NAVAL POSTGRADUATE SCHOOL

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1 NAVAL POSTGRADUATE SCHOOL MONTEREY, CALIFORNIA MBA PROFESSIONAL REPORT Th Survivor Bnfit Plan: A Cost-Bnfit Analysis By: Advisors: Scott E. Batty, and Tho Kang Dcmbr 2007 William R. Gats, Raymond E. Franck Approvd for public rlas; distribution is unlimitd.

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3 REPORT DOCUMENTATION PAGE Form Approvd OMB No Public rporting burdn for this collction of information is stimatd to avrag 1 hour pr rspons, including th tim for rviwing instruction, sarching xisting data sourcs, gathring and maintaining th data ndd, and complting and rviwing th collction of information. Snd commnts rgarding this burdn stimat or any othr aspct of this collction of information, including suggstions for rducing this burdn, to Washington hadquartrs Srvics, Dirctorat for Information Oprations and Rports, 1215 Jffrson Davis Highway, Suit 1204, Arlington, VA , and to th Offic of Managmnt and Budgt, Paprwork Rduction Projct ( ) Washington DC AGENCY USE ONLY (Lav blank) 2. REPORT DATE Dcmbr TITLE AND SUBTITLE Th Survivor Bnfit Plan: a Cost-Bnfit Analysis 6. AUTHOR(S) Scott E. Batty and Tho Kang 7. PERFORMING ORGANIZATION NAME(S) AND ADDRESS(ES) Naval Postgraduat School Montry, CA SPONSORING /MONITORING AGENCY NAME(S) AND ADDRESS(ES) N/A 3. REPORT TYPE AND DATES COVERED MBA Profssional Rport 5. FUNDING NUMBERS 8. PERFORMING ORGANIZATION REPORT NUMBER 10. SPONSORING/MONITORING AGENCY REPORT NUMBER 11. SUPPLEMENTARY NOTES Th viws xprssd in this thsis ar thos of th author and do not rflct th official policy or position of th Dpartmnt of Dfns or th U.S. Govrnmnt. 12a. DISTRIBUTION / AVAILABILITY STATEMENT 12b. DISTRIBUTION CODE Approvd for public rlas; distribution unlimitd. 13. ABSTRACT (maximum 200 words) Invsting for on s futur is a concrn for th majority of military rtirs. Srvic mmbrs hav mor choics than thir civilian countrparts whn planning for rtirmnt. On altrnativ availabl to military mmbrs is th Survivor Bnfit Plan (SBP), which allows rtirs to provid for thir family s wlfar in th vnt of thir untimly dath. Th purpos of this papr is to analyz th cost ffctivnss of SBP in comparison to othr insuranc or invstmnt options. This papr provids an ovrviw of SBP and possibl altrnativs. Additionally, a mathmatical modl has bn constructd that conducts a cost-bnfit analysis of SBP and altrnativs to dtrmin th most bnficial cours of action for futur rtirs. Our major conclusion is that SBP is th most attractiv availabl option only if th military mmbr xpcts to liv for a sufficintly long priod and also xpcts his (or hr) spous to outliv him by a significant amount. Howvr, this rsult is snsitiv to rat of inflation SUBJECT TERMS Survivor Bnfit Plan, Cost-Bnfit Analysis, Military Rtir, Lif Insuranc 15. NUMBER OF PAGES PRICE CODE 17. SECURITY CLASSIFICATION OF REPORT Unclassifid 18. SECURITY CLASSIFICATION OF THIS PAGE Unclassifid 19. SECURITY CLASSIFICATION OF ABSTRACT Unclassifid 20. LIMITATION OF ABSTRACT NSN Standard Form 298 (Rv. 2-89) Prscribd by ANSI Std UU i

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5 Approvd for public rlas; distribution is unlimitd THE SURVIVOR BENEFIT PLAN: A COST-BENEFIT ANALYSIS Scott Batty, Captain, Unitd Stats Marin Corps Tho Kang, Major, Unitd Stats Army Submittd in partial fulfillmnt of th rquirmnts for th dgr of MASTER OF BUSINESS ADMINISTRATION from th NAVAL POSTGRADUATE SCHOOL Dcmbr 2007 Authors: Scott E. Batty Tho Kang Approvd by: William R. Gats, Lad Advisor Raymond E. Franck, Support Advisor Robrt N. Bck, Dan Graduat School of Businss and Public Policy iii

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7 THE SURVIVOR BENEFIT PLAN: A COST-BENEFIT ANALYSIS ABSTRACT Invsting for on s futur is a concrn for th majority of military rtirs. Srvic mmbrs hav mor choics than thir civilian countrparts whn planning for rtirmnt. On altrnativ availabl to military mmbrs is th Survivor Bnfit Plan (SBP), which allows rtirs to provid for thir family s wlfar in th vnt of thir untimly dath. Th purpos of this papr is to analyz th cost ffctivnss of SBP in comparison to othr insuranc or invstmnt options. This papr provids an ovrviw of SBP and possibl altrnativs. Additionally, a mathmatical modl has bn constructd that conducts a cost-bnfit analysis of SBP and altrnativs to dtrmin th most bnficial cours of action for futur rtirs. Our major conclusion is that SBP is th most attractiv availabl option only if th military mmbr xpcts to liv for a sufficintly long priod and also xpcts his (or hr) spous to outliv him by a significant amount. Howvr, this rsult is snsitiv to rat of inflation. v

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9 TABLE OF CONTENTS I. INTRODUCTION...1 A. THE SURVIVOR BENEFIT PLAN (SBP) A Financial Support Systm SBP Cost SBP Modl Dscription...2 II. SBP PROGRAM OVERVIEW...3 A. BACKGROUND Spous Only and Formr Spous Childrn Only Spous (Formr Spous) and Childrn Insurabl Intrst...4 III. SBP MODEL...7 A. SPECIFICATIONS Objctiv Functions Elmnts of NPV Summary of Constraints...10 IV MODEL ASSUMPTIONS...11 A. OVERVIEW Th Social Scurity Offst Dpndncy and Indmnity Compnsation (DIC) Tax and Its Implications Prcnt Formula: SBP Prmiums Rsrv Componnt Survivor Bnfit Plan (RCSBP) CSB/REDUX Mortality Rats Halth Concrns Lngth of Insuranc Policy Inflation and Intrst Rats...17 V. RISK...19 A. OVERVIEW Risks Applicabl to All Financial Solutions Risks Applicabl Only to th SBP Risks Applicabl to Trm Lif Insuranc Altrnativs Risks Applicabl to an Indx Fund Altrnativ Risks Applicabl to T-Bill Altrnativs...25 VI. COMPARISON OF VARIOUS RETIREE OPTIONS...27 A. OVERVIEW Scnario On Scnario Two Scnario Thr...30 vii

