Study of Retirement Income Account Allocations Among Equities, Bonds and Fixed Income Annuities

Transcription

1 Study of Retirement Income Account Allocations Among Equities, Bonds and Fixed Income Annuities January 1, 1980 through December 31, 2006 November 2007 Retirement Income Income Management Strategies Division

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3 Table of Contents Overview...2 Important Information About This Study...3 From Asset Allocation to Retirement Income Account Allocation...4 Study Methodology...6 Case Studies...8 The Base Case...8 The Laddered Annuity Case...10 The Beneficiary Protection Case...12 Planning Implications...15 Appendix Index of Charts and Tables...i Definitions and Assumptions...ii Historical Illustrations Account A...viii Account B...xi Account C...xiv Account D...xvii

4 Overview This study evaluates results of various allocations within a hypothetical Retirement Income Account tested to produce a targeted level of retirement income from January 1, 1980 through December 31, 2006 (referred to as throughout this study). This period was chosen because it represents approximately the length of time that a prudent person, retiring today at age 65, should consider for purposes of planning a lifetime income stream. It also represents a period of generally favorable performance of the equity and bond markets. The objective of this study was to gain insight on how alternative combinations of retirement income asset classes might have performed had a full range of retirement income solutions been offered at the start of this test period. The Income Management Strategies Division (IMSD) believes that this study, and the analytical engine behind it, will be useful to financial advisors in designing effective retirement income strategies that use a mix of asset classes, including U.S. equities, U.S. bonds, and fixed income annuities. This will be the first of a series of studies developed for financial advisors, which will explore other aspects of retirement income planning, including asset withdrawal strategies and evaluation methodologies, introduction of other forms of income annuities, and the impact of living benefit guarantees and associated fees. In addition, we will be publishing results for other historical periods. We welcome comments, requests and feedback. 2

5 Important Information About This Study The hypothetical illustrations cited in this study are not representative of the performance of any individual security. Hypothetical illustrations may be useful in indicating one or more possible outcomes, among many possible results. Since past performance and market conditions may not be repeated in the future, and the length of time a person may be in retirement may vary by individual, any person s retirement goals may not be met by following the allocations based on the illustrations. The impact of the timing of investment returns and interest rates can be significant and have a material effect on achieving retirement goals. There is no guarantee that an investor will receive the investment returns illustrated or with the same time sequences illustrated. The impact of inflation has not been reflected in the income results illustrated, nor has the impact of COLA-protected income annuities, since the latter were not available at the start of the study period. Analysis of an investor s purchasing power could result in different conclusions. The methodology underlying this study is based on historical investment returns and is not meant to project performance. Also, the annuity purchase rates are based on historical interest rates and assumptions as to mortality but may not reflect current immediate annuity pricing. Over time, IMSD may change the assumptions and/or the weight given to the economic parameters underlying our model as we take into consideration and analyze additional historical data. Market variables in the future may not perform as they have in the past. If relationships measured by the study vary significantly from what we have assumed, the evaluation of alternative plans may not be accurate. The value of these illustrations may be significantly impacted and the ability of any individual who relies on them to meet retirement goals may be impacted as well. Since the activity modeled in a given illustration has not actually occurred, the results of the illustration may under- or overcompensate for the impact, if any, of certain market factors and may also underestimate the impact of market extremes and the related risk of loss. Other investment categories not considered may have characteristics similar or superior to those being analyzed. 3

6 From Asset Allocation to Retirement Income Account Allocation In recent years, financial advisors have embraced the advantages of asset allocation strategies. By arranging investment portfolios according to asset class guidelines based on the client s risk tolerance and time horizon, many advisors have helped investors increase diversification, reduce volatility and improve performance. Of course, asset allocation and diversification help minimize risk but can never eliminate it. Now, as vast numbers of baby boomers (Americans born between 1946 and 1964) move into retirement, financial advisors face a different challenge adapting asset allocation concepts from an accumulation model to an income distribution model. The financial concepts that are part of allocated investment programs are becoming the raw materials of new income programs, created near the onset of retirement and aimed at achieving lifetime income security. IMSD believes that the basic concept of asset allocation and the resulting productive habits instilled in investors over time can provide the framework for meeting diverse retirement income needs. However, we also recognize that a new form of asset allocation model will now be needed to generate retirement income because: 1. In accumulation-focused allocation programs, asset growth is driven primarily by appreciation in stocks, bonds and other asset classes. Realistic rates of sustainable retirement income, however, are determined primarily by prevailing interest rates, such as yields on U.S. Treasury securities. 2. An important asset class for purposes of generating guaranteed retirement income, fixed income annuities (income annuities), is not often included in accumulationbased allocation programs. Many investors have little or no exposure to the benefits of the guaranteed lifetime income available outside of any pension plan or Social Security. (Note: With a fixed income annuity, the guarantees of income are dependent on the ability of the insurance company issuing the contract to meet its obligations over a period of time.) 3. A typical accumulation-based allocation program follows structured guidelines for each asset class (e.g., 60% stocks, 40% bonds). Such guidelines also can have a role in retirement income accounts; however, income annuities potentially add a new dimension to allocation structures, because they can be purchased through a lump-sum premium or with periodic premiums. When income annuities are purchased periodically for retirement income, the amount of income they produce is directly affected by prevailing interest rates at the time of purchase. This adds an important, dynamic new variable to asset allocation structures. These three points formed the starting line of this study. Beyond them, we began with an open mind as to how an asset allocation program designed for retirement income should be structured. Since we are aware of no other company that has conducted a similar study, we relied mainly on good judgment in developing the study s methodology and assumptions. (See the Appendix for details on assumptions.) 4

7 Three Asset Classes, Four Accounts With this initial study in this emerging discipline, we have simplified the inputs so that the outputs will form a useful foundation upon which to build new planning concepts. The asset allocations that we have evaluated consist of three asset classes: U.S. equities U.S. bonds Fixed income annuities We created Retirement Income Account allocations mixed among these classes. (See Table I below.) We then back-tested these allocations in head-to-head comparisons using three cases. The Base Case (Account A) compares an allocation of U.S. equities and U.S. bonds to an allocation of U.S. equities, U.S. bonds, and a fixed income annuity purchased with a lump-sum premium (Account B). The Laddered Income Annuity Case (Account C) compares Account A above to an allocation of U.S. equities, U.S. bonds, and a fixed income annuity purchased periodically. The Beneficiary Protection Case (Account D) is the same as Account C above, except that the fixed income annuity in the account includes a period certain benefit. The period certain benefit provides protection to the beneficiary in the case of early death of the investor. Detailed illustrations of these Accounts are found in the Appendix. Table I Retirement Income Account Allocations Account A Account B Account C Account D Deposit $100,000 $100,000 $100,000 $100,000 Initial Allocation: Equities 50% 50% 50% 50% Initial Allocation: Bonds 50% 16.7% 30% 30% Initial Allocation: Income Annuity None 33.3% 20% 20% Periodic Purchases of Income Annuity None None Annually until Retirement Income Target is reached Form of Income Annuity for Male 65 None Life Only Life Only Life with 20-Years Certain Annual Rebalancing of Equities To initial To initial From 62.5% equities-37.5% bonds and Bonds* 50% equities-50% bonds 75% equities-25% bonds allocation after initial purchase, allocation allocation shifting 2.5% from bonds to equities each year until an 80%-20% mix is attained after the seventh year. *In practice, the advisor may deploy a different rebalancing to reflect then-current circumstances. 5

8 Study Methodology Time Period and Client Profile A 65-year-old male who retired in 1980 had a life expectancy of about 19 years, according to the mortality assumptions used in the study. A financial advisor who designs a retirement income plan for such an investor might conservatively assume that income should continue beyond life expectancy, or alternatively develop a plan for lifetime income. Since the purpose of this study is to gain planning insight by evaluating the past, we have analyzed a period of similar historical length from Specifically, we began this study on January 1, 1980 and have assumed income planning for a male then-age 65. We assumed that the investor was comfortable investing in the market and was in reasonably good health. Retirement Income Account Retirement income can be derived from many sources including: (1) defined benefit pensions, (2) Social Security, and (3) withdrawals from savings and investments. We modeled a situation in which $100,000 of savings/investment assets were earmarked in an account dedicated to retirement income. Since we did not consider any tax impact in this study, it does not matter whether these assets are tax qualified (retirement plan) or nonqualified. Taxes are important considerations when embarking on any financial transaction, and tax advice should be obtained before implementing any retirement income strategy. Retirement Income Target Rather than assume a specific budget objective for the investor, we developed a target amount of annual income by looking at relatively risk-free income alternatives that were available at the start of the study period. Accordingly, we set the income at the level available if a 10-year Treasury note were purchased at the start. Specifically, we assumed for the purposes of determining the Retirement Income Target that the $100,000 portfolio would produce the same income (translating the semi-annual coupon into annual income) as a series of 10-year U.S. Treasury notes bought, held to maturity, and then rolled over to a new maturity of the same instrument every 10 years. The table below summarizes the income target used consistently throughout all three cases in this study. Table II Retirement Income Target for All Accounts 10-Year Treasury Annual Income Year an Income Investor s Age Note Yield* Target for Period of Target is Set When Target is Set (Start of Year) This Period Income % $10, % $8, % $6, *The yield on the Treasury note is the annual effective rate corresponding to the nominal rate. 6

