Demystifying Drawdowns for Retirees

Diane Somerville & John De Ravin

© Deloitte Consulting Pty Ltd, John De Ravin

This presentation has been prepared for the Actuaries Institute 2018 Financial Services Forum.

The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the

Institute and the Council is not responsible for those opinions.

Agenda

• Background

• Core motivations and needs in retirement

• Guidance around spending

• NZ Retirement Income Interest Group paper

• General considerations

• Criteria for drawdowns

• An idea

Background

• Objective of super is to provide income in retirement

• But Australia is a lump sum, defined contribution environment

• ABPs dominate retirement products

– In due course CIPRs/MyRetirement will become more important (budget covenant) & address part of the issue

• Retirees may not be financially literate yet only a minority seek advice

– How should a retiree invest his or her ABP?

– How much can the retiree(s) afford to spend?

– SIS minimum provides some guidance – but a blunt tool

• How can trustees support decisions about drawdown?

A growing need for retirement solutions

1.00 0.80 0.60 0.40 0.20 0.00 0.20 0.40 0.60 0.80 1.00

Population (Millions)

2012

Male Female

1.00 0.80 0.60 0.40 0.20 0.00 0.20 0.40 0.60 0.80 1.00

Age00-0405-0910-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-8080-8485-8990-9495-99

Population (Millions)

2032

Male

Female

Source: ABS Population Projections – Series B

Old-age dependency ratio will almost double

in the next 35 years

Source: OECD ‘Pensions at a Glance 2017’

Figure 1.1. The old-age dependency ratio will almost double in the next 35 years on average

Number of people older than 65 years per 100 people of working age (20-64), 1975-2050

0

10

20

30

40

50

60

70

80

90

2015 1975 2050

Expected years in retirement (2016)

Source: OECD ‘Pensions at a Glance 2017’

France

Belgium

Italy

Greece

Austria

Spain

Poland

Canada

Australia

Netherlands

Switzerland

United Kingdom

Germany

OECD

Denmark

Norway

Sweden

Japan

United States

New Zealand

Iceland

Chile

Note: Effective retirement age shown is for five year period 2011-16. Pensionable age is shown for 2016.

Panel A. Expected years, women, 2016 Panel B. Expected years, men, 2016

Source: OECD estimates based on the results of national labour force surveys and the European Union Labour Force Survey. Life expectancy estimates are calculated from United Nations Population Prospects: 2017 Revision.

60.0

61.3

62.1

62.0

62.0

62.2

62.6

65.9

65.2

63.5

66.0

64.6

63.3

65.1

63.7

66.2

65.8

70.2

66.8

68.4

69.7

71.0

23.6

21.3

21.8

20.6

21.0

21.5

17.5

18.9

19.6

19.9

19.0

19.3

19.5

18.1

19.1

18.1

18.7

15.5

17.2

16.7

15.9

13.7

83.6

82.6

83.9

82.6

83.0

83.8

80.2

84.8

84.8

83.4

85.0

83.9

82.8

83.1

82.8

84.4

84.5

85.6

84.0

85.1

85.6

84.6

55 60 65 70 75 80 85 90

60.3

59.7

61.3

60.2

60.6

62.6

59.8

63.1

63.6

62.3

64.3

63.2

63.2

63.6

63.1

64.4

64.6

68.8

65.4

66.4

67.2

67.2

27.6

26.1

25.6

25.5

25.4

25.3

24.4

23.9

23.7

23.6

23.3

22.9

22.6

22.5

22.2

22.0

21.9

21.1

20.6

20.4

19.6

19.5

87.8

85.8

86.9

85.7

86.0

87.9

84.1

87.0

87.2

85.9

87.5

86.1

85.8

86.1

85.3

86.4

86.5

89.8

86.0

86.9

86.9

86.6

5560657075808590

Life expectancy at effective age of labour Years in retirement Effective age of force exit labour force exit

Effective age of Years in Life expectancy atlabour force exit retirement effective age of labour

force exit

A variety of drivers leading to changes in consumer

behaviour

Consumers

Trust (conduct)

Go direct

Self knowledge

Product needs

• What product will suit consumer

needs best?

• Retirement / Longevity/

Insurance

Big data

• Potential asymmetry of

information with the consumer

knowing much more than the

product provider (insurer or

fund)

• The “quantified self” = consumers can now

know much more about their own health

and prospects and this will only increase

• Technology adoption for self-

help, research and social media

connections

• Direct market grows for simpler

products

• What does this mean

for margins?

• Do consumers end up with

appropriate products and

coverage?

• Financial advice experiences

• Reputational risk will continue to

play a big role

A mixture of very different needs for different consumers

at different stages of retirement

“While we found that High Asset consumers

were more likely to be comfortable about

retirement than Low Asset consumers (68

percent versus 41 percent), many consumers

in both asset classes were worried about

retirement. More often than not, the level of retirement preparedness was found to be a stronger indicator of consumer attitudes and behavior than relative asset level.”

“Mining the Retirement Market”

Deloitte US

There are some common needs to consider

• Products and services that are designed to speak to core motivations create stickier experiences, are more stable in demand and require less customisation in delivery

Health Wealth Happiness Legacy• Do I have specific

illnesses or care requirements?

• What are my forecasted annual health costs?

• Am I active in preventative health management?

• Is aged care in my current plans?

• Are my retirement savings adequate?

• How dependent will I be on a pension?

• Have I optimised my investment portfolio?

• What role will my property/s play?

• Will I need money before my super is available?

• How do I want to spend my retirement?

• How do I explore new hobbies and experiences as I change life stages?

• Do I have dependents, parents or siblings I want to care for?