10 4. Scnario Four Scnario Fiv...32 VII. SUMMARY, CONCLUSIONS, AND TOPICS FOR FURTHER RESEARCH...33 A. SUMMARY AND CONCLUSIONS...33 B. TOPICS FOR FURTHER RESEARCH...33 LIST OF REFERENCES...35 APPENDIX A. SCENARIO ONE...37 APPENDIX B. SCENARIO TWO...39 APPENDIX C. SCENARIO THREE...41 APPENDIX D. SCENARIO FOUR...43 APPENDIX E. SCENARIO FIVE...45 APPENDIX F. PREFERRED PLUS - GENERAL...47 APPENDIX G. PREFERRED PLUS - MEDICAL...49 APPENDIX H. USEFUL SBP LINKS...51 INITIAL DISTRIBUTION LIST...53 viii

11 LIST OF FIGURES Figur 1. Inflation Rat vs. Avrag Annual Incras in Military Pay...22 Figur 2. NPV Rsults from Scnario On...27 Figur 3. Snsitivity Analysis Rsult of Scnario On...28 Figur 4. NPV Rsults of Scnario Two...29 Figur 5. NPV Rsults of Scnario Thr...30 Figur 6. NPV Rsults of Scnario Four...31 Figur 7. NPV Rsults of Scnario Fiv...32 ix

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13 LIST OF TABLES Tabl 1. Summary of Prvious Two-Tir Systm...12 Tabl 2. RCSBP Options...15 xi

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15 ACKNOWLEDGMENTS Th authors would lik to thank Brigadir Gnral Raymond Franck, USAF (Rt.) and Dr. William Gats for thir guidanc in this acadmic ndavor. Additionally, th authors would lik to thank thir familis for all th lov and support thy hav providd throughout th duration of this invstigation. Non of this rsarch could hav bn compltd without thir fforts. xiii

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17 I. INTRODUCTION A. THE SURVIVOR BENEFIT PLAN (SBP) 1. A Financial Support Systm Providing financial support and frdom for on s family is a major concrn for many Amricans. Th Dpartmnt of Vtrans Affairs has dvisd an optional insuranc plan that assists rtiring military srvic mmbrs planning how to provid for thir familis upon thir dath. Th Survivor Bnfit Plan (SBP) is a financial support systm that provids a portion of th rtird srvic mmbr s pnsion to a spcifid family mmbr (or possibly a clos businss associat) upon th dath of th srvic mmbr. This financial bnfit is thn givn in monthly installmnts, similar to an annuity, to th spcifid family mmbr for an indfinit priod of tim. This plan is dsignd to assist rtird srvic mmbrs in caring for thir spouss aftr thir dmis; howvr, thr ar typs of programs within th SBP that allow srvic mmbrs to car for othrs aftr thir dath. 2. SBP Cost Th Survivor Bnfit Plan looks lik a sound financial program but it is not fr for th rtird srvic mmbr. This plan is lik a lif insuranc policy whr th srvic mmbr must pay a monthly f from rtirmnt until dath in ordr for his or hr bnficiary to rciv paymnt. Howvr, unlik a lif insuranc policy th paymnts only apply so long as th dsignatd bnficiary is still aliv. In cass whr th bnficiary dis bfor th rtird srvic mmbr, th paymnts mad toward this plan bcom a sunk cost. In this cas, th rtird srvic mmbr could b bttr off purchasing an annuity aftr rtirmnt as opposd to nrolling in SBP. Ths problms can pos multipl qustions for th rtiring srvic mmbr basd upon his or hr 1

18 situation. Ths qustions includ whthr th srvic mmbr should nroll in SBP and if so, how much of a contribution should thy mak to maximiz bnfits from this program? 3. SBP Modl Dscription In ordr to assist srvic mmbrs who will dcid whthr or not to nroll in th SBP, our MBA projct will construct a modl to dtrmin th optimal dgr of SBP participation (if any). This modl will assist in conducting a cost-bnfit analysis of th SBP (SBP modl can b accssd at: This modl will considr lif xpctancy of th srvic mmbr and th spous, th opportunity cost of capital, rank of th rtiring srvic mmbr, and inflation. Additionally, this documnt will srv as an appndix to th modl which has bn cratd. Containd within will b brif discussions of altrnativs to th SBP. This appndix will also contain th bulk of our rsarch, to includ assumptions and risks. Finally displayd will b our conclusions as to th financial soundnss of th SBP and th snsitivity of th invstmnt into SBP whn thr ar fluctuations in ags of dath of both th bnficiaris and th invstors. 2

19 II. SBP PROGRAM OVERVIEW A. BACKGROUND Thr ar fiv programs availabl within th SBP. Spous Only Covrag, Formr Spous Only Covrag, Childrn Only Covrag, Spous/Formr Spous with Childrn Covrag, and Insurabl Intrst. Th majority of ths programs hav diffrnt costs and dath bnfits associatd with thm. What is common to all is a 55 prcnt disbursmnt basd on th slctd bas amount. Th SBP is basd upon a bas amount, or a prcntag of th rtirmnt pay, which is lctd on th dat of rtirmnt. For xampl, if a rtir lcts to hav full covrag, thn th bas amount would b 100 prcnt of th monthly rtirmnt pay. If th rtir lcts to hav only 60 prcnt covrag, thn th bas amount would b 60 prcnt of th monthly rtird pay. Howvr, th bas amount must b at last $300. Both th costs and th bnfits associatd with th SBP ar basd upon which program is chosn. Ths ar discussd in th following paragraphs. Thr is a maximum amount of paymnts into th Survivor Bnfit Plan. Onc th rtir has paid into th plan for 30 yars or 360 paymnts, and has rachd 70 yars of ag, thn h or sh is fully vstd in th plan and will no longr hav to surrndr a portion of his or hr monthly pay. 1. Spous Only and Formr Spous Ths particular programs ar th most basic and th most utilizd. Each program provids th spous or formr spous with th montary bnfit upon th dmis of th rtir. Programs costs ar calculatd by multiplying th bas amount by 6.5 prcnt. For xampl, if th bas amount wr $1000 pr month, thn th cost pr month to a rtir would b $65 pr month until th srvic mmbr s dath. Upon his or hr dath, th bnfit towards th spous/formr spous would b $550 pr month ($1,000 x.55 %= $550) basd upon th prvious bnfit calculation. 3