9 Chart I Retirement Income Targets from ,000 10,000 Annual Income (Nominal $) 8,000 6,000 4,000 2, Equity and Bond Returns As a proxy for the returns in U.S. equities, the study uses the S&P 500 Total Return Index (TR), which measures returns in a basket of large U.S. stocks including the reinvestment of dividends. As a proxy for U.S. bond returns, the study uses the Lehman Aggregate Corporate Bond Index. In each case, the study models the actual historical returns produced by a mix of stocks and bonds held in mutual funds. Annual returns in both stock and bond indices were reduced by 0.50% (50 basis points) to approximate historical mutual fund expense ratios for index funds over the study period. (Note: An index is unmanaged and an investor cannot invest directly into an index. An investment in mutual funds involves risk and an investor s shares may be worth more or less than their original cost when redeemed, and it is possible to lose money.) Fixed Income Annuity Purchase Rates Three main variables determine the income payouts produced by fixed income annuities: (1) the age and sex of the annuitant and payout form chosen, (2) the mortality table used by the insurance company issuing the annuity, and (3) interest rates used by the insurance company, which usually reflect investments held in the insurance company s general account. The study assumes a 65- year-old male annuitant using (a) a lifetime income payout with level annual payments and with no period certain benefit for the Base Case and Laddered Annuity Case, and (b) a lifetime income payout with level annual payments and with a 20-year certain period for the Beneficiary Protection Case. The purchase rate is based on an annuitant mortality table established in 2000 projected forward or backward to the annuity purchase date (see details in the Appendix). Interest rates are equal to 10-year U.S. Treasury note annual effective yields at the start of each year. Results: In evaluating the results, we looked at a full range of values, in terms of both dates and economic measures. The attached illustrations show three economic measures: Liquid Value The current market value invested in equities and bonds. Beneficiary Value The amount available to the beneficiary at the death of the investor equal to the Liquid Value and the commuted value of any period certain benefit from the income annuity. Total Account Value The value of the account for the healthy investor (with a life expectancy of a comparative annuity purchaser on that date), which equals the Liquid Value plus the current purchase value of the income annuity. The annuity has no cash surrender value. For more details on the study s methodology and assumptions, see the Appendix. 7

10 Case Studies The Base Case The Base Case was designed to answer a basic question: Can the addition of a lump-sum purchase of a fixed income annuity at the start of retirement enhance a retirement income allocation consisting of U.S. stocks and U.S. bonds? To answer the question, we compared results of two hypothetical Retirement Income Accounts (Accounts A and B): Account A A $100,000 account was equally allocated (on January 1, 1980) between U.S. equities (50%) and U.S. bonds (50%). We assumed this mix because it was commonly recommended by leading financial firms and advisors in the early 1980s. Also, it is representative of portfolio allocations of some 65-year-old investors today who are retiring. The target amount of retirement income was withdrawn annually, at the end of each year. The investment portfolio was rebalanced annually at the end of each year back to the initial mix of equities and bonds. At the end of the 27-year period of historical returns (January 1, 1980 through December 31, 2006), for example, Account A has a final Liquid Value of $489,346, just under five times the original $100,000 deposit. In Account A, as well as in all of the other accounts tested, the target amount of retirement income was paid out annually and in full during the entire period. Account B Account B begins with the same allocation as Account A, except that 33.3% of the Account was used to purchase the income annuity. This amount was withdrawn from the U.S. bond component to approximate the same level of overall market risk as in Account A, leaving a mix of equities and bonds. The target amount of retirement income was produced first by income from the income annuity and then through withdrawals from stock/bond investments annually, at the end of each year. The investment portfolio was rebalanced annually at the end of each year back to the initial mix of equities and bonds. Results: Over the same 27-year period of historical returns ( ), Account B generates the same target retirement income as Account A and has a final liquid value of $667,688, more than six times the original $100,000 deposit. 8

11 Table III and Chart II below summarize results of the Base Case at both the end of the historical period and the end of the life expectancy period. (Results for all time periods are shown in the Appendix.) Table III Comparison of Liquid Value and Total Account Value Between Accounts A and B at End of Selected Periods After Full Historical Period After Life Expectancy Period ( ) ( ) Total Account Total Account Liquid Value Value Liquid Value Value Account A $489,346 $489,346 $391,373 $391,373 Account B $667,688 $686,275 $509,907 $536,450 Chart II Comparison of Liquid Value Between Accounts A and B from $800,000 Base Case Liquid Value (Nominal $) $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 Cross over $509,907 $391,373 Account B $667,688 Account A $489,346 $100,000 Life Expectancy $0 1/1/80 12/31/85 12/31/90 12/31/95 12/31/00 12/31/06 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 9

12 Base Case Analysis Both Accounts tested in the Base Case produced the same levels of retirement income, year by year. However, Account B produced a higher final Liquid Value at the end of the full historical period. Thus, for the investor who lives beyond life expectancy this suggests that a lump-sum purchase of a fixed income annuity can be an effective component in an income-focused asset allocation program. In evaluating this case, financial advisors may want to further consider the following reasons why Account B produced higher long-term values than Account A: 1. The interest rate environment in which fixed income annuities are purchased is important. In this case, 33.3% of the $100,000 was allocated to purchase a fixed income annuity on January 1, 1980, when interest rates were near a historic peak. Of course, at the start of any investor s retirement, it is impossible to know whether interest rates are near a peak, compared to rates that will follow. 2. The relative advantage of a program such as Account B vs. Account A will increase if the investor outlives life expectancy. If this hypothetical investor lives beyond the end of the study period (age 92), the guaranteed lifetime income from fixed income annuities will add even more value. 3. Including fixed income annuities in a retirement income allocation can help reduce any negative impact of taking withdrawals from investments in fluctuating or down markets. In summary, the Base Case demonstrates that when fixed income annuities are included in an allocation designed for retirement income, they shoulder a large part of the incomeproducing load. In addition, the inclusion of the fixed income annuity is similar to adding a Fixed Asset Class and therefore allows for a higher equity allocation. While increasing the potential for upside of the portfolio, a higher allocation to equities increases the risk of downside potential. The Laddered Annuity Case The Base Case also carries one potential drawback of including fixed income annuities in retirement income allocations: the potential value of such annuities can depend on the interest rate environment when they are purchased. To help overcome this drawback, financial advisors can suggest the periodic purchase of fixed income annuities, a technique that has some benefits in common with laddering or dollar cost averaging into investment portfolios. For example, if a portion of an investment portfolio is used to purchase fixed income annuities over several years of retirement, some purchases will benefit from higher interest rates while others will receive lower rates. The Laddered Annuity Case thus tests a second question: Does it make sense to consider the periodic annual purchase of fixed income annuities? To answer this question, Account A (the same as in the Base Case) is compared to a new Account C. Account C The $100,000 account was allocated (on January 1, 1980) among U.S. equities (50%), U.S. bonds (30%), and an initial purchase of a fixed income annuity (20%). This left a mix of equities and bonds in the investment portfolio. Starting in the second year, additional fixed income annuity purchases were made annually until 100% of the initial income target ($10,597 per year) was reached. Withdrawals to purchase these annuities (after the first year) were allocated 10

13 proportionately between equities and bonds. The investment portfolio was rebalanced annually at the end of each year with an increasing allocation to equities as described in Table I. Results: At the end of the 27-year period of historical returns ( ), Account C has a final liquid value of $735,292. Table IV and Chart III below summarize results of the Laddered Annuity Case at both the end of the historical period and at the end of life expectancy period. (Results for all time periods are shown in the Appendix.) Table IV Comparison of Liquid Value and Total Account Value Between Accounts A and C at End of Selected Periods After Full Historical Period After Life Expectancy Period ( ) ( ) Total Account Total Account Liquid Value Value Liquid Value Value Account A $489,346 $489,346 $391,373 $391,373 Account C $735,292 $777,821 $522,839 $583,570 Chart III Comparison of Liquid Value Between Accounts A and C from Laddered Annuity Case $800,000 Liquid Value (Nominal $) $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 Cross over $522,839 $391,373 Account C $735,292 Account A $489,346 $100,000 Life Exp ectancy $0 1/1/80 12/31/85 12/31/90 12/31/95 12/31/00 12/31/06 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 11

14 Laddered Annuity Case Analysis The Laddered Annuity Case demonstrates that fixed income annuities can work effectively within a retirement income allocation structure whether they are purchased: (1) in a lump sum at the start of retirement, or (2) periodically during the early years of retirement. In fact, financial advisors may want to discuss fixed income annuities with their clients under two very different purchase strategies: The lump-sum purchase works best when the client is able to lock in an attractive annuity purchase rate in one year; however, attractive can be judged only with hindsight, especially in periods of volatile interest rates. Periodic purchases of fixed income annuities while increasing the guaranteed income component may help mitigate any potentially negative impact of annuity purchases made during adverse interest rate environments. Also, purchasing income annuities at increasingly older ages can increase income payout rates. When 100% of the retirement income goal is achieved, the weight of the investment portfolio can be shifted toward equities. There is no guarantee that the Laddered Annuity strategy will produce better results than making a simple lump-sum purchase of income annuity benefits. The Beneficiary Protection Case Critics of fixed income annuities will surely note that both the Base and Laddered Annuity cases would produce less attractive results if the investor the sole annuitant in both cases died early in retirement. Of course, most clients have different sources of retirement planning money, and we have assumed to this point that the $100,000 savings used in the prior two cases is earmarked strictly for personal retirement income not the needs of a surviving spouse or heirs. The Beneficiary Protection case is designed to address a third question: What is the impact on results when the income annuity includes a beneficiary protection benefit? The needs of a surviving spouse or heirs are considered in the third and final case in the study. Account D The $100,000 account was allocated identically to Account C. The only difference is the payout method for all annuity purchases is assumed to be life with 20-year certain period. The certain period for income annuities ends on January 1, Results: At the end of the 27-year period of historical returns ( ), Account D has a final liquid value of $546,200. (See Table VI.) However, the beneficiary value, for example, at the end of the early years of retirement is significantly higher versus Account C. (Results for all time periods are shown in the Appendix.) See Table V and Chart IV on the next page for comparisons at the end of selected periods. 12