• What do I want to be remembered for?

• How do I connect with my community now that I am not working?

No ‘one size fits all’

• A range of sources for financial and other solutions

Drawdown “rules of thumb” from NZ1

1”Decumulation options in the NZ market: how rules of thumb can help”, Christine

Ormrod & Retirement Income Interest Group, November 2016.

Rule of Thumb Critique

6% rule: 6% of F(t) No recognition of asset allocation; no

recognition of age; volatile

4% rule: 4% of F(0)*CPI(t)/CPI(0) Stable but runs risk of running out of

funds OR significant under-spending

Fixed date rule: 1/(N-t) * F(t) Assets expire after N years; volatile

Life expectancy rule:

F(t)/e(x+t)

No recognition of interest earnings;

volatile

Considerations (situation of client)

• Client attitude to consider some reduction in spending as age

increases

• How much spending flexibility (wants vs needs)

• Drawdown rate not an issue for clients who live off real

investment return

• Time preferences of individuals: more spending now, or later

• Allow for demographic and financial circumstances of client including intended bequests, gifts, inheritances, one-off expenses

• Consider aged care needs (RAD/DAP)

Considerations (assumptions for calculations)

• How will client invest?

– More aggressive asset allocation ➔ higher return (& risk)

• Need to assess likely real investment return

• Allow for assumed mortality improvements

• To what survival percentile should the client be assumed to

survive?

• How should the client address longevity risk?

• Should an immediate or deferred annuity be part of the plan?

Considerations (complexity of means testing)

• Targeting stable real spending is difficult for those with assets

within the asset testing range (or just above)

– Ignoring the age pension produces significant increases in

total income as assets diminish

– However it is difficult to predict the extent to which this will

happen & hence allow for future age pension entitlements

• How to respond to age pension means testing incentives

– EMTRs are very high in certain asset ranges

– Strong incentives to adopt strategies to maximise age

pension entitlement

Possible Approaches

• Academic approach: optimise the PV of expected future utility from consumption expenditure

– Requires a utility curve – would be necessary to ensure that these curves could be robustly and stably estimated

• Stochastic approach: for example, “what expenditure can I sustain in real terms, with 90% probability?”

– Take probabilistic approach to investment returns, survival, possibly health status or aged care needs

• Deterministic approach: use an explicit formula based on “central estimate” assumptions for each relevant variable

• Update calculated drawdown regularly (control cycle)

Smoothing the more volatile approaches

• Spending will be volatile if proportional to beginning of year

assets unless constrained

• One possible constraint: smooth asset values

• OR adopt a rule limiting real spending increases or decreases

– Spend(t) = F(t)/a(x+t,r)

– Subject to 0.95*Spend(t-1)≤Spend(t)≤1.05*Spend(t-1)

– Where F(t)=balance of funds at beginning of year t

– a(x+t,r)= annuity factor for retiree originally aged x, after t years, at real interest rate r

– Spend(t)=permissible real expenditure in year t

An app for guidance

• Guidance on an appropriate level of drawdown

• Aid to retirees and those approaching retirement

• Allow for assumed mortality improvements

A simple account-based pension example

• Member inputs: retirement age, gender, retirement balance,

risk appetite, relative health

• Solve for payout

– Capital runs out at end of life expectancy (not before or

after)

– Constant real value of payouts

– Subject to legislative minimums

TRUE Re-Calculate

Member Inputs:

Gender (M, F) M

Current Age 60

Retirement Age 65

Retirement Balance $1,500,000

Life Expectancy Decile (1 to 10, i.e. shortest to longest; Average) A

Investment Risk Appetite (Low, Medium, High) M

Desired Annual Withdrawal Amount $50,000

Output:

Life Expectancy Age 87

Age at which funds run out under desired withdrawal (subject to minimum) >100

Supportable Annual Withdrawal @ Current Dollars; Investment Scenario = Best-estimate $76,160

Re-Calculate

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

65 67 69 71 73 75 77 79 81 83 85 87

ANNUAL WITHDRAWALSDesired/Minimum Withdrawal Desired Withdrawal 'Optimal' Withdrawal

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

65 67 69 71 73 75 77 79 81 83 85 87

ACCOUNT BALANCEDesired/Minimum Withdrawal 'Optimal' Withdrawal

A simple account-based pension example (ctd)

TRUE Re-Calculate

Member Inputs:

Gender (M, F) M

Current Age 60

Retirement Age 65

Retirement Balance $1,500,000

Life Expectancy Decile (1 to 10, i.e. shortest to longest; Average) A

Investment Risk Appetite (Low, Medium, High) M

Desired Annual Withdrawal Amount $100,000

Output:

Life Expectancy Age 87

Age at which funds run out under desired withdrawal (subject to minimum) 81

Supportable Annual Withdrawal @ Current Dollars; Investment Scenario = Best-estimate $76,160

Re-Calculate

0

20,000

40,000

60,000

80,000

100,000

120,000

65 67 69 71 73 75 77 79 81 83 85 87

ANNUAL WITHDRAWALSDesired/Minimum Withdrawal Desired Withdrawal 'Optimal' Withdrawal

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

65 67 69 71 73 75 77 79 81 83 85 87

ACCOUNT BALANCEDesired/Minimum Withdrawal 'Optimal' Withdrawal

A simple account-based pension example (ctd)

Future enhancements

• Consumer-oriented digital solution

• Include age pension

• Factor in non-super savings and investments including family home

• Allow for both members of a couple

• Other retirement income products – deferred annuities, lifetime annuities, group self-annuitisation products

• Allow for potential aged care costs

• Stochastic modelling

➔ Holistic view of retirement income

Questions & Discussion