basis 7 see options in table to right 70%If fixed period, define initial period at age 67 40 period for each age will = N - (age - 67) 90%If fixed period, define min # yrs to use 5 fixed period will decline by 1 each yr until it hits this level
RP2014 joint life 50%
PV factor real return for discount rate 70%Fixed value? Or mkt-based? 0 0 = fixed value; 1 = market-based 90%If fixed value, define expected real return on bonds 0.00% likely range = 0.00% to 2.50%Assumed return premium to recognize for risk assets 0.00% enter the full premium for risk assets, and the portion of this used will be based on asset allocation;
use zero for conservative basis which will ignore risk premium for this purposeOver-ride to base SWP spend rate, using "X% Rule" (i.e. initial spend amt = X% time initial balance, with inflation adjustment for future payments)
Over-ride applies to first N years 18 enter 99 to use the X% rule for all yearsInitial spend rate 6.50%Inflation to use
Fixed value? Or CPI? 1 0 = fixed value; 1 = CPIIf fixed value, define inflator rate 2.50%
Maximum spend rate as % of remaining funds 8.00%
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Results -- Overview
Retirement period “sliced” into three segments for analysis
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Age groupings used in analysis:
67 72 77 82 87 92 97 102 107 112 117
Expected deaths by age from a group of 67-yr. old retirees
First 15 years: ages 67 to 8126% of deaths in this age band
Next 10 years: ages 82 to 9135% of deaths in this age band
All remaining years: ages 92 and up39% of deaths in this age band
Sample Results: Group AnnuityImmediate annuity -- Insurance company
Include 15-yr certain period death benefits? 1 0 = no, 1 = yes; protects against loss of annuity premium (approx.) due to "early" deathCOLA 2.5% enter fixed rate from 0% to 3%, in 0.5% increment, or enter 99% for CPI-based COLALoad for expenses/profits/contingencies 5% generally use 5% for a group annuity or 15% for a retail annuity
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Range of income benefits as percent of baseline*:*"Baseline" benefits are based on conversion of age 67 balance to lifetime income using a fixed-price lifetime annuity, interest rate = 6.1%, no load, full CPI COLA, no death benefits. Age sub-group values are weighted averages, using deaths at each age as the weighting factor.
0%
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200%
0%
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67 72 77 82 87 92 97 102 107 112 117
Income Benefits as % of Baseline(Mean value, and inter-quartile range)
Sample Results: Group Annuity, contd.
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First 15 years: ages 67 to 81 Next 10 years: ages 82 to 91 All remaining years: ages 92 and up
%tile %tile %tile95% 100.4% 95% 104.6% 95% 105.9%90% 95.7% 90% 98.9% 90% 99.9%75% 90.0% 75% 91.5% 75% 92.0%50% 83.2% 50% 83.4% 50% 83.2%25% 77.3% 25% 76.1% 25% 75.3%10% 72.6% 10% 69.7% 10% 68.1%5% 69.6% 5% 66.1% 5% 63.2%
Mean 84.1% Mean 84.1% Mean 84.0%
84.1%
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84.1%
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84.0%
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90%
100%
110%
120%
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140%
150%
160%
170%
Alternate benchmarks
100% = Full baseline, no death benefit
93% = Baseline, but with death benefit
84% = Group annuitypricing, with death benefit & fixed 2.5% COLA
77% = Retail annuitypricing, with death benefit & fixed 2.5% COLA
Sample Results: Group Annuity, contd.
Sensitivity to initial age 67 conditions:
Initial interest rate at age 67: Mean Mean Mean High (avg. highest quintile) 97.0% 97.3% 97.7% Medium ( avg. 20th to 80th percentile) 83.3% 83.2% 83.1% Low (avg. lowest quintile) 73.5% 73.5% 73.0%
Expected inflation at age 67: Mean Mean Mean High (avg. highest quintile) 93.4% 93.3% 93.5% Medium ( avg. 20th to 80th percentile) 83.0% 83.2% 83.2% Low (avg. lowest quintile) 77.8% 77.6% 76.9%
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Sample Results: Group Annuity, contd.
Shortfall risk / "failure rate" = probability of ratio to baseline value falling below:
First 15 yrs. Next 10 yrs. Age 90 Age 95 Age 100 Age 105 Age 110(Ages 67 to 81) (Ages 82 to 91)
60% of baseline 0.6% 2.0% 47.0% 26.5% 10.4% 2.3% 0.3%50% of baseline 0.0% 0.0%40% of baseline 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%30% of baseline 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Volatility risk = probability that ratio to baseline value (3-yr. average) drops by more than:
First 15 yrs. Next 10 yrs. Next 10 yrs.(67 to 81) (82 to 91) (92 to 101)
Decline by 10+ percent 2.4% 2.5% 2.9%Decline by 15+ percent 0.2% 0.3% 0.6%Decline by 20+ percent 0.0% 0.0% 0.0%Decline by 25+ percent 0.0% 0.0% 0.0%
-------------- Shortfall risk (using 3-yr. avg.) ----------------- -------------- Failure rate at: -----------------
----------- Survival probability -----------
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Sample Results: Group Annuity, contd.
Death benefits paid as percent of total payments
First 15 yrs. Next 10 yrs. All remaining yrs.(67 to 81) (82 to 91) (92 and up)
%tile95% 10.7% 0.0% 0.0%75% 10.7% 0.0% 0.0%50% 10.7% 0.0% 0.0%25% 10.7% 0.0% 0.0%5% 10.7% 0.0% 0.0%
Mean 10.7% 0.0% 0.0%
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Sample Results: 4% Rule
Range of income benefits as percent of baseline*:*"Baseline" benefits are based on conversion of age 67 balance to lifetime income using a fixed-price lifetime annuity, interest rate = 6.1%, no load, full CPI COLA, no death benefits. Age sub-group values are weighted averages, using deaths at each age as the weighting factor.
0%
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0%
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180%
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67 72 77 82 87 92 97 102 107 112 117
Income Benefits as % of Baseline(Mean value, and inter-quartile range)
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Sample Results: 4% Rule, contd.
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Level of accessible wealth as percent of final pay (inflation adjusted)(Note that the age 67 value is before the purchase of any annuities.)
0%
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1000%
0%
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1000%
67 72 77 82 87 92 97 102 107 112 117
Accessible Wealth as % of Final Pay (infl. adjusted)(Mean value, and inter-quartile range)
Sample Results: 4% Rule, contd.
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Death benefits paid as percent of total payments
First 15 yrs. Next 10 yrs. All remaining yrs.(67 to 81) (82 to 91) (92 and up)
%tile95% 42.7% 75.1% 92.0%75% 36.8% 65.7% 84.6%50% 33.0% 58.7% 76.5%25% 28.9% 48.3% 60.0%5% 23.7% 30.3% 28.3%
Mean 33.0% 56.3% 79.9%
Sample Results: IRS RMD Schedule
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Range of income benefits as percent of baseline*:*"Baseline" benefits are based on conversion of age 67 balance to lifetime income using a fixed-price lifetime annuity, interest rate = 6.1%, no load, full CPI COLA, no death benefits. Age sub-group values are weighted averages, using deaths at each age as the weighting factor.
0%
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0%
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67 72 77 82 87 92 97 102 107 112 117
Income Benefits as % of Baseline(Mean value, and inter-quartile range)
Sample Results: IRS RMD Schedule, contd.
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Level of accessible wealth as percent of final pay (inflation adjusted)(Note that the age 67 value is before the purchase of any annuities.)
