Monthly Archives: March 2010

The future of retirement

The American Academy of Actuaries announced the program for its 2010 Enrolled Actuaries Meeting, April 11-14, in Washington, D.C.

Over 60 sessions will be held, covering everything from the Pension Protection Act (PPA) to fiduciary responsibilities to minimum funding and benefit restrictions.

The meeting features a special general session, “The Future of Retirement (or Where Will We Be in 2030),” on April 14 at 11:15 a.m. Veteran policy experts will discuss retirement issues and provide some insider perspective on future retirement policy. Panelists include Frank Todisco, Senior Pension Fellow, American Academy of Actuaries; Phyllis C. Borzi, Assistant Secretary of Labor for Employee Benefits Security, U.S. Department of Labor; Judy A. Miller, Chief of Actuarial Issues, American Society of Pension Professionals; and Stephen C. Goss, Chief Actuary, U.S. Social Security Administration.

Longevity risk

Noel Abkemeir, principal and consulting actuary with the Chicago office of Milliman, thinks Benjamin Franklin got it half right when he wrote that nothing is certain but death and taxes.

“That was in the 18th century,” Abkemeir writes in a recent article about annuities. In the 21st century, nothing is certain but longevity and taxes.

As he points out, although longevity is a known financial risk, it’s not very well understood. We tend to reduce it to “average life expectancy” in retirement planning, and therein lies the problem.

“Planning only though life expectancy is like pretending that longevity does not exist.” In fact, longevity “begins at life expectancy”—the risk is that an individual will live longer than average.

Moreover, purchasers of annuities tend to be healthier, and live longer, than the general population. And we’re adding about 1.5 years of life expectancy every year to the general mortality rate. Don’t overlook the possibility for significant life-extending medical breakthroughs, either.

Retirement planning needs to take into account both the possibility that someone will live a long time and the uncertainty of just how long that will be.

Abkemeir, who specializes in the design and pricing of annuities and life insurance products, thinks annuities can address longevity risks in market segments, particularly high-income retirees who show mortality as much as one-third lower than purchasers of small annuities, according to research published by the Society of Actuaries. Consequently, their planning horizon is about three years longer.

How best to manage longevity risk? Abkemeir outlines a few annuity-based approaches that can address the longer-term need for income among higher income clients.

Is there life after retirement?

Declining house values as well as deep losses in the stock markets—two major components of wealth for the average American—have jeopardized the retirement plans of many people. Now that economic recovery seems to be underway, the regulatory authorities are beginning to assess the need for financial reform, especially as it relates to retirement security.

Consequently, the federal Labor and Treasury departments have just issued a wide-ranging call for information, the language of which suggests the scope and intention of the effort:

. . . to solicit views, suggestions and comments from plan participants, plan sponsors, plan service providers and members of the financial community, as well as the general public, to assist the Agencies in evaluating what steps, if any, they could or should take, by regulation or otherwise, to enhance the retirement security of participants in employer-sponsored retirement plans and IRAs by facilitating access to, and use of, lifetime income or other arrangements designed to provide a stream of lifetime income after retirement.

In particular, the feds are wondering “what explains the low usage rate of lifetime income arrangements” and are there peculiar traits to these financial instruments—too much complexity, expensive management fees, etc.—that drive people away from them.

These regulatory efforts will certainly affect life insurers and others who make and market guarantee financial products, such as annuities, as well as the millions of consumers seeking added security and stability for their retirement investments.

Three recent articles on the Milliman website—highlighted in past blog entries—speak directly to the challenges facing the life insurance industry, especially in light of the scrutiny by federal agencies like Labor and Treasury.

Risky business

If the past two years have taught us anything, it’s that human behavior doesn’t always conform to mathematical formulae and projections, especially in complex and dynamic environments like global finance. Consequently, as companies move towards risk-based solvency capital more accurate modeling of the extreme behavior of the enterprise can translate into real capital benefits.