20 2. Childrn Only This program can b an automatic covrag whn an activ duty mmbr dis and thr is an ligibl child or childrn, but no ligibl spous. Othrwis, this program can b slctd in liu of Spous Only covrag with th approval of th spous. Eligibility for childrn undr this program is th sam as with (Formr) Spous with Childrn covrag. Qualifications undr this program includ childrn undr th ag of 18, or 22 if pursuing a full-tim cours of study, child is unmarrid, or is handicappd and not capabl of slf-support (USMC Manpowr & Rsrv Affairs [USMC M&RA], ND). Paymnt annuitis ar basd on th 55 prcnt formula of th rtird pay which is dividd among th ligibl childrn. As on child bcoms inligibl, th total annuity amount is thn dividd among th rmaining ligibl childrn. Th cost of th program is calculatd basd on th ag of th rtir and of th youngst child at th tim of rtirmnt. Tabls dpicting th various rats ar includd in th modl. A bnfit of Childrn Only covrag is discussd in th assumption sction rgarding concurrnt rcipts with th VA s Dpndncy and Indmnity Compnsation (DIC). 3. Spous (Formr Spous) and Childrn In this program, th spous is th primary bnficiary (s Spous Only and Formr Spous sction) and th childrn only rciv bnfits upon th dath of th spous or through rmarriag prior to th ag of 55. Th ligibility rquirmnts and bnfit paymnts for childrn ar th sam as th Child Only covrag listd prviously. Th cost of th program is also calculatd basd on ag of th rtir, th ag of th youngst child, and th ag of th spous at th tim of rtirmnt. Th prmium includs th rgular cost for (Formr) Spous Only covrag (6.5 prcnt) plus th additional cost to also covr th childrn. Th tabls dpicting th various rats ar includd in th modl. 4. Insurabl Intrst This program is uniqu as it allows th rtiring srvic mmbr to includ family mmbrs othr than his or hr spous. Family mmbrs closr in rlation than a cousin 4

21 ar ligibl. Ths includ parnts, brothrs, sistrs, aunts, uncls, or vn grandparnts. Th bnfits associatd with this program ar also 55 prcnt of th bas amount. Th cost, howvr, is calculatd in a vry diffrnt mattr; basd upon th diffrnc in ag btwn th bnficiary and th rtir. Th bas cost of th insurabl intrst plan is 10 prcnt of th bas amount. In addition, for vry full fiv yars oldr th rtir is in ag than th bnficiary; th cost incrass anothr 5 prcnt pr month. For xampl if th rtir was 42 yars old and th bnficiary was 20 yars old, thn thr would b an ag diffrnc of 22 yars. This ag diffrnc would quat to 4 full fiv yar priods. Thrfor th cost would b as follows: Cost = 10 + (4*5%) = 30% of th bas amount Th bnfit pr month is calculatd by subtracting th cost pr month from th bas amount and thn multiplying that amount by 55 prcnt. Th rsult is th montary bnfit that is paid to th insurabl intrst pr month. For xampl, if th bas amount wr $1000 and th ags of th rtir and th bnficiary wr th sam as abov thn th bnfit pr month would b calculatd as follows: Bnfit = 55% * [1000 (1000 * 30%)] = 55% * 700 = $385 pr month 5

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23 III. SBP MODEL A. SPECIFICATIONS In ordr to ascrtain th tru valu of this program, a modl had to b cratd which would wigh th costs and th bnfits of th Survivor Bnfit Plan and thn compar SBP to availabl altrnativs. This was not an asy task as thr ar many variabls and quations that nd to b includd to mak this modl valid. 1. Objctiv Functions This modl compars two invstmnt options to th SBP whil conducting th cost bnfit analysis. Ths two financial options ar a gnric invstmnt option, which can b liknd to an indx fund, and a trm lif insuranc option. Each financial option has its own risks and rwards, which will b idntifid in futur sctions. Onc a suitabl altrnativ to th SBP is dtrmind, an algorithm that could dtrmin possibl worth of th plans is thn ndd. According to th OMB Circular A- 94, th masur of valu to idntify if a projct is worth undrtaking is Nt Prsnt Valu (Offic of Managmnt and Budgt [OMB], 1992). Th rfrnc and standard altrnativ options ar translatd into th objctiv functions. Th thr objctiv functions ar th Final Nt Prsnt Valu (NPV) of th Survivor Bnfit Plan, Final Nt Prsnt Valu of th gnric invstmnt, and Final Nt Prsnt Valu of th trm lif insuranc policy. Ths thr objctiv functions, which ar dfind as NPV of Bnfit NPV of Cost, ar compard to ach othr. If th NPV of th SBP is highr than th othr two options, thn th srvic mmbr should nroll in SBP; if th NPV of th gnric invstmnt is highr than th othr two options, thn th srvic mmbr should invst th sam amount in th gnric invstmnt that h or sh would hav invstd in SBP; if th NPV of th lif insuranc option is highr than th othr two options, thn h or sh should invst in a trm lif insuranc policy with prmiums quivalnt to th SBP cost. 7

24 To dtrmin th Final NPVs, th dcision variabls had to b dtrmind. Ths variabls ar illustratd in th influnc diagram attachd and th final quations ar discussd in dtail blow. 2. Elmnts of NPV To dtrmin th Final Nt Prsnt Valu of ach plan rquirs a calculation to dtrmin ach lmnt of th final formula. This is brokn down in quation format blow. NPV of Cost of SBP = Yarly Contribution into SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Th final yar is dtrmind by th most probabl yar of dath of rtir. This is basd upon th Actuarial Mortality Tabls givn by th Social Scurity Administration (SSA). Whn using th calculator, th rtir can ithr us th National lif xpctancy avrag for his or hr ag group or can stimat thir lif xpctancy. This may b usd if th rtir has a mdical condition or othr circumstanc that may shortn his or hr lif span, or has rason to anticipat a longr than avrag lif span. NPV of Bnfit of SBP = Yarly Paymnt to Bnficiary from SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Th first yar that is usd in this quation is th sam yar in which th bnficiary bgins to rciv bnfits. In short, th first yar in this quation is th stimatd yar of dath of th rtir bcaus th bnficiary dos not rciv bnfits until th rtir dis. Additionally, th NPV s final yar is th stimatd yar that th bnficiary will di. 8

25 NPV Cost of Gnric Invstmnt = Yarly Contribution into SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Sam tim priod ruls apply to this quation as th NPV of Cost of SBP. Sinc this is an altrnativ option, it is assumd that th contribution into this gnric invstmnt pr yar would b th sam as th contribution pr yar into SBP. NPV Bnfit of Gnric Invstmnt = Futur Valu of Invstmnt [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Th Futur Valu of th Invstmnt assums that th contributd mony grows continually during th invstmnt priod. Th tim priod which is usd is th yar that th bnficiary will rciv th lump sum paymnt from th invstmnt (.g., whn th rtir dis). It should b notd that this NPV of th bnfit assums th bnficiary rcivs a lump sum as opposd to an annuity. NPV Cost of Lif Insuranc = Lif Insuranc Prmium Basd on Cost of SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] + Diffrnc Btwn Insuranc Prmiums and Cost of SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Th prmiums wr calculatd by rfrncing what on would hav invstd into th SBP and thn dtrmining th lif insuranc amount and prmium dpnding on SBP invstmnt. Th dlta was viwd sparatly and is assumd to b invstd into an indx fund of th rtir s choic. 9