15 Table V Comparison of Liquid Value and Beneficiary Value Between Accounts C and D at End of Selected Periods After 10-Year Period ( ) After Life Expectancy Period ( ) Liquid Value Beneficiary Value Liquid Value Beneficiary Value Account C $127,730 $127,730 $522,839 $522,839 Account D $89,365 $164,696 $381,007 $400,797 Chart IV Comparison of Beneficiary Value Between Accounts C and D from Laddered Annuity and Beneficiary Protection Cases Beneficiary Value (Nominal $) $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 $164,696 $127,730 $522,839 $400,797 Certain Period Life Exp ectancy $609,885 $455,067 1/1/80 12/31/85 12/31/90 12/31/95 12/31/00 12/31/06 Account C Account D Certain Value (D)* This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. *Certain Value (D) included in the Beneficiary Value for Account D represents the present value of income payments remaining to the end of the 20-year certain period, which may optionally be available as a lump sum upon the death of the annuitant. 13

16 Table VI and Chart V below summarize results of the Beneficiary Protection Case at both the end of the historical period and the end of life expectancy period. (Results for all time periods are shown in the Appendix.). Table VI Comparison of Liquid Value and Total Account Value Between Accounts A and D at End of Selected Periods After Full Historical Period After Life Expectancy Period ( ) ( ) Total Account Total Account Liquid Value Value Liquid Value Value Account A $489,346 $489,346 $391,373 $391,373 Account D $546,200 $588,729 $381,007 $442,498 Chart V Comparison of Liquid Value Between Accounts A and D from $800,000 $700,000 Beneficiary Protection Case Cross over Liquid Value (Nominal $) $600,000 $500,000 $400,000 $300,000 $200,000 $391,373 $381,00 7 Account D $546,200 Account A $489,346 $100,000 $0 Life Expectancy 1/1/80 12/31/85 12/31/90 12/31/95 12/31/00 12/31/06 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. Beneficiary Protection Case Analysis When investors are concerned about meeting both personal income goals and legacy goals with the same pool of money, financial advisors may wish to consider adding a period certain payout to the fixed-income annuity allocation(s). For a married couple, a similar goal could be achieved by selecting a joint-and-survivor annuity payout method. Beneficiary protection is purchased under an income annuity at an extra cost that will impact the performance of the retirement income account over time. However, even when this protection is included, a portfolio that includes a fixed-income annuity allocation can be a reasonable alternative to an account with only a stock/bond allocation investment portfolio. 14

17 Planning Implications IMSD believes that this study demonstrates the potential to design a variety of asset allocation disciplines for the income distribution phase of investors lives. We also believe that income-focused allocation programs may eventually become as sophisticated as those already developed for the asset accumulation phase. As more baby boomers enter their retirement years, perhaps it is inevitable that a variety of incomefocused strategies will be refined in the years ahead some of which may include several new asset classes. As a starting point for further thought, we suggest that the foundation of income allocation should be built on three basic asset classes: (1) U.S. equities, (2) U.S. bonds, and (3) fixed income annuities. Whether the income annuity is purchased with a lump sum at the start of retirement or purchased periodically is a critical decision. These three asset classes, working together, can create a plan that seeks a combination of lifetime income protection, capital preservation, and asset growth potential. The income annuity purchase decision introduces the dynamic planning benefit of gradually increasing the guaranteed income component while avoiding the potentially negative impact of annuity purchases made during adverse interest rate environments. Financial advisors can add value to the retirement income allocation process in several ways: 1. Choosing the right mix of initial asset classes (near the start of retirement) for each of their clients needs. 2. Adjusting or rebalancing the mix of classes for changes in their clients life situations or goals. 3. Guiding the timing of periodic purchase of fixed income annuities included in the allocation program. 4. Including in the allocation program a consideration of each of their clients beneficiary needs, as reflected in the choice of an income annuity, by including either a survivor income benefit or a period certain benefit. 15

18 Study of Retirement Income Account Allocations Among Equities, Bonds and Fixed Income Annuities Supplement No. 1 March 2008

19 Table of Contents Important Information About This Study...S1 Introduction and Objectives...S2 Methodology...S2 Study Returns and Rates over First 5 Years for the Respective Start Date Periods...S3 The Case Studies...S4 S9 10-Year Treasury Note Income Match Case...S4 10-Year Treasury Note Income Match Case Analysis...S6 Life and 20-Year Certain Fixed Income Annuity Match Case...S6 Life and 20-Year Certain Fixed Income Annuity Match Case Analysis...S8 Historical Analysis of 181 Runs Between 1965 and S9 Supplement Study Conclusions...S11 Planning Implications for Advisors...S11 Tables and Charts Table S1 Historical Investment Rates/Returns, Beginning of Years S3 Table S2 Summary Results after 27 Years: Life and 20-Year Certain Annuity Match...S8 Chart S1 Comparison of Historical Investment Rates/Returns, Years S3 Chart S2 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1980)...S4 Chart S3 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1975)...S5 Chart S4 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1970)...S5 Chart S5 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1980)...S6 Chart S6 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1975)...S7 Chart S7 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1970)...S7 Chart S8 Analysis of Cash Flow for Accounts A, B, C, and D (Start Date of January 1, 1970)...S9 Chart S9 Comparison of Liquid Value Results for Each Monthly Start Date from January 1, 1965 to January 1, 1980 for Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case)...S10 Chart S10 Analysis of Liquid Value Crossover Points Account A vs. Account C...S10

