Retirement provision in scary markets : introduction / Hazel Bateman - Who's Afraid of the Big Bad Bear. Most of the contributing chapters were at the 'Retirement Provision in Scary Markets' conference held in Sydney, Australia, in July 2003.
VULNERABILITY TO SCARY MARKETS
However, the movement in the consumer price index, the indicator responsible for determining the real value or purchasing power of pension savings, appears more frightening, from a maximum of 2948 per cent. per year in Brazil in 1990 to a low of -1.0 per cent. per year in Japan in 2002. However, it is also argued that this will be offset by increased savings elsewhere in the world.
STRUCTURE OF THE BOOK
Two questions are considered – the impact of financial market scares on labor supply and the impact of labor market scares on retirement income adequacy. The next two chapters are about the impact of scary markets in the retirement/decumulation phase.
CONCLUDING COMMENTS
Brazilian pension reforms are very similar to those taking place in the US, UK and Australia. However, unlike these countries, the Brazilian pension reforms are taking place against a background of extraordinary macroeconomic volatility and uncertainty.
NOTES
In this chapter, Flávio Rabelo introduces the current Brazilian pension system and discusses the proposed reforms, while highlighting the major difficulties associated with pension reform in a volatile and developing economy.
Who’s afraid of the big bad bear?
Or why investing in stocks for retirement isn't scary, and why investing without stocks is scary.
Ronald Bewley, Nick Ingram, Veronica Livera and Sheridan Thompson 1
INTRODUCTION
Another part of the investment challenge for retirees that is often overlooked by conventional pension plans is the risk of an asset allocation that is overweight fixed interest and other low-yielding investments. In the context of special circumstances and the issue of retirement investments, we consider three relevant questions.
IS THE WORLD MORE SCARY?
This expansion of the sample is particularly important because the Asian crisis occurred in the last few months of Campbell et al. Australian shares experienced losses for a year or more before recovering losses 6 per cent of the time.
IS THERE LIFE WITHOUT EQUITIES?
For a conservative investor who is only willing to bear 6 percent volatility, again, including Australian shares offers less risk for an equivalent return. Despite being the highest risk asset class, we see that even for the most conservative investor, including Australian shares offers significant diversification benefits in terms of lower risk.
WHY ARE RETIREES DIFFERENT FROM OTHER INVESTORS?
So there is a strong case for equities, especially in the early years of retirement, when the portfolio holding period required is longer than in the latter stages of retirement. Intuitively, if returns are negative in the early years, this can dramatically impact the portfolio's ability to support the desired lifestyle for the required period.
DO EQUITIES REALLY ADD VALUE IN RETIREMENT?
For a retiree with a 40 percent allocation to stocks in the first stage, but no distribution in the next two stages, the probability of zero wealth increases rapidly. The probability of zero wealth in the first 15 years of retirement is negligible, regardless of investment strategy.
CONCLUSIONS
A long investment period together with a large fund overcomes potential losses in the equity part of the investment. Regardless of the size of the lump sum available, retirees are estimated to be least likely to outlive their assets if a significant portion of their assets are invested in stocks.
NOTE
Assessing the risks in global fixed interest portfolios
Geoffrey Brianton
CHANGES IN THE BOND MARKETS
Boots in the UK was one of the first to convert their DB fund into bonds in a profile matching their ongoing liabilities. The vast majority of growth in the corporate market was in US dollar-denominated bonds.
CREDIT RISK AND DIVERSIFICATION
In the event that the bond is upgraded, the return is higher than 7 per cent. due to the capitalized value of the improvement in the bond's credit rating. By comparing this expected return with the return for an unchanged BBB bond, an estimate of the expected loss due to the bond's credit risk is obtained.
MACRO AND MICRO CREDIT MANAGEMENT
The Australian market is dominated by the financial sector, which comprises about a third of the total market. The problem faced by a manager looking to add value through stock selection is the aforementioned asymmetric nature of individual bond returns.
CONCLUSION
The role of index funds in retirement asset allocation
David R. Gallagher
These benchmarