Growth assets, bonds and annuities finding the right mix? Nick Callil Watson Wyatt Australia

Growth assets, bonds and annuities finding the right mix? Nick Callil Watson Wyatt Australia

Living longer more likely than we think Probability 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 73% chance of 1 member living until 90 Almost 1 in 5 chance of 1 member living until 100 0% 65 70 75 80 85 90 95 100 Female Alive Male Alive At least one alive Assumptions - Base Mortality: ABS Life Tables, Australia 2005-2007; Socio-economic status (SES) allowance: 75% of base rates at age 60 rising to 95% of table at age 100 and over; Mortality Improvement: 25-year improvement factors in Australian Life Tables 2000-02 (Australian Government Actuary) it is the uncertainty of retirement period that makes the retirement problem challenging

Risk of Running out of money ( Ruin ) varying investment strategies 100% 90% 80% High growth allocations more effectively combat longevity risk 70% Probability 60% 50% 40% Investment strategy has little impact here 30% 20% 10% 0% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 101 103 105 90% Growth 50% Growth 70% Growth 30% Growth 0% Growth Assumptions: $500,000 initial account balance; $37,621 pa (indexed) Target Income; Watson Wyatt global asset model stochastic returns; single means tested age pension allowed for

Growth less effective where poor returns strike early in retirement period 100% 90% 80% Adverse : average real 5-year return of -5% pa occurs in the first 10 years following retirement Probability 70% 60% 50% 40% High growth strategy performs worse under adverse conditions 30% 20% 10% 0% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 101 103 105 90% - Normal 90% - Adverse 50% - Normal 50% - Adverse Assumptions: $500,000 Initial account balance; $37,621 pa (indexed) Target income; Watson Wyatt global asset model returns; single means tested age pension allowed for

Investment Strategy can depend on target income (spending) level Risk of Ruin after 25 years Various Asset Allocations (including 30 year lifecycle funds) Various spending strategies (initial spend = x% of account of $500K, indexed thereafter) Probability 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 6% 7% 8% 9% 30% Growth 50% Growth LC70to30 LC70to50 Allocation For lower retirement spending targets, the reward for higher growth allocations is reduced 70% Growth LC90to50 LC90to70 90% Growth

Adding annuities to the mix Consider a retirement portfolio comprising a mix of growth defensive annuities (lifetime, CPI indexed) Critical assumptions annuity pricing what part of invested portfolio does annuity replace?

Current Annuity pricing 70/30 strategy, annuity replaces bonds 90% confidence interval of remaining account balance 600,000 400,000 200,000 0 65 70 75 80 85 90 95 100-200,000-400,000-600,000-800,000 Non-Annuity Annuity Mean - Non-Annuity Mean - Annuity Assumptions: $500,000 Initial account balance; $37,621 pa Target income; 70% Growth, 30% Bonds/Cash or Annuities Current annuity pricing: $4,900 per $100,000

Compulsory world pricing 70/30 strategy, annuity replaces bonds 90% confidence interval of remaining account balance 600,000 400,000 200,000 0 65 70 75 80 85 90 95 100-200,000-400,000-600,000-800,000 Non-Annuity Annuity Mean - Non-Annuity Mean - Annuity Assumptions: $500,000 Initial account balance; $37,621 pa Target income; 70% Growth, 30% Bonds/Cash or Annuities Compulsory world pricing: $6,900 per $100 K

Compulsory world pricing 70/30 strategy, annuity replaces equities and bonds 90% confidence interval of remaining account balance 600,000 400,000 200,000 0 65 70 75 80 85 90 95 100-200,000-400,000-600,000-800,000 Non-Annuity Annuity Mean - Non-Annuity Mean - Annuity Assumptions: $500,000 Initial account balance; $37,621 pa Target income; 70% Growth, 30% Bonds/Cash versus 50% Growth, 20% Bonds/Cash, 30% Bonds/Cash or Annuities Under this approach, the non-annuity portion of the portfolio is invested 70/30 (rather than 100% growth)

Observations Value of adding an annuity increases as retiree lives longer Annuity as defensive asset increases growth exposure over time Annuity pricing is critical

The future of Product Design? NEST EGG 1/3 1/3 Pensions/ Annuities 1/3 Mutual Funds & Managed Accounts Sequence of Returns Protection Source: Adapted from Moshe A. Milevsky

Limitations of reliance Watson Wyatt has prepared this presentation for general information and education purposes only. No action should be taken based on this document as it does not include any detailed analysis into your own scheme specifics. This document is provided to the recipients solely for their use, for the specific purpose indicated. This document is based on information available to Watson Wyatt at the date of the document and takes no account of subsequent developments after that date. It may not be modified or provided to any other party without Watson Wyatt s prior written permission. It may also not be disclosed to any other party without Watson Wyatt s prior written permission except as may be required by law. In the absence of our express written agreement to the contrary, Watson Wyatt accepts no responsibility for any consequences arising from any third party relying on this document or the opinions we have expressed. This document is not intended by Watson Wyatt to form a basis of any decision by a third party to do or omit to do anything. Please note that investment returns can fall as well as rise and that past performance is not a guide to future investment returns.

The sequence of returns matters Both scenarios (25 years): Mean return: 9.5% pa CPI = 4% pa 25 Year Decumulation Phase: Year-end account value (Spending = 9% of initial balance, CPI indexed) 400% 300% Year End Account (mult of initial bal) 200% 100% 0% -100% 65 70 75 80 85-200% -300% -400% March 1931 " April 1984

Ruin and Inadequacy 45,000 40,000 Target Income Level, 37,621 $ 35,000 30,000 25,000 20,000 Ruin: where assets depleted, only income is age pension Inadequacy: where income falls below pre-specified adequate level Adequate Income Level, 19,450 15,000 10,000 5,000 0 65 70 75 80 85 90 95 100 Pension Annuity Account Based Pension