In “Keeping it Simple” (login required), appearing in InsuranceERM, London-based Milliman actuary Neil Cantle makes a convincing case for simple agent-based approaches for modeling complex financial behaviors.

He finds that because “model complexity and run-time are in constant tension,” behavior-based approaches that aim to realistically model the features of business portfolios also tend to increase calculation time, mainly because of their complexity.

A solution may lie in agent-based models, which can model complex behaviors by using very simple rules.

As Cantle points out, the concern to account for all factors and forces may actually produce a paradoxical effect.

 “There is possibly an irony in the fact,” Cantle concludes, “that the future direction of modelling into behaviour-based approaches . . . will actually require us to make the structure of the models simpler in order to study more complex behaviors!”

Hedging the individual investor

Ken Mungan, Milliman’s Financial Risk Management practice leader, is quoted extensively in an article about Milliman’s customized hedging strategies for individual accounts, in the March 16 edition of Retirement Income Journal (access to the entire article requires login).

“We’re seeing the emergence of a client account on a platform with a protection strategy that would contain hedge aspects,” according to Mungan. “So many people have withdrawn from the market. This would give them protection.”

Milliman’s new service is driven by three factors: the failure of diversification during the recent global financial crisis, low bond returns, and the need for Baby Boomers to invest in equities in order to make up for their failure to save enough for retirement.

Mungan explains that Milliman’s approach offers investors a middle path—between advisory services with unprotected portfolios and complete market exposure, on one hand, and variable annuities with living benefits, on the other. Individual investors can participate in uncomplicated hedges that protect against severe downturns without abandoning gains if markets rise. It’s an approach uniquely suited to investors with anxieties about entering a volatile equities markets still feeling the effects of the recent financial crisis.

Does this service compete with some of Milliman’s traditional clients, such as insurers offering VA products?

Not really. In fact, Mungan thinks Milliman’s approach will actually create new business for insurance companies—by increasing the demand for unbundled living benefit riders, aka stand-alone living benefits (SALBs).

More details on the approach can be found at “Overcoming challenges through portfolio protection” on the Milliman website, an article Mungan co-authored with his Chicago colleagues Ghalid Bagus and Matt Zimmerman (who is also quoted in the RIJ article).

“Retirement security” for the neXt generation

All the focus on Boomer angst about retirement in the post-financial crisis world tends to overshadow the dilemmas faced by members of Generation X, those born between 1965 and 1980.

The financial crisis, the Great Recession, and the potential for a career-crippling  jobless recovery have exacerbated the problems of this key demographic, who are already confronting a future without pensions, a sure-to-be-changed social security system, increased taxes, and mountains of personal debt.

Throw in an increasing life expectancy—not to mention the financially depressed circumstances of their parents (and how that will affect inherited wealth—see the blog entry “Prescription for Disaster”)—and you have the ingredients for an actuarial nightmare that asset managers and financial advisors of all stripes will need to confront.

In fact, a recent article in—a major source of information for this crowd—is actually saying that the old prescriptions were wrong; the neXt generation is going to need to put away a lot more than $1 million dollars to live reasonably well in retirement (think $3 million in some cases).

And this at a time when real growth probably won’t return to the Boomer-fueled economic expansion of the past 30 years.

Among other things, these factors are going to redefine what constitutes “retirement security” for this generation.

The expectation that more money is needed than previously expected, reinforced by neXt Generation authorities like, will dictate how financial providers and advisors adapt traditional investment instruments such as variable annuities and other guarantee products to address the unique challenges of Generation X-ers.

Financial management in a changed (and changing) world

Even before things went sour in the financial markets, individuals were having to take on more responsibility for planning and funding their own retirements.

The decline of defined benefit (DB) pensions over the past two decades—and corresponding rise in 401(k)-type retirement savings programs—has been accompanied by an explosion of financial planners, planning tools, and products, all aimed at helping individual investors navigate an increasingly complex financial marketplace.