26 NPV Bnfit of Lif Insuranc = Amount of Insuranc Purchasd [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] + Futur Valu of th Diffrnc Btwn Insuranc Prmiums and Cost of SBP [(1+ % Rturn on Opportunity Cost of Capital)^Yar] / [(1 + Rat of Inflation)^Yar] Not: Th amount of th lif insuranc purchasd bcoms zro whn th policy xpirs. Thrfor, for th majority of modl usrs, th lif insuranc policy xpirs aftr th 30 yar point and th NPV dcrass drastically. Aftr making ths calculations, a final NPV of both altrnativs can b dtrmind. Onc th final NPVs ar dtrmind, thy can b compard in th modl to dtrmin whthr or not SBP is th bst invstmnt option. Howvr, thr wr a numbr of constraints that applid to this modl. Th majority of thm ar military pay rlatd, lik yars of srvic must b at last 20 yars to rciv a rtirmnt bnfit. Ths constraints ar listd blow. 3. Summary of Constraints Yars of Srvic 20 Yars Yars of Srvic 40 Yars Yars of Srvic 30 Yars if Rank O-6 Ag at Rtirmnt 38 Yars of Ag Bas Amount $300 Bas Amount 100% of Bas Rtirmnt Pay Max cost for Insurabl Intrst < 40% of Bas Rtirmnt Pay Max # of paymnts = 360 or 30 yars AND ag > 70 10

27 IV MODEL ASSUMPTIONS A. OVERVIEW This projct maks svral assumptions for ovrall simplicity and usrfrindlinss. To provid a usr-frindly documnt, som simplifications wr ncssary but do not impact th ovrall objctiv - to provid usful guidanc to futur rtirs in a condnsd format that supports a mor informd dcision. Information rgarding ach assumption is providd blow to clarify th modl and to nhanc th radr s gnral knowldg. 1. Th Social Scurity Offst This modl assums that th SBP annuity rcivd by th ligibl bnficiary occurrd with an ffctiv rtirmnt dat of 1 April 2008 and thraftr, at th 55 prcnt rat. Additionally, othr factors that may affct SBP, paymnts such as othr social scurity and Vtrans Affairs (VA) bnfits, ar not addrssd to avoid unncssary complxity in th simulation. Links to various organizations frquntlyaskd-qustions sctions ar providd in Appndix G along with ky SBP information from th Dfns Financ and Accounting Srvic (DFAS) and svral othrs. This information, supplmntd by rtirmnt counslors and a rtir s own fforts, will nsur that th most up-to-dat information is availabl whn considring th ffcts of social scurity bnfits on SBP paymnts. Undr th prvious two-tir systm, an ligibl SBP bnficiary rcivd 55 prcnt of th slctd bas amount. Upon raching th ag of 62, that bnficiary s SBP annuity was rducd to 35 prcnt for th purpos of offstting social scurity survivor bnfits. Th National Dfns Authorization Act for fiscal Yar 2005 liminats this rduction at ag 62 to maintain a 55 prcnt SBP annuity through th lif of th ligibl bnficiary. Eliminating th social scurity offst will bcom ffctiv 11

28 on 1 April Eligibl bnficiaris who rach 62 yars of ag prior to that dat fac a phas-out of th offst that bgan on 1 Octobr 2005 and nds on 31 March 2008 (U.S. Army Human Rsourcs Command, ND): Tabl 1. Summary of Prvious Two-Tir Systm Priod For months prior to Octobr 2005 Octobr 2005 through March 2006 April 2006 through March 2007 April 2007 through March 2008 April 2008 and aftr Amount of Annuity 35 prcnt 40 prcnt 45 prcnt 50 prcnt 55 prcnt Sourc: Aftr DOD SBP Wbsit (Fbruary 2007) For xampl, a 62-yar-old bnficiary that bgins to collct SBP paymnts on 1 January 2008 will rciv an annuity of 50 prcnt until 1 April 2008 whn it incrass to 55 prcnt. Phasing-out th social scurity offst liminatd th supplmntal survivor bnfit plan (SSBP) which providd rtirs th option to protct thir bnficiary from th rduction in annuity to 35 prcnt at th ag of 62. For simplicity, th social scurity offst is ignord and th modl assums that SBP annuity paymnts will bgin on or aftr 1 April Dpndncy and Indmnity Compnsation (DIC) On of th VA bnfits that is xcludd from th modl is th DIC program. DIC stipnds ar compnsation for ligibl surviving spouss of srvic mmbrs whos daths hav bn stablishd by th VA as srvic-connctd. Concurrnt SBP and DIC paymnts ar not allowd, so SBP paymnts ar rducd dollar for dollar. For xampl, a widow ntitld to a $1,000 SBP paymnt and a DIC paymnt of $1,033 rcivs th highst of th two, in this cas $1,033, not both (.g. $2,033). In 2003, du to an incras 12

29 of widows from th Global War on Trrorism, Congrss has allowd concurrnt rcipts for srvic mmbrs who did aftr 23 Novmbr 2003 by dsignating surviving childrn as bnficiaris instad of th spouss (Alvarz, 2006). Evn though this stp by Congrss ass rstrictions on th SBP, widows of srvic mmbrs who did prior to 23 Novmbr 2003 ar still not authorizd concurrnt rcipts of th SBP and DIC stipnd. In th prvious xampl of th DIC stipnd xcding th SBP paymnt, th bnficiary is rfundd all SBP contributions at fac valu without considration for intrst. In addition, th rfund is thn taxd (to th dcrmnt of widows bnfits). 3. Tax and Its Implications Th modl ignors th tax brackt of th rtir whil paying SBP prmiums and th tax brackt of th surviving spous whil rciving SBP bnfits. Howvr, gnral tax information as it prtains to SBP is providd as background information. SBP contributions ar non-taxabl and do not count against taxabl incom but SBP paymnts to th bnficiary ar taxabl. Thrfor, th tru cost of SBP is lss than th rtir s contribution to th program sinc SBP prmiums ar basd on pr-tax dollars (USMC M&RA, ND). A tax bnfit ariss whn (as typically occurs) th rtir s tax brackt is highr during th contribution phas than th bnficiary s tax brackt during th SBP annuity phas (DoD Offic of th Actuary, 2007). Th SBP dcision should b basd on th spcific tax situation of th rtir and thir spous (.g. non-rsidnt alin SBP bnficiary living ovrsas) and currnt tax laws vn though not addrssd in this modl. DFAS and th IRS should b contactd rgarding non-rsidnt alin issus, bcaus SBP annuitis may rsult in a 30 prcnt tax withholding (USMC M&RA, ND) Prcnt Formula: SBP Prmiums Rcnt changs in th SBP hav mandatd that th prmiums for th spous program b a constant 6.5 prcnt for all srvic mmbrs. Th DoD SBP wbsit stats that if you bcam a mmbr of a uniformd srvic on or aftr March 1, 1990, and you ar rtiring for lngth of srvic [not for disability or at ag 60 as a rsrvist (nonrgular srvic)], SBP costs will b calculatd only undr th 6.5 prcnt formula 13