0%
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1000%
67 72 77 82 87 92 97 102 107 112 117
Accessible Wealth as % of Final Pay (infl. adjusted)(Mean value, and inter-quartile range)
Sample Results: IRS RMD Schedule, contd.Shortfall risk / "failure rate" = probability of ratio to baseline value falling below:
First 15 yrs. Next 10 yrs. Age 90 Age 95 Age 100 Age 105 Age 110(Ages 67 to 81) (Ages 82 to 91)
60% of baseline 16.6% 15.0% 47.0% 26.5% 10.4% 2.3% 0.3%50% of baseline 3.5% 5.0%40% of baseline 0.2% 0.8% 1.3% 6.7% 49.1% 99.6% 100.0%30% of baseline 0.0% 0.1% 0.2% 1.1% 19.1% 97.9% 100.0%
-------------- Shortfall risk (using 3-yr. avg.) ----------------- -------------- Failure rate at: -----------------
----------- Survival probability -----------
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Death benefits paid as percent of total payments
First 15 yrs. Next 10 yrs. All remaining yrs.(67 to 81) (82 to 91) (92 and up)
%tile95% 27.7% 42.6% 53.5%75% 27.1% 42.2% 53.2%50% 26.7% 41.9% 53.0%25% 26.3% 41.6% 52.8%5% 25.8% 41.2% 52.5%
Mean 26.7% 41.9% 53.0%
Newer Design Ideas
Longevity annuities- For use with SWP’s to capture cost-efficient mortality risk pooling- Papers
• “Real Longevity Insurance with a Deductible: Introduction to Advanced-Life Delayed Annuities” by Moshe Milevsky, NAAJ (2005)
• “An Annuity That People Might Actually Buy” by Anthony Webb, Guan Gong, and Wei Sun, CRR Brief (2007)
• “The Longevity Annuity: An Annuity for Everyone?” by Jason Scott, FAJ (2008) Variable benefits during payout
- Insured variable annuities (retail and group products)- Embedded within “Target Benefit” DB plan- Collective self-annuitization schemes
• “Payouts from Defined Contribution Plans: A Collective Risk-sharing Framework, by Rowland Davis, SOA (2013)
• “Optimal Retirement Tontines for the 21st Century: With Reference to Mortality Derivatives in 1693, by Moshe Milevsky and Thomas Salisbury SOA (2013)
• “Variable Payout Annuities” by Phelim Boyle, Mary Hardy, Anne MacKay, David Saunders, SOA (2015)
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Sample Results: Combo with 12% of Fund Alloc. To Longevity Anny. & Balance to SWP
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Range of income benefits as percent of baseline*:*"Baseline" benefits are based on conversion of age 67 balance to lifetime income using a fixed-price lifetime annuity, interest rate = 6.1%, no load, full CPI COLA, no death benefits. Age sub-group values are weighted averages, using deaths at each age as the weighting factor.
0%
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67 72 77 82 87 92 97 102 107 112 117
Income Benefits as % of Baseline(Mean value, and inter-quartile range)
Sample Results: Combo with Longevity, contd.
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Level of accessible wealth as percent of final pay (inflation adjusted)(Note that the age 67 value is before the purchase of any annuities.)
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67 72 77 82 87 92 97 102 107 112 117
Accessible Wealth as % of Final Pay (infl. adjusted)(Mean value, and inter-quartile range)
Sample Results: Combo with Longevity, contd.
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First 15 years: ages 67 to 81 Next 10 years: ages 82 to 91 All remaining years: ages 92 and up
%tile %tile %tile95% 83.9% 95% 143.8% 95% 150.4%90% 83.9% 90% 129.9% 90% 132.9%75% 83.9% 75% 106.4% 75% 107.4%50% 79.4% 50% 87.2% 50% 88.0%25% 70.0% 25% 73.6% 25% 73.9%10% 63.1% 10% 63.3% 10% 65.3%5% 58.6% 5% 58.9% 5% 59.2%
Mean 76.0% Mean 92.7% Mean 94.3%
76.0%
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92.7%
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170%
94.3%
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170%
Alternate benchmarks
100% = Full baseline, no death benefit
93% = Baseline, but with death benefit
84% = Group annuitypricing, with death benefit & fixed 2.5% COLA
77% = Retail annuitypricing, with death benefit & fixed 2.5% COLA
Sample Results: Combo with Longevity, contd.
Shortfall risk / "failure rate" = probability of ratio to baseline value falling below:
First 15 yrs. Next 10 yrs. Age 90 Age 95 Age 100 Age 105 Age 110(Ages 67 to 81) (Ages 82 to 91)
60% of baseline 13.3% 24.6% 47.0% 26.5% 10.4% 2.3% 0.3%50% of baseline 5.1% 12.1%40% of baseline 1.2% 4.0% 0.0% 0.0% 0.1% 1.2% 11.1%30% of baseline 0.1% 0.4% 0.0% 0.0% 0.0% 0.1% 0.9%
-------------- Shortfall risk (using 3-yr. avg.) ----------------- -------------- Failure rate at: -----------------
----------- Survival probability -----------
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Death benefits paid as percent of total payments
First 15 yrs. Next 10 yrs. All remaining yrs.(67 to 81) (82 to 91) (92 and up)
%tile95% 29.3% 42.1% 49.7%75% 23.7% 36.0% 44.2%50% 21.2% 33.3% 40.2%25% 19.8% 30.8% 36.3%5% 19.0% 27.0% 30.2%
Mean 22.3% 33.6% 40.1%
Collective Payout Plan: Overview
Provides efficient pooling of individual mortality risk. Benefits provided in a form of variable annuity:
- Conditional indexing, plus- Bonus payments
Risk is shared collectively across the group of covered annuitants. Uses modest equity allocation to enhance long-term returns. Offers much more stable pricing for conversion of lump sum to
annuity stream, compared with market priced annuities – removes interest rate risk at point of retirement.
Structure provides a natural way to manage aggregate longevity risk.
http://pensionsectionnews.soa.org/Vizion5/viewer.aspx?issueID=2&pageID=27
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Collective Payout Plan: Plan Specs
Lump sum at retirement is moved into a separate fund Fund maintains constant 35% equity allocation Base annuity payments determined
- Lifetime payments- Fixed 2% COLA- Interest rate for pricing is greater of 5%, or prior year average 10-year
Treasury yield + 50 basis points Bonus payments made when plan has sufficient surplus, based on fixed
graded schedule, keyed to the plan funded status- Bonus of +5% with funded ratio of 120%- Growing to bonus of +75% with funded ratio over 175%
Temporary COLA suspension if underfunded- Suspended whenever funded ratio < 100% in 2 out of the prior 3 years- Restored when funded ratio is >105%- Rules are relaxed during initial period of fund maturation
Right to reduce regular payment is reserved to Board decision in case of extreme underfunding (never occurred in model)
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Illustration
Here is one of the simulation scenarios, from a “mature” program, with results near to the median outcome (PV of cohort benefits under collective plan = 122% of PV under group annuity)
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Years retired:1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Plan funded ratio 103% 105% 100% 98% 108% 116% 116% 121% 118% 120% 123% 128% 125% 135% 119% 130% 127% 119%COLA 2% 2% 2% 0% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%Bonus percent 0% 0% 0% 0% 0% 0% 0% 5% 0% 0% 5% 5% 5% 15% 0% 5% 5% 0%
Years retired:19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
Plan funded ratio 126% 126% 127% 118% 113% 122% 104% 98% 102% 115% 118% 115% 118% 117% 119% 101% 104%COLA 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%Bonus percent 5% 5% 5% 0% 0% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Benefit from group annuity:
initial benefit based on market interest rate of 3.75%; fixed
2% COLA
Base benefit from collective plan:
initial benefit based on plan interest rate of 5.00%;
contingent 2% COLA
Bonus payments
Key Simulation Results for Mature Program
Bonus payments- Frequency averages about 60%- Average bonus:
• When paid, about 18% of regular payment.• Counting non-bonus years, about 11% of regular payment
COLA suspension- Frequency averages less than 5%
Funded ratio- Generally in the range of 115% to 135%- Below 100% with about 5% probability
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Simulation Results: Compare Net Present Value
This chart shows results under the collective program for selected cohorts, assuming that the first retiree cohort entering the payout program is 10 years after the Secure Choice plan is established. The metric shown is the ratio of the net PV for benefits compared to those under a standard group annuity with a fixed 2% COLA. A value greater than 100% means the collective program provides more value (i.e. 125% means 25% higher value).