Ken Mungan, Ghalid Bagus, and Matt Zimmerman, from Milliman’s Financial Risk Management practice, discuss new approaches to risk management that help overcome challenges for portfolio protection in the post-global financial crisis environment.

Risk management based on asset diversification has been central to these innovations.

However, as the authors point out, traditional asset diversification failed to mitigate the effects of a financial marketplace where most asset classes declined simultaneously. Clearly, financial advisors need  new risk management protection strategies that “involve assembling and managing a portfolio of hedge assets tailored to each client’s investments.”

Such an approach seeks to counteract the natural tendency of the average investor to buy high, when the market is strong, and to sell low, after significant market decline, which, of course, plays havoc with investment returns.

The authors detail a strategy that reduces risk and enhances the overall value of an investment portfolio by locking in gains from underlying investments and harvesting gains from the hedge portfolio during severe market corrections.

Managing mortality

How does volatility in future mortality assumptions affect the valuation of life contingent liabilities?

That’s the question Stewart Silverman, a principal and consulting actuary in the New York office of Milliman, sets out to answer in “Risk Factors: Managing Mortality Risk.”

Life insurers have been focusing on economic factors, and rightly so given the state of the global economy. But, as Silverman points out, this focus “may have caused many insurers to lose sight of the emerging mortality and longevity risks on their books.”

In the future, however, that risk is likely to grow—people are living longer, leading better lives, and enjoying the benefits of technological innovation in healthcare. Insurers would be well advised to prepare for its influence.

After reviewing the roots of volatility—inappropriate assumptions and difficulty in predicting improvements in mortality brought on by improvements in technology and lifestyle changes—he focuses on how the stochastic analysis that insurers now use to understand asset risk offers similar potential for managing mortality and longevity risks.

More important than the simple fact that life span is increasing, however, is “the fact that the huge strides in longevity over the past 50 years occurred in fits and starts.”

It’s the uneven nature of the improvement in longevity that poses the greatest threat to cash-flow patterns for insurers and financial servicers.

After the fall: Toward sustainable guarantee products

The increasing popularity over the past decade of all kinds of financial products that guaranteed a return—variable annuities with investment guarantees, equity-indexed annuities, structured notes, and the like—was based on the idea that they could offer investors upside participation when equities rally while limiting downside losses when markets decline.

Well, along comes the global financial crisis and providers of these products discovered their promises were unsustainable—they were trapped between record low interest rates and historically high volatility.

That conundrum, according to Ghalid Bagus, a principal and financial risk management consultant in the Chicago office of Milliman, brought to the fore issues most investors tended to gloss over in better times—illiquid guarantees, exposure to the provider’s credit risk, and lack of transparency.

Bagus believes that it’s possible to design sustainable guarantee products if investors, not providers, own the hedge assets. The investor can liquidate the hedges they own at any time, credit risk can be mitigated through use of exchange-traded hedges (where margin requirements can help restrain risk), and investors can see the hedges they own as well as the risks being hedged.

Prescription for disaster: Lack of readiness for retirement meets market volatility

Even before the global financial crisis and Great Recession, few Americans were financially prepared for retirement.

In the most recent Employee Benefit Research Institute’s Retirement Confidence Survey, 43% of workers now say they have less than $10,000 in savings. That’s up from 39% in 2009.  Workers with less than $1,000 jumped to 27% from 20% in 2009. And, predictably, 2009 saw fewer workers actually saving for retirement—down from 75% to 69%.

Most alarming: “In total, more than half of workers (54 percent) report that the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000.”

Given the current housing market, including the value of their primary home wouldn’t help much anyway.

The survey found that only 46% of workers have actually tried to calculate what they need for a comfortable standard of living in retirement.

No surprise there. The average American investor—already behind the eight ball—is probably worrying more about staying clothed, housed, and fed.

Still, the survey is yet another piece of evidence of the looming crisis as nearly 80 million people move into retirement over the next decade or so.