30 Prior to this chang th prmium prcntag would hav bn 2.5 prcnt of th first $ ($652 on 1 April 2007) of th lctd bas amount plus 10 prcnt of th rmaining bas amount. For as of calculation, th SBP modl will b calculatd using only th 6.5 prcnt rul. Sinc this modl will prdominat in futur yars, th prior prmium calculation will not b usd. 5. Rsrv Componnt Survivor Bnfit Plan (RCSBP) This modl only applis to activ duty prsonnl. It dos not considr th rsrv componnt (.g. Rsrv and National Guard mmbrs). Activ duty srvic mmbrs ar automatically covrd undr SBP aftr 20 yars of srvic, but a rsrvist s bnficiary dos not hav standard SBP covrag until rtirmnt pay bgins at ag 60. In accordanc with th Survivor Bnfit Plan (SBP): Guid for a Spous of a Military Rtir (Dfns Civilian Prsonnl Managmnt Srvic, 2003), an ligibl rsrvist must follow on of th thr options listd in Tabl CSB/REDUX Th Carr Status Bonus (CSB) and REDUX will not b usd in this modl. REDUX is a rtirmnt program for srvic mmbrs that intnd to srv for 20 yars; it allows thm to opt for a $30,000 bonus (CSB) at thir 15-yar mark. In xchang for th bonus, th srvic mmbr rcivs a smallr rtirmnt chck. Th altrnativ is normal rtirmnt basd on th high-3 rtirmnt plan. Th CSB dcision is mad during th 15 th yar of srvic and is irrvrsibl onc mad. Unlik SBP with th standard high-3 rtirmnt plan, th REDUX s cost-of-living-adjustmnts (COLA) ar not basd on th normal Consumr Pric Indx (CPI). Rathr, th REDUX COLA adjustmnts ar basd on th CPI minus on prcnt xcpt at ag 62 whn th REDUX program provids for a on tim COLA adjustmnt as if th rtir was undr th high-3 systm. Aftrward, th REDUX COLA adjustmnt rsums its CPI minus on prcnt calculation (Congrssional Budgt Offic, 2006). 14

31 Tabl 2. RCSBP Options Option A: Th mmbr dclins to mak an lction for or against SBP covrag until raching ag 60. Thr would b no protction in th yars btwn bcoming rtirmnt-ligibl and attaining ag 60. Undr Option A, th survivor would nvr rciv any SBP bnfits if th rtird mmbr did bfor ag 60. Option B: A mmbr can guarant th survivor an annuity starting on th dat th rtir would hav attaind ag 60 if th rtir dis bfor ag 60. If dath is aftr ag 60 th annuity bgins th day aftr th dat of dath. Option C: This option guarants th survivor will rciv an RDCSBP annuity immdiatly upon th dath of th rtird Rsrv/national Guard mmbr, vn if dath occurs bfor ag 60. Sourc: Aftr Guid for a Spous of a Military Rtir (Updatd 2003) CSB/REDUX also contains factors that affct its cost vs. bnfit comparison. Som of th ky points of CSB/REDUX ar: 1) th longr th srvic mmbr livs, th gratr th loss in rtirmnt incom; 2) both th REDUX and high-3 rtirmnt ar adjustd for inflation, but th REDUX is adjustd lss; 3) th highr rank and lss tim of srvic, th gratr th rduction in rtirmnt incom; 4) fast-trackrs who rtir undr th REDUX program xprinc gratr loss of rtirmnt incom; and 5) REDUX rtirmnt incom is significantly smallr than th high-3 plan (Qustr & L, 2005). With th rducd rtirmnt incom undr REDUX, som rtirs may not b abl to afford SBP. Th spcific ffcts of REDUX on SBP ar unknown at this tim and ar in any cas byond th scop of th modl. Thus, with its numrous variabls, th modl will not captur th CSB/REDUX in its cost-bnfit analysis. 7. Mortality Rats Lif xpctancy has a hug ffct on both costs and bnfits. To addrss this problm, mortality tabls from th DoD Offic of th Actuary and th SSA ar usd to 15

32 calculat dath rats. Ths mortality tabls ar usd assuming that thy ar rprsntativ of th gnral population by ag and gndr at th tim of rtirmnt, for both th rtir and thir spous. Additionally, th modl includs a data tabl that displays dath ags of both th rtir and th bnficiary. This data tabl displays which financial option is bst dpnding on th ags at dath of both th rtir and th bnficiary. This data tabl allows th usr to kp constant all inputs in th modl, but varis th ags of dath, thrby allowing th usr to dtrmin th bst financial option dpnding on ags of dath. In ssnc this provids th usr a brak vn point for ach plan dpnding on ags of dath. This ability for paramtric adjustmnt allows usrs of th modl to conduct a snsitivity analysis if dsird. 8. Halth Concrns Financial bnfits of th SBP and th compard altrnativs all dpnd upon th ag at dath of th military srvic mmbr. Whil srvic mmbrs all hav varying halth lvls whn thy rtir, this modl assums that all rtiring srvic mmbrs ar in good gnral halth. This assumption has two ffcts on th modl. First, poor halth advrsly affcts th rtir s xpctd ag of dath. If th rtir s ag of dath dcrass, thn th total tim a bnficiary would rciv financial compnsation would incras. This will incras th NPV of SBP bnfits and dcras th NPV of th costs associatd with th SBP. Th ffct on th lif insuranc option will b similar to th ffct on SBP, incrasing th bnfit NPV and dcrasing cost NPV. Th ffct on th invstmnt option would b compltly diffrnt. Th NPV of th cost would dcras, but th NPV of th bnfits would dcras as wll du to a dcras in th invstmnt account s principal at tim of dath. A scond implication of wors halth would b a dramatic incras in lif insuranc prmiums. Currntly, th modl uss a prfrrd plus (Appndix F&G) lif insuranc policy for comparison purposs. 1 Th prfrrd plus lif insuranc policy is only availabl to rtirs in vry good physical halth. If a rtir wr not in good 1 All lif insuranc quots in th modl ar basd on a prfrrd plus status (Appndix F&G) and wr acquird from 16