20 Important Information About This Study The hypothetical illustrations cited in this study are not representative of the performance of any individual security. Hypothetical illustrations may be useful in indicating one or more possible outcomes, among many possible results. Since past performance and market conditions may not be repeated in the future, and the length of time a person may be in retirement may vary by individual, any person s retirement goals may not be met by following the allocations based on the illustrations. The impact of the timing of investment returns and interest rates can be significant and have a material effect on achieving retirement goals. There is no guarantee that an investor will receive the investment returns illustrated or with the same time sequences illustrated. The impact of inflation has not been reflected in the income results illustrated, nor has the impact of COLA-protected income annuities, since the latter were not available at the start of the study period. Analysis of an investor s purchasing power could result in different conclusions. The methodology underlying this study is based on historical investment returns and is not meant to project performance. Also, the annuity purchase rates are based on historical interest rates and assumptions as to mortality but may not reflect current immediate annuity pricing. Over time, IMSD may change the assumptions and/or the weight given to the economic parameters underlying our model as we take into consideration and analyze additional historical data. Market variables in the future may not perform as they have in the past. If relationships measured by the study vary significantly from what we have assumed, the evaluation of alternative plans may not be accurate. The value of these illustrations may be significantly impacted and the ability of any individual who relies on them to meet retirement goals may be impacted as well. Since the activity modeled in a given illustration has not actually occurred, the results of the illustration may under- or overcompensate for the impact, if any, of certain market factors and may also underestimate the impact of market extremes and the related risk of loss. Other investment categories not considered may have characteristics similar or superior to those being analyzed. S1

21 Introduction and Objectives This is Supplement No. 1 to the Study of Retirement Income Account Allocations Among Equities, Bonds and Fixed Income Annuities: January 1, 1980 through December 31, 2006 (referred to as the Study ) issued in November 2007 by MassMutual Financial Group. The reader should read the Study as well as this Supplement in order to better understand the objectives, methodology, and results of the new case studies presented in this supplement, and the terms and definitions used in the Study and this supplement. After the Study was released, some financial advisors, as well as financial writers, asked what the results of the Study would have been if starting dates other than January 1, 1980 had been chosen, and in particular, during a period of favorable investment market performance at the start, and unfavorable investment performance at the start. In addition, they asked what if income-matching approaches other than matching the cash flow from 10-year Treasury notes had been chosen. The objective of this supplement is to answer the following two questions: 1. Would the Study conclusions have changed if start dates from 1965 to 1980 had been tested? 2. Would the Study conclusions have changed if the withdrawals matched the income from a fixed lifetime income annuity with a 20-year certain period available on the start date? Methodology For these supplemental studies, the results were obtained by matching income from 10-year Treasury notes (as used in the Study). In addition, the income from a fixed income annuity with a 20-year certain period was matched. Annual income is the amount to match and the attempt to sustain it for life. The match amount is either the yield from a 10-year Treasury note or the equivalent of a life and 20-year certain fixed income annuity. Results were obtained at monthly starting dates from January 1, 1965 through January 1, 1980 and represent outcomes for 181 separate 27-year periods. Three of these starting dates are illustrated in this supplement: January 1, 1980 (the start date used in the Study) January 1, 1975 (with a relatively favorable investment performance during the first 5 years) January 1, 1970 (with a relatively unfavorable investment performance during the first 5 years) Historical analysis was performed utilizing the distribution of all 181 outcomes. See the section Historical Analysis on page 9. S2

22 Study Returns and Rates over First 5 Years for the Respective Start Date Periods The first 5 years following the three start dates were markedly different. Generally the performance during the first years following implementation of a retirement income plan has a significant impact on the long-term success of that plan. Table S1 and Chart S1 below show the returns of the S&P 500 Total Return Index (TR) and the Lehman Bros. Aggregate U.S. Bond Index (refer to the section Equity and Bond Returns in the Study for a detailed explanation of these indices), as well as the 10-year Treasury note rates over three 5-year periods: , , and S&P 500 Total Return Index (TR) measures returns in a basket of large U.S. stocks including the reinvestment of dividends. The yield on the Treasury note is the annual effective rate corresponding to the nominal rate. Lehman Aggregate U.S. Bond Index is the U.S. Domestic Bond Index. Table S1 Historical Investment Rates/Returns, Beginning of Years 1-5 Year Commencing January Rate on 10-Year Treasury as of Jan % 6.6% 6.0% 6.5% 7.0% S&P 500 Total Return Index 4.0% 14.3% 13.5% (14.8%) (26.5%) Lehman Bros. Aggregate U.S. Bond Index(*) 14.6% 9.9% 7.3% 3.3% (2.6%) Year Commencing January Rate on 10-Year Treasury as of Jan % 7.9% 6.9% 7.9% 9.4% S&P 500 Total Return Index 37.3% 23.7% (7.3%) 6.6% 18.6% Lehman Bros. Aggregate U.S. Bond Index(*) 14.2% 15.6% 3.0% 1.4% 1.9% Year Commencing January Rate on 10-Year Treasury as of Jan % 12.8% 14.5% 10.6% 12.2% S&P 500 Total Return Index 32.1% (4.9%) 21.1% 22.4% 6.1% Lehman Bros. Aggregate U.S. Bond Index 2.7% 6.2% 32.6% 8.4% 15.1% Chart S1 Comparison of Historical Investment Rates/Returns, Years % 10-Year Treasury 35% Lehman Aggregate U.S. Bond Index* 40% S&P 500 Total Return Index 14% 12% 10% 8% 6% 4% 2% 30% 25% 20% 15% 10% 5% 0% 30% 20% 10% 0% -10% -20% 0% % % Study Year (*) Based on Lehman Long Term Credit before 1976 S3

23 The Case Studies 10-Year Treasury Note Income Match Case This case compares Accounts A, B, C, and D in the Study (refer to the Study for a description of the four Accounts) to answer the following question: What would the results have been if the 10-year Treasury note match studies had begun as of January 1, 1975 and January 1, 1970, as well as January 1, 1980 (the Study start date)? Chart S2 below shows the results for each of the four Account funding strategies used in the Study. The top graph charts the Liquid Value of the Investment Portfolio for each Account over the 27-year period of the Study under the 10-year Treasury note income approach. The bottom graph shows the annual income amounts over the 27-year period. The top graph in each of the charts shows the Liquid Value of the Investment Portfolio for each Account over the 27-year period of the Study. Similarly, the bottom graph displays the annual income amounts at the end of each period. The call-outs in the right margin show the liquid value and the annual income amounts at the end of the study period. Detailed year-over-year illustrations of each of Accounts A, B, C, and D for the 27-year period from January 1, 1980 through December 31, 2006 are contained in the Study. Chart S2 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1980) Value Beginning of Year (Nominal $) Annual Income (Nominal $) $1,000,000 $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 Liquid Value for Accounts A, B, C, and D Age $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account C $735,292 Account B $667,688 Account D $546,200 Account A $489, Yr. Period End Annual Income $6,533 (A, B, C, D) S4

24 Similarly, Chart S3 and Chart S4 below show the results for each of the four Accounts used in the Study assuming the period of study began on January 1, 1975, and January 1, 1970, respectively. Chart S3 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1975) Liquid Value for Accounts A, B, C, and D Value Beginning of Year (Nominal $) Annual Income (Nominal $) $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $ Age $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account B $1,062,158 Account C $1,041,853 Account D $809,221 Account A $738, Yr. Period End Annual Income $7,983 (A, B, C, D) Chart S4 Comparison of Liquid Value Between Accounts A, B, C, and D (10-Year Treasury Note Income Match Case, Start Date of January 1, 1970) Value Beginning of Year (Nominal $) Annual Income (Nominal $) $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $ Age Liquid Value for Accounts A, B, C, and D $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account C $237,786 Account B $138,921 Account A $41,553 Account D $0 27-Yr. Period End Annual Income $8,087 (A, B, C) $8,035 (D) S5

25 10-Year Treasury Note Income Match Case Analysis It is significant to note that by including a fixed income annuity as part of the account, Accounts C and B outperform Account A in all three start dates from a long-term liquidity point of view. In cases of unfavorable market performance, Account A runs out of liquid value and consequently cannot sustain any income, while Account D runs out of liquid value but has substantial annuity income locked in. (This is also borne out in the Life and 20-year certain approach discussed later see Chart S9.) In Chart S4 on the previous page, Account A has a modest amount of liquid value, while Account D ran out of liquid value, just missing its goal of securing $8,087 by $52 and achieving $8,035 payable for life. Life and 20-Year Certain Fixed Income Annuity Match Case This case compares Accounts A, B, C, and D in the Study to answer the following question: What would the results have been if the monthly income produced by a fixed lifetime income annuity with a 20-year certain period had been used as the income match, beginning January 1, 1980, January 1, 1975, and January 1, 1970? Charts S5, S6, and S7 below show the results for each of the four Accounts used in the Study assuming the period of study began on January 1, 1980 (the Study start date), January 1, 1975, and January 1, 1970, respectively. Chart S5 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1980) Value Beginning of Year (Nominal $) Annual Income (Nominal $) $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $ Age Liquid Value for Accounts A, B, C, and D $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account C $437,045 Account B $385,019 Account D $237,964 Account A $234, Yr. Period End Annual Income $11,857 (A, B, C, D) S6

