Session # R1 The Use of Life Annuities in an Optimal Retirement Portfolio

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1 Investment Symposium March 13-14, 2014 New York, NY Session # R1 The Use of Life Annuities in an Optimal Retirement Portfolio Moderators Martin Belanger, FSA, FCIA Brett Dutton, FSA, MAAA, EA Presenter Don Ezra, FIA

Retirement Portfolio Moderators Martin Belanger, FSA,

2 The Use of Annuities in an Optimal Retirement Portfolio Lessons from my personal experience, by Don Ezra Aspects I will cover 1. Longevity risk 2. Annuities 3. An optimal investment portfolio for a retiree 2 C Don Ezra Consulting Services, Ltd. 1

will cover 1. Longevity risk 2. Annuities 3.

3 Only three dials to turn Reduce ambition Add to assets Increase risk 3 Which is bigger, longevity risk or investment risk? Consider two worlds: Longevity fixed, investment returns uncertain Investment returns fixed, longevity uncertain Which creates a wider distribution? 4 C Don Ezra Consulting Services, Ltd. 2

Consider two worlds: Longevity fixed, investment returns uncertain Investment

4 The numbers At age 60 (22 year period) 6% expected annual return, 8% standard deviation $1 invested in bonds has a mean accumulation of $3.65, with a standard deviation of $1.37 Coefficient of variation = 1.37/3.65 = 0.38 Cost of life annuity of $1 a year has a mean of $11.20, standard deviation of $3.14 (RP2000, 6%) Coefficient of variation = 3.14/11.20 = Conclusions At age 60, longevity risk is smaller than investing 100% in fixed income By age 75, longevity risk is bigger than investing 100% in equities The risk reduction from an annuity increases as age increases At some stage before age 75, buying longevity protection is probably sensible Source: How should retirees manage investment and longevity risk in a defined contribution world? by Don Ezra; Rotman International Journal of Pension Management, Spring C Don Ezra Consulting Services, Ltd. 3

28 5 Conclusions At age 60, longevity risk is smaller than investing 100% in fixed income By age 75, longevity risk is bigger than investing 100% in equities The risk reduction from an annuity

5 When to buy insurance? High probability Low probability High impact Budget for the expense Buy insurance Low impact Budget for the expense Accept disruption 7 Conclusion Buy a deferred lifetime income annuity that commences at my age 85, and continues while either my wife or I stays alive 8 C Don Ezra Consulting Services, Ltd. 4

Low impact Budget for the expense Accept disruption 7 Conclusion Buy a deferred

6 Why don t I like an immediate annuity? Split it into a front end (to age 85) and a back end (after age 85) Back end: deferred annuity, which I like Front end: Reverse limited premium whole life policy: why would I want this? 9 Other aspects Price JLS expectancy 29 years, 5% would have at least one alive after 41 years 41/29 = 140% = cost of self-insuring (at real 0%) Too expensive, unless money s worth is less than 100/140 = 70% (and chance of default > 5%) Different form of longevity protection: GMWB/GLWB Pro: Take investment risk, own assets Con: Can t customize risk, opaque pricing 10 C Don Ezra Consulting Services, Ltd. 5

7 The goals that affect our asset planning 11 The goals that affect our asset planning We have three goals (and therefore need three instruments): Longevity protection: Given the uncertainty of our lifespans, insure against outliving our expectancy Growth: Our desired lifestyle is richer than we are Safety: No further assets to add, so don t shock us with a sudden it s time to turn the spending dial down 12 C Don Ezra Consulting Services, Ltd. 6

outliving our expectancy Growth: Our desired lifestyle is richer than we are Safety: No further assets to add,

8 Our three instruments 13 Our three instruments 1. Longevity protection: a deferred lifetime income annuity that will kick in if we survive past my 85 th birthday 1. Growth: Equities, hoping to raise our personal funded ratio past 100% (the thrive assets) 1. Safety: Five years of total spending invested in short term fixed income (the survive assets), and possibly even longer for the spending on essentials 14 C Don Ezra Consulting Services, Ltd. 7

1. Growth: Equities, hoping to raise our personal funded ratio past 100% (the thrive assets) 1.

9 What that achieves for us 15 What That Achieves for Us No financial worries about lifespan Five years notice of having to turn down the spending dial Five years to give equities a chance for the risk premium to materialise In that five-year period, constantly re-evaluate: If we want to extend the five-year ladder of safety What nice-to-have spending is at risk? We ve avoided shallow risk * for five years We remember happiness and the rest of our life abundance portfolio ** * Concept of Bill Bernstein ** Concept of Ed Jacobson 16 C Don Ezra Consulting Services, Ltd. 8

want to extend the five-year ladder of safety What nice-to-have spending is at risk?

10 Thank you! Now for your part: react via comments, questions, push-back! 17 C Don Ezra Consulting Services, Ltd. 9

Should I Buy an Income Annuity?

Should I Buy an Income Annuity? Prepared For: Valued Client Prepared By: CPS The purchase of any financial product involves a trade off. For example when saving for retirement, you are often faced with making a trade off between how