Daniel E. Winslow, FSA, CPA – Winslow Financial LLC
Kirk A. Kreikemeier, CFP®, CFA, FSA - Pebble Valley Wealth Management
Impact of Low Interest Rates on Insurance Companies and Retirement Portfolios
CAA Workshop – March 20, 2013
Contact Information
2
Daniel E. Winslow, FSA, CPA – Winslow Financial LLC Registered Investment Adviser and Fee Based Planner
[email protected] 222 E. Wisconsin Ave., Suite 214 Winslow-Financial.com Lake Forest, IL 60045 (847) 217-0366
Kirk A. Kreikemeier, CFP®,CFA, FSA - Pebble Valley Wealth Management
Registered Investment Adviser and Fee-Only Planner [email protected] 4365 Lawn Avenue, Suite 5
pvwealthmgt.com Western Springs, IL 60558
(708) 246-2366
Topics covered today
{CONTACT DAN WINSLOW FOR SLIDES ON THE
FIRST THREE TOPICS}
Brief history of interest rates, deficits and money supply
Insurance company stock price performance
Insurance product changes
{SLIDES FOR FOLLOWING TOPICS SHOWN HERE –
KIRK’S PART OF PRESENTATION}
Typical retiree portfolio and why low rates matter
Measures to capture rate risk
No free lunch as retirees “hunt for yield”
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Questions on a retiree’s mind
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“Why is my portfolio impacted by low rates more than others?”
“Haven’t fixed income returns been high lately?”
“How much are these low rates hurting my income?”
“Treasuries are safe. Can’t I just pick the high yielding ones?”
“Didn’t treasuries perform well during the last crisis?”
“What else can I do for more income?”
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Context Graph #1 – Price vs. Total Return
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$10,000 past 15 yrs in US Large Cap (w/ and w/o dividends)
Media and free data services typically only provide price return
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Source: Morningstar Office
Context Graph #2 – When did you start?
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US Equity Annlzd Return: start ‘98=4.60%; start ‘03=8.66%
Bond volatility low; inflation vs. cash; diversify ≠ insurance
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Source: Morningstar Office
Context Graph #3 – Bond returns by Type
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Aggregate bond returns solid, but quite a range within the index
30-Year treasury and high yield credit had very large swings
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Source: Morningstar Office Source: Morningstar Office
Why low rates matter for a retiree
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Retiree portfolio has more cash and fixed income
o Source of income and lower volatility in portfolio
Use historical return/risk but can’t ignore current market
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Total return = price change + income
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Yield is common metric but must consider potential price move
Price return for bonds has been larger driver but can be negative
Equities provide nice dividends but also carry price risk
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Income return has declined significantly
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Current income returns are far below historical levels
Income impact on $500,000 portfolio more than 50% drop
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Risk in portfolio as investors “hunt for yield”
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Given current environment, investors looking for more yield
Applies to both individuals and insurance companies
Focus is typically on income but be aware of risks
Use historical analysis but adjust for current environment
o Current low level of treasury rates
o Active Federal Reserve and other central banks
o Economic and credit cycle
o Uncertain tax law changes
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Common risk measures
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Equities - standard deviation
Bonds - duration or DV01
Duration = - (∆ Px / Px) / ∆ Rate
DV01 = Absolute ∆ Px given 1 basis point ∆
“Rate” can be driven by treasury rate and/or credit spread
Test question: “The lower the coupon rate, the ___ the duration?”
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Source: PVWM, Excel, par bonds
Historic treasury rate for key maturities
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Strategy #1 – Buy longer Treasuries
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INCOME - Extra 2.61% yield but substantially more rate risk
RISK - +2.50% rate rise could lose an extra 33% of value
“Went from risk-free return to return-free risk.”
Approximate change in bond portion of $500,000 portfolio
using first-order duration statistic and given rate change
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Historic corporate spreads
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Strategy #2 – Buy corporate credit
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INCOME - Earn additional spread over treasury
RISK – along with rate risk, taking credit risk
Similar duration, but higher credit risk, able to increase yield
Floating-rate funds take very little rate risk but high credit risk
Approximate change on same portfolio, first-order estimates
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Strategy #3 – Dividend-paying stocks
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INCOME - Dividend yield exceeds common bond indices
RISK - has over 4x price volatility of bond index
Focus on ‘low-beta’ stocks to reduce volatility but still > 3x
Qualified dividends have favorable tax; watch sector exposure
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Strategy #4 – Maintain same withdrawal
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INCOME – maintain lifestyle regardless of current market
RISK – deplete savings sooner than expected
‘Safe withdrawal rate’ based on total return concept
Each year the dollar withdrawal amount increased by inflation
During low returns, implicitly withdrawing more principal
Study by Blanchett, Finke, Pfau adjusted for current low rates
Safe withdrawal rate of 2.8% (vs. 4.0%) for a 90% success over 30 yrs
http://news.morningstar.com/pdfs/blanchett_lowbondyield_1301291.pdf
Sequence risk – impact of early years’ portfolio returns
Concerns after equity market loss; similar concerns after rates rise
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Market impact on safe withdrawal rate
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Preliminary research shows 4% may not always work
Source: “Can We Predict the Sustainable Withdrawal Rate for New Retirees” Pfau, Journal of Financial Planning, Aug 2011
Don’t spend excess
after good years
Be flexible on
spending after
severe crisis
Low actual
inflation helps
Recent study
concluded 2.8%
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Sequence risk using static withdrawal rate
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Forward– retire on 12/31/71 with initial 5% withdrawal rate
and actual portfolio returns over next 24 years
Backward– same actual returns but experience them in reverse
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Source: Blanchett, Finke, Pfau study
Conclusions
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Be aware of return source for fixed income
Know the duration of your portfolio holdings
Locking in low rates on debt is good, but be careful on assets
Look at risk/reward trade-off; take action, but be aware
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Appendix 1 – Barclays Agg Composition
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Only 21% corporate; 37% treasury and agency; MBS shrinking
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Source: Barclays US Aggregate Bond Index Fact Sheet
Appendix 2 – Treasury rate vs. credit spread
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Negatively correlated, especially during stress (-.31% overall)
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Appendix 3 – Curve and Fed
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1994 Fed shocked the 2-year; Bernanke’s Fed transparent but…
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Appendix 4 – Equity and Inflation – ’71-’95
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Reference for “Sequence Risk” – inflation matters
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Contact Information
26
Daniel E. Winslow, FSA, CPA – Winslow Financial LLC Registered Investment Adviser and Fee Based Planner
[email protected] 222 E. Wisconsin Ave., Suite 214 Winslow-Financial.com Lake Forest, IL 60045 (847) 217-0366
Kirk A. Kreikemeier, CFP®,CFA, FSA - Pebble Valley Wealth Management
Registered Investment Adviser and Fee-Only Planner [email protected] 4365 Lawn Avenue, Suite 5
pvwealthmgt.com Western Springs, IL 60558
(708) 246-2366
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