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Post-Retirement Risks. Longevity Family issues Health and long-term care Business and public policy Investment. 1. Longevity Risk. Outliving your resources Problems created when death occurs Death of a spouse First-to-die life insurance. One Way to Plan?. Use life expectancy to plan

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post retirement risks
Post-Retirement Risks
  • Longevity
  • Family issues
  • Health and long-term care
  • Business and public policy
  • Investment
1 longevity risk
1. Longevity Risk
  • Outliving your resources
  • Problems created when death occurs
  • Death of a spouse
    • First-to-die life insurance
one way to plan
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
longevity risk
Longevity Risk

Source: Unisex Table V


Annual Percentage of DeathsPopulation of 65 Year Olds

Life Expectancy

Source: 2000 Individual Annuity Mortality table

life probabilities at age 65
Life Probabilities at Age 65



Source: Society of Actuaries RP-2000 Table

the uncertainty of life
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”
implications for longevity risk
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
managing longevity risk
Managing Longevity Risk
  • Social Security
  • Annuities
  • Reverse mortgages
2 family issues
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
other family matters
Other Family Matters
  • Care of a grandchild or other dependent
  • Elder care for retiree parents
  • Paying for college while in retirement
3 healthcare and long term care risks
3. Healthcare and Long-Term Care Risks
  • Costs
    • Medicare, insurance premiums and coverage, prescription drugs, LTC
  • Geographic resources
    • Caregivers, facilities
    • Ability to live alone
  • Advance directives
    • POAs, living wills
ltc needs issues
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

types of ltc insurance
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
ltc policy features
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
housing needs
Housing Needs
  • Downsizing for early retirees
  • Relocation issues
  • Retiree expectations
  • Home as an asset
    • Natural disasters (e.g., earthquake or flood)
4 business public policy risk
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
legislative changes
Legislative Changes
  • Social Security
    • Later start ages for boomers
  • Medicare
tax rate change risk
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

historical income tax rates
Historical Income Tax Rates



2004 top rate: 35%

historical income brackets
Historical Income Brackets



2004 top rate: 35%

more income tax rate variables
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
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


$70,000 = 28% income tax bracket

If the surviving spouse needs only $50,000, then would be 25% bracket

Change in Filing Status
the best tax income
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
an ordinary illustration
Ordinary income tax


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

An “Ordinary” Illustration
5 investment risk
5. Investment Risk
  • Inflation risk
  • Interest rate risk
  • Market risk
inflation risk
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
historical inflation rates by year
Historical Inflation Rates by Year

Source: Bureau of Labor Statistics

defining inflation for a retiree
Defining Inflation for a Retiree
  • One rate: CPI
  • By expense type
    • Healthcare
    • Food/utility
    • Home value
    • College
    • Others
inflation by components of cpi
Inflation by Components of CPI

Source: Bureau of Labor Statistics

when do you want your risk
When Do You Want Your Risk?

Source: Nick Murray, The New Financial Advisor. Used with permission. For broker/dealer use only.

strategies for handling inflation risk
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
interest rate risk
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
historical interest rates
Historical Interest Rates

Source: Federal Reserve

market risk
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
reduction of risk over time


5-year holding periods


20-year holding periods


Compound annual return












Reduction of Risk Over Time

1-year holding periods


Smallcompany stocks





Each bar shows the range of compound annual returns for each asset class over the period 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.

market risk going forward
Market Risk Going Forward
  • Future expectations
    • Equity risk premium
  • Predictions & debates
a deterministic quiz
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?

recovery returns
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

lessons learned
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
retiring in different decades
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…
more lessons learned
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
asset allocation
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
investor characteristics
Investor Characteristics
  • Age
  • Investment experience
  • Risk tolerance
  • Personal financial factors
  • Risk capacity
managing portfolio risk
Managing Portfolio Risk
  • Rebalancing
  • Diversification
techniques for measuring risk pros and cons
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
monte carlo basics
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)
the imulator game
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!
wealth forecasting with cashflows mc simulation
Wealth Forecasting With Cashflows: MC Simulation


Portfolio Balance



















monte carlo pros cons

Uses multiple variables

Shows probabilities

Attempts to deal with the unexpected

Easy to see results of variable changes


Can be interpreted as certainty

Historical assumptions

Differences in probabilities are difficult to grasp

Can’t predict very unusual events

Monte Carlo Pros & Cons