33 halth thn prfrrd plus lif insuranc would not b availabl. Insuranc prmiums would drastically incras, thrby dcrasing th total NPV of th lif insuranc option. 9. Lngth of Insuranc Policy W assum that a long-trm lif insuranc policy will b purchasd. Lif insuranc is gnrally purchasd to nabl th bnficiary to maintain th sam standard of living as whn th srvic mmbr was aliv. Th longst trm lif insuranc policy availabl is a 30-yar policy. Our assumptions stat that th maximum tim a rtir will us a lif insuranc policy is 30 yars. At th nd of th 30 yar priod, th rtir is assumd not to purchas additional lif insuranc. This assumption rcognizs that prmiums would b vry high for a rtir who is at last 68 yars of ag, which is th minimum ag for rtirmnt at 38 with a 30 yar trm policy. 10. Inflation and Intrst Rats Inflation is a big risk for long-trm invstors. This modl accounts for inflation by dividing th discountd opportunity cost of capital by th discountd rat of inflation, turning th NPV into constant dollars and assuming a nominal discount rat. This modl uss th rat of inflation givn by th Prsidnt s Mid Yar Economic Rviw and uss th six yar inflation as instructd by th OMB Circular A-94 (OMB, 1992). Th DoD Offic of th Actuary rcommnds inflation and intrst rats of thr prcnt and six prcnt rspctivly (DoD Offic of th Actuary, 2007). Th modl follows OMB Circular A-94 rcommndation of 2.5 prcnt for inflation (OMB, 1992). Similar to th probability of dath, th usr has th option to conduct paramtric adjustmnts to both inflation and intrst rats. Intrst rats can thrfor b adjustd basd on th rtir s assssmnts and attituds toward risk. Othrwis, th modl uss six prcnt as a dfault intrst rat and an inflation rat of 2.5 prcnt. 17

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35 V. RISK A. OVERVIEW Th dtrmination of which altrnativ is th bst long-trm solution dpnds on many diffrnt factors. Som can b controlld by th invstor, lik th annual contribution, whil othr factors cannot b controlld. Ths risks will b discussd in dtail throughout this chaptr. Whil som of ths risks apply both to th SBP and its financial altrnativs, othrs only apply to on particular invstmnt program. 1. Risks Applicabl to All Financial Solutions Inflation is a hug risk that affcts all financial plans for th long trm byond tn yars. Individuals who ar planning for thir long-trm financial halth nd to considr inflation whil choosing th plan that will bst suit thir nds. For xampl, whn slcting a long-trm financial altrnativ with a fixd rturn (lik a trm lif insuranc policy), on must considr whn th bnfit will accru. If th payout from th lif insuranc policy occurs aftr a substantial priod of tim, lik 20 yars, thn th payout will not b as valuabl as it could hav bn aftr a tn yar tim priod. Th valu of a dollar today is lss than th valu of a dollar tomorrow for long-trm fixd bnfit programs. This ffct on (ral) valu can b xtrm or subtl dpnding on th rat of inflation. For xampl, th U.S. Dpartmnt of Labor dtrmind that th rat of inflation masurd by th Consumr Pric Indx (CPI) avragd 2.7 prcnt pr yar ovr th past 15 yars. Ovr tim, this modst annual incras in prics slowly causs th valu of a dollar to dcras ovr tim. Howvr, thr hav bn priods in which th rat of inflation was significantly highr. For xampl, inflation xcdd 11% in crtain yars in th 1970s and arly 1980s (Burau of Labor and Statistics, 2007). If thr wr additional priods of xtrm inflation, thn a fixd bnfit long-trm invstmnt would b worth considrably lss in futur yars than prviously prdictd. 19

36 A constant inflation rat had to b usd to account for inflation within th costbnfit analysis modl. This rat is a variabl that can b adjustd in th modl, but th rcommndd rat is 2.5 prcnt, basd upon th guidanc providd by OMB Circular A- 94. OMB rcommnds using an inflation rat drivd from conomic assumptions within th Whit Hous s Mid Sssion Rviw (OMB, 1992). If th NPV calculation is for an xtndd priod of tim (byond svn yars) thn th rat of inflation for th svnth yar should b usd. It should b notd, howvr, that this rat is mrly an ducatd guss and could fluctuat considrably in latr yars. On of th SBP s major slling points is rducing th risk of inflation bcaus th bnfits ar inflation-adjustd. This is don using th cost of living adjustmnts that ar gnrally applid vry yar to military srvic mmbrs pay and bnfits. But thr ar problms with this solution for inflation as discussd in th nxt sction. 2. Risks Applicabl Only to th SBP Thr ar two significant risks uniqu to th SBP; unxpctd actions of th bnficiary and incrass in military pay. Th primary risk to th SBP option is unxpctd actions of th bnficiary. Unxpctd actions can includ rmarriag bfor ag 55 or th dath of th bnficiary prior to th rtir s dath. If th SBP bnficiary dis bfor th rtir thn th prvious contributions to th SBP program ar lost (Offic of th Undr Scrtary of Dfns for Prsonnl and Radinss, 2007); thy cannot b rcoupd. Also, any paymnts that hav bn mad cannot roll ovr to anothr bnficiary. Thrfor, whn th bnficiary has halth concrns, th SBP may not b th bst option considring th risk of prdcasing th military mmbr. Additionally, th bnfits to th spous stop immdiatly in cass whr th srvic mmbr dis bfor th spous, but th spous rmarris prior to th ag of 55. In thory, this rflcts th additional walth that th bnficiary will assum onc rmarrid. This risk is unavoidabl, as th actions of on s widowd spous ar out of his or hr span of control, and should b considrd in raching a SBP dcision 20

37 An additional risk to th SBP is annual COLA adjustmnts that ar applid to military and rtird srvic mmbr s bas pay. Th COLA is an annual rais in bas pay for all military srvic mmbrs and rtirs. This rais, which is supposd to incras military pay to account for inflation and for subsqunt raiss in civilian job pay, is dsignd to kp military srvic mmbrs salaris on par with civilians in similar filds. This rais, which is passd into law by Congrss annually through th Prsidnt s budgt, is gnrally an annual incras. Howvr, this incras is not guarantd. In practic, this pay incras is givn ach yar at th rqust of th Prsidnt and with th approval of Congrss. This annual incras is affctd by many diffrnt factors and can gratly affct both th costs and bnfits for th SBP. Th rat at which military pay incrass varis gratly dpnding on th political climat, conomic conditions, and th Unitd Stats global position. Political climat can hav a hug ffct on th annual cost of living adjustmnt. Th Prsidnts national scurity policis and thir agndas rgarding th siz and structur of th armd srvics can influnc this incras dramatically. For xampl, th mid 1990s saw a dramatic shift in this country s global military position. Th Cold War was smingly ovr and thr was a 40 prcnt rduction in th numbr of activ duty military prsonnl (Goldich, 2005). Th fall of th Sovit Union also rsultd in a downsizing of th U.S. military and rcruiting targts accordingly lowrd. This dcras in prsonnl rquirmnts also rducd th montary incntivs to both kp and attract nw prsonnl. Congrss approvd military pay incrass for thr yars wr actually lss than th rat of inflation du to ths factors. Th country thn xprincd rosion in ral incom that vntually causd a pay gap btwn civilian and military jobs. This pay gap bgan to rciv mdia attntion, so Congrss incrasd military pay rats fastr than inflation to clos th gap. Th ris in military pay vrsus inflation can b sn in Figur 1, which illustrats th substantial varianc btwn th two. Howvr, th disparity btwn military pay incrass and inflation may soon com to an nd. Congrss has nactd nw laws that assist military srvic mmbrs. In 21