26 Chart S6 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1975) Value Beginning of Year (Nominal $) Annual Income (Nominal $) Liquid Value for Accounts A, B, C, and D $1,000,000 $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $ Age $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account B $842,534 Account C $838,627 Account D $601,177 Account A $596, Yr. Period End Annual Income $9,394 (A, B, C, D) In the case of start date January 1, 1970, the graphs in Chart S7 below show much lower liquid values as well as lower income amounts (except for Account C) at the end of the 27-year period than the other two issue dates. In addition, income payments decrease toward the end of the 27-year period, a reflection of decreasing liquid values and the inability to make up the income match differential (in all cases except for Account C). Chart S7 Comparison of Liquid Value Between Accounts A, B, C, and D (Life and 20-Year Certain Fixed Income Annuity Match Case, Start Date of January 1, 1970) Value Beginning of Year (Nominal $) Annual Income (Nominal $) $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $ Age Liquid Value for Accounts A, B, C, and D $12,000 $9,000 $6,000 $3,000 $0 This example is for illustrative purposes only and does not reflect the performance of any specific investment. Past performance is no guarantee of future results. 27-Yr. Period End Portfolio Value Account C $41,325 Account A $0 Account B $0 Account D $0 27-Yr. Period End Annual Income $9,811 (C) $6,555 (D) $3,270 (B) $0 (A) S7

27 Life and 20-Year Certain Fixed Income Annuity Match Case Analysis The results at the end of the 27-year period for Accounts A, B, C, and D (the case studies in the Study) for each of the start dates (January 1 of the years shown) are as follows: Table S2 Summary Results after 27 Years: Life and 20-Year Certain Annuity Match Liquid Value for Account Values at End of 27-Year Period Annual Income for Account Issue Date A B C D A B C D 1/1/ ,325 3,270 9,811 6,555 1/1/ , , , ,177 9,394 9,394 9,394 9,394 1/1/ , , , ,964 11,857 11,857 11,857 11,857 Lowest Highest The effectiveness of including an income annuity is even more evident with the life and 20-year certain annuity income-matching approach than with the 10-Year Treasury note coupon-matching approach. It may also be instructive to examine the cases with a start date of January 1, 1970, which result in Accounts A, B, and D running out of liquid value. Looking at Chart S8 on the next page, the sources of cash flow have been split into the three components equity component, bond component, and income annuity. Account A is able to match the annual income amount of $9,811 until age 82 before exhausting the account. Account B matches the annual income amount until age 86 before running out of liquid value; however, the initial income annuity that was purchased continues to provide $3,270 annually for life. Account C built up the goal of protecting the full amount of $9,811 after age 74, which amount is payable annually for life, and allows any remaining liquid value to grow undisturbed. Account D, with its period certain beneficiary protection, does not achieve the full income goal by the time the liquid value is zero; however, it built up a locked-in annual income annuity of $6,555 after age 74. Note also that these progressions give further insight as to how the equity component and the bond component were allocated in each Account. S8

28 Chart S8 Analysis of Cash Flow for Accounts A, B, C, and D (Start Date of January 1, 1970) Account A Cash Flow Annual Income (Nominal $) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 Age Account C Cash Flow As if issued 1/1/70 Annual Income (Nominal $) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 As if issued 1/1/70 Account B Cash Flow As if issued 1/1/70 Withdrawal from Equity Component Withdrawal from Bond Component Withdrawal from Equity Component Withdrawal from Bond Component Income from IA $0 Age Annual Income (Nominal $) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 Age Account D Cash Flow As if issued 1/1/70 Annual Income (Nominal $) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 Withdrawal from Equity Component Withdrawal from Bond Component Income from IA Withdrawal from Equity Component Withdrawal from Bond Component Income from IA $0 Age Historical Analysis of 181 Runs Between 1965 and 1980 Monte Carlo Analysis provides for the creation of large numbers of randomized scenarios. Each variable, such as equity return, inflation, interest, etc., is logically randomized within constraints of known models of behavior and experience. From this, a distribution of results ranging from downside to upside can be examined. Simulation Success Rates (SSR) can be established a low rate, say 10%, represents an upside (aggressive) just 10% of results exceed this level; and a high rate, say 90%, represents a downside (conservative) 90% of results exceed this level. Similarly, a distribution of results can be drawn by creating historical scenarios using actual equity returns, interest rates, etc., and by starting on a large number of dates in the past, historical success rates may be established. Chart S9 on the next page shows the end of 27-year period Liquid Value under the Life and 20-year certain income match for every monthly starting date from 1/1/1965 through 1/1/1980. Here, the number of scenarios is 181. It can be seen that Account C produces the highest ending Liquid Value in almost all cases and Account B in a few instances. Account A generally produces the second lowest and runs out of liquidity in a number of cases. Account D produces the lowest Liquid Value in many cases, however, while always having protected a significant portion of the income goal. To read Chart S9, the grid line marked 65 below and 91 above indicates that $100,000 was invested on the issue date as of 1/1/1965, and the Liquid Value as of 12/31/1991 was approximately $240,000 for Account C. S9