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Yr 10 Yr 20 Yr 30 Yr 4099% 109% 120% 140% 143%90% 107% 115% 131% 132%75% 106% 113% 126% 126%50% 105% 110% 122% 121%25% 105% 108% 117% 116%10% 104% 106% 112% 111%1% 103% 102% 103% 102%
Average 105% 110% 122% 121%
Prob. < 100% 0.0% 0.6% 0.3% 0.5%
---- Cohort retiring in year: ---- Results when plan is “mature”
Observations
Benefits- Virtually always better, on a PV basis, when compared with a standard group
annuity- Year-to-year variability is not excessive
Generational equity- As with all collective plans, a mature plan produces better benefits than during
the initial years, due to the need to build reserve balances- However, unlike with an accumulation program, the early retiree cohorts can still
be assured of better payout results than under a standard group annuity• Lump sum cash flows into the plan carry an implicit reserve• COLA suspension rules can be more favorable for early cohorts (to balance
the lower likelihood and level of bonuses, on average) Governance: the plan can operate almost completely with fixed rules, eliminating the
need for discretionary decisions
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Version 1
Introduction
On the following slides you will be asked questions. In each case, two people have made
permanent decisions on how to invest a portion of their money in retirement. You are asked to judge
which person has made a better choice. In all scenarios, each person has some savings and receives
$1,000 each month in social security, in addition to the portion of savings mentioned in each
question. Each person has chosen a different way to invest this portion ($100,000) of their savings.
They have already set aside money to leave for their children when they die. The choices are
intended to be financially equivalent and based on personal preferences for investing in retirement.
Life annuity
Mr. Red: Mr. Red invests $100,000 in an account which earns $650 each month for as long as he
lives. He can only withdraw the earnings he receives, not the invested money. When he dies, the
earnings will stop and his investment will be worth nothing.
20-year period annuity
Mr. Orange: Mr. Orange invests $100,000 in an account which earns $650 each month for 20 years.
He can only withdraw the earnings he receives, not the invested money. After 20 years, the earnings
will stop and his investment will be worth nothing. However, if he dies before then, he may leave
remaining earnings to charity.
35-year period annuity
Mr. Blue: Mr. Blue invests $100,000 in an account which earns $500 each month for 35 years. He
can only withdraw the earnings he receives, not the invested money. After 35 years, the earnings will
stop and his investment will be worth nothing. However, if he dies before then, he may leave
remaining earnings to charity.
Consol bond
Mr. Green: Mr. Green invests $100,000 in an account which earns a 5% interest rate. He can only
withdraw the interest he receives, not the invested money. When he dies, he may leave the remaining
earnings, which continue forever, to charity.
Savings account
Mr. White: Mr. White invests $100,000 in an account which earns a 4% interest rate. He can
withdraw some or all of the invested money at any time. When he dies, he may leave any remaining
money to
charity.
Version 2
Introduction
On the following slides you will be asked questions. In each case, two people have made
permanent decisions on how to spend a portion of their money in retirement. You are asked to judge
which person has made a better choice. In all scenarios, each person has some savings and can spend
$1,000 each month from social security in addition to the portion of income mentioned in each
question. Each person has chosen a different financial product for a portion ($100,000) of their
savings. They have already set aside money to leave for their children when they die. The choices are
intended to be financially equivalent and based on personal preferences for spending in retirement.
Life annuity
Mr. Red: Mr. Red pays $100,000 at retirement so he can spend $650 each month for as long as he
lives in addition to social security. When he dies, there will be no more payments.
20-year period annuity
Mr. Orange: Mr. Orange pays $100,000 at retirement so he can spend $650 each month until he is
85 years old in addition to social security. When he turns 85, he will have no additional money left to
spend. However, if he dies before he is 85, he may leave remaining payments to charity.
35-year period annuity
Mr. Blue: Mr. Blue pays $100,000 at retirement so he can spend $500 each month until he is 100
years old in addition to social security. When he turns 100, he will have no additional money left to
spend. However, if he dies before he is 100, he may leave remaining payments to charity.
Consol bond
Mr. Green: Mr. Green pays $100,000 at retirement so he can spend $400 each month for as long as
he lives in addition to social security. When he dies, he may leave remaining payments, which will
continue forever, to charity.
Savings account
Mr. White: Mr. White pays $100,000 at retirement so he can choose an amount to spend each month
in addition to social security. How long his money lasts depends on how much he spends. If he
spends only $400 per month, he has money for as long as he lives. When he dies, he may leave the
remainder to charity. If he spends $650 per month, he has money only until age 85. He can
spend down faster or slower than each of these options.