38 Novmbr 2004, a prmannt law 37 USC 1009 was amndd to mandat that military monthly pay will now b incrasd by at last th annual prcntag incras of th Employmnt Cost Indx (Goldich, 2005). Th Employmnt Cost Indx (ECI) is calculatd by th U.S. Dpartmnt of Labor and Statistics and masurs how much civilian pay incrass pr yar. Additionally, HR 1585, sction 606 of fiscal yar 2008 s Dpartmnt of Dfns s budgt rqust, guarants military pay raiss that ar 0.5 prcnt highr than th ECI through FY 2012, although this has yt to b approvd (H.R. 1585, 2007). This disparity btwn th rat of inflation and th ECI could thortically b mitigatd by passing ths laws. Howvr, potntial for risk still xists as lawmakrs, who hav th ability to incras military pay, can pass anothr law rpaling th amndmnt to 37 USC 1009 in th vnt of a massiv downsizing or som othr rason. Figur 1. Inflation Rat vs. Avrag Annual Incras in Military Pay 6.0% 5.0% 4.0% 3.0% 2.0% % Pay incras % inflation 1.0% 0.0% Sourc: Aftr DFAS military paytabls (2007); and CPI avrags from th U.S. Dpartmnt of Labor, Burau of Labor Statistics (2007). Lin Chart was cratd basd on information providd in ths two rfrncs. 22

39 3. Risks Applicabl to Trm Lif Insuranc Altrnativs Thr ar two major risks associatd with a lif insuranc option: financial halth of th lif insuranc company, and th possibility that th bnfit runs out prior to th bnficiary s dath. Ths risks ar not compltly avoidabl, but can b mitigatd with propr rsarch and planning. Lif insuranc companis can fac financial troubls lik any othr businss. Whil insolvncy is not common, it can and dos happn. In cass whr th insuranc company gos bankrupt, many policy holdrs los thir covrag and accounts. Howvr, thr ar programs which may hlp invstors or bnficiaris of lif insuranc policis. Michal Moran, spoksprson for th Amrican Insuranc Association says: Thr is, in vry stat, an insolvncy fund. Whn insurrs go insolvnt, trusts from that company pay th claims thy can, but vry oftn thr ar claims still pnding aftr th insolvnt insurr cass to xist. Ths pnding claims com to th insolvncy fund to b paid out ovr a priod of tim. What this law says is that high-nt-worth insurd s b that an individual or company with a nt worth of mor than $25 million cannot mak a first-party claim against th insolvncy fund. Thr is always prssur to mt th dmand, and th public policy rational is that you want to pay th claims to th popl who nd it most first with th availabl dollars (Claims, 2006, p.46). Whil th insolvncy fund may partially protct invstors, it is nithr an absolut nor a univrsal solution. This fund is dsignd to assist individuals who should rciv claims, as opposd to thos who paid prmiums, but hav yt to hav a rason to mak a claim. For xampl, a 70-yar-old man with a whol lif insuranc policy may rcovr nothing if th insuranc company gos bankrupt. A good way to mitigat this problm is conducting basic rsarch on th lif insuranc company s financial halth. Whil smallr insuranc companis may hav lowr rats than that of largr companis, thy could also b financially lss stabl. Inflation can likwis pos a grat risk to th lif insuranc altrnativ as th valu of a fixd bnfit may dclin gratly ovr an xtndd priod of tim. On considring a lif insuranc policy dtrmins th valu of th insuranc policy by 23

40 calculating how much thir family would nd in th vnt of thir dath; th insuranc purchasd is usually fixd in today s dollars. Howvr, th tim of dath may not b for 30 to 40 yars in th cas of military rtirs, as military srvic mmbrs can rtir at a rlativly arly ag. If a rtir is attmpting to dtrmin how much lif insuranc his family will nd in 30 to 40 yars, th rat of inflation will hav a hug impact on this calculation. This ffct of inflation lads to th scond and probably th most dangrous risk associatd with lif insuranc; th bnficiary running out of mony. This can asily happn if bnficiaris spnd mor than thy should from a budgtary standpoint or if th lif insuranc bnfit was mrly too low to account for inflation. Howvr, if th rtir taks into account that inflation may b rathr high, thn h or sh may purchas an xtrmly xpnsiv lif insuranc option that may or may not b paid for an xtndd priod of tim. To rduc ths risks, a twofold cours of action would gnrally b bst. First, a halth assssmnt should b takn prior to dciding what typ of provisions to mak. If th rtir is disabld or posssss som sort of ailmnt that lowrs his or hr lif xpctancy, thn th rtir rachs th nxt dcision point. Halth ailmnts can dramatically incras th prmiums on would pay for lif insuranc; thrfor, th rtir should dtrmin if thr is a policy that h or sh can purchas that is not too costly. Scond, if no such policy xists, thn SBP might b a good option. Howvr if a policy is availabl thn th rtir must dtrmin which option would prsnt thm with th highst final NPV: SBP or th lif insuranc policy. Howvr, if no physical malady xists, thn a smallr lif insuranc option might b a good choic. As tim gos on, dpnding on th rtir s financial position, additional lif insuranc can b purchasd to account for th ffcts of inflation. 4. Risks Applicabl to an Indx Fund Altrnativ Th risks of th stock markt can b quatd to th risk on ncountrs whn invsting in th Standard and Poor s 500 Indx as opposd to SBP. This altrnativ is not 24

41 narly as risky as choosing to invst in a singl stock du to th risk mitigation that occurs whn invstmnts ar divrsifid. Howvr, th ris and fall of th stock markt in gnral crats an inhrnt risk. Whil th stock markt has gnrally don vry wll in th long-run, it has major swings in th short run. For xampl, th Dow Jons Industrial Avrag (DJIA) has grown at roughly prcnt pr yar sinc 1983 (Dow Jons & Company, 2007). This may sound lik a dcnt invstmnt, but during that priod of tim thr wr yars whr th DJIA dclind at rathr rapid rats, lik in 2002 whn th DJIA dclind 16 prcnt in valu. 2 Rapid swings in stock markt pric could gratly affct invstors, spcially if incom stability is critical. Whil th avrag rturns of th stock markt may mak it appaling for long-trm invstmnt, short-trm instability maks it a risky option for rtirmnt incom, particularly in th short run. 5. Risks Applicabl to T-Bill Altrnativs T-bills pos a small risk that on s bnficiary runs out of mony. Thr is a possibility that th T-bill s financial backr, th U.S. Govrnmnt, will go undr during th lifspan of th bnficiary, but th liklihood of that occurring is slim. If an individual rtir wr to invst in T-bills as opposd to SBP, thn this would constitut an invstmnt that would nvr b lost, as T-bills can b willd to othr partis in th vnt of th bnficiary s arly dath. Howvr, th SBP pays bnficiaris indfinitly whil a T-bill account could b xhaustd dpnding on siz of th account and th bnficiary s spnding rat. A mans to rduc th risk of indx funds and T-bills is a combind stratgy that includs invstmnts in both altrnativs. This would mitigat som of th risk inhrnt in th swings of th markt, whil arning a highr rat of avrag rturn than achivd by invsting in T-bills alon. 2 All Dow Jons Industrial Avrag data has bn rcivd from th DJIA wbsit Whil this wbsit dos not giv th brak down of th avrag gain or loss ovr th tim fram rfrncd, th man is asily calculatd using th data points containd on th wbsit. 25

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43 VI. COMPARISON OF VARIOUS RETIREE OPTIONS A. OVERVIEW To dtrmin if th SBP is a good financial option, multipl scnarios must b analyzd. Outcoms from th modl can vary gratly dpnding on th inputs th usr dfins whn ntring thir information into th modl. Thrfor, an in-dpth analysis will b conductd into fiv diffrnt rtir scnarios to judg th financial fasibility of th SBP. Th variabls for ach rspctiv scnario will b ntrd into th modl to dtrmin th optimal financial plan. Th rsults calculatd by th modl ar discussd blow. To illustrat how th modl is affctd by th usr s dmographics, th analysis will kp crtain variabls constant. For ths purposs, th analysis will assum a 2.5% inflation rat and 5.0% nominal rat for th opportunity cost of capital. 1. Scnario On Th srvic mmbr is a 38-yar-old mal, who is an E-7 with 20 yars of srvic for rtirmnt purposs, and who dsirs a financial plan that will covr his 38- yar-old wif and 10-yar-old child. All of ths charactristics ar thn inputtd into th modl assuming an avrag lif xpctancy for both th rtir and th spous. Th modl yilds th data prsntd in Figur 2. Figur 2. NPV Rsults from Scnario On Altrnativ NPV SBP Indx Fund Insuranc Sourc: From SBP Modl If th rtir wr to invst all prospctiv SBP contributions into an indx fund that yildd a 5.0% incras pr yar, thn this altrnativ provids th bst rsult (.g., 27

44 highst NPV valu). This of cours assums that th ags at dath for both th rtir and his spous ar basd upon th national avrag; 76 and 81, rspctivly. Howvr, rsults can chang significantly dpnding upon th ags of dath. To illustrat th snsitivity to dath ags rfr to Figur 3, which is a lss dtaild vrsion of th graph dpictd in Appndix A. Figur 3. Snsitivity Analysis Rsult of Scnario On Sourc: Aftr Appndix A of SBP Modl Whil th indx fund, notd as MS in th data tabl, is th bst option using th avrag lif xpctancy for both th spous and th rtir, it is not always th bst plan. Th abov figur displays a macro vrsion of th snsitivity analysis. Th ara indicatd in rd signifis th priods whn th trm lif insuranc policy is th bst financial plan. In this particular xampl, if th rtir wr to di within 30 yars aftr rtirmnt, thn th trm lif insuranc policy would hav th highst NPV. Howvr, th trm lif 28

45 insuranc policy is not indicatd as th bst option if th xpctd ag of dath of th rtir is byond that 30 yar priod. Rathr, th indx fund bcoms th bst option (th ara highlightd in blu in Figur 3). If th rtir wr instad to invst in an indx fund for a long priod of tim, thn h would ssntially b slf insurd bcaus th invstmnt would grow substantially during rtirmnt. Th aras in blu and rd dominat th figur, indicating that indx funds and trm lif insuranc options ar th bst financial plans for th majority of th tim. Th qustion thn ariss as to whn SBP is th bst option. Rfrring to Appndix A, SBP only bcoms th bst option for th rtir if h dis at 68 and his spous outlivs him byond 78 yars of ag. By looking at Figur 3, thr is only a vry small window whr SBP (indicatd in grn) yilds th highst NPV compard to th othr invstmnt options. This occurs only whn lif insuranc has xpird and th bnficiary survivs his or hr spous for a long nough tim priod that th mony in th indx fund runs out bfor th bnficiary bcoms dcasd. This figur dmonstrats that SBP bcoms th bst option for only a small prcntag of th tim. 2. Scnario Two Scnario Two assums that th rtiring srvic mmbr is a 48-yar-old fmal with 30 yars of srvic. This individual is an E-9 who dsirs a financial plan to covr hr 48-yar-old husband. Whil using th sam rats for th opportunity cost of capital and inflation, th modl yildd th rsults sn in Figur 4. Figur 4. NPV Rsults of Scnario Two Altrnativ NPV SBP Indx Fund Insuranc Sourc: From SBP Modl 29

46 Th rsults from th modl show that onc again th gnric invstmnt has th highst NPV compard to th lif insuranc option and th SBP option. Ths rsults ar similar to Scnario On and additionally, th data tabls for Scnario On (Appndix A) and Two (Appndix B) also show rmarkably similar snsitivitis to lif xpctancy varianc. Dspit th similaritis btwn th two scnarios, on distinctiv xcption xists; th SBP has an vn smallr window of optimality in this scnario. 3. Scnario Thr Scnario Thr assums that th rtiring srvic mmbr is a mal who is 44 yars old with 22 yars of activ duty. This rtiring srvic mmbr is an O-5 who wishs to covr his 44-yar-old wif and fiv-yar-old child. Assuming th sam rats for inflation and th opportunity cost of capital as in th prvious scnarios, all input valus ar ntrd into th SBP modl. Th modl rsults ar shown in Figur 5. Figur 5. NPV Rsults of Scnario Thr Altrnativ NPV SBP Indx Fund Insuranc Sourc: From SBP Modl Likwis, this looks vry similar to th prvious scnarios, whr th NPV of th SBP and th trm lif insuranc option ar both ngativ. Th indx fund altrnativ rprsnts th bst option in all of ths scnarios. Additionally, th snsitivity analysis as sn in Appndix C looks vry similar to th prvious scnarios, whr th SBP option is th bst altrnativ for a vry small ara of th data tabl. Th rsults of ths thr scnarios indicat that th SBP is sldom th prfrrd option, vn as rank and yars of srvic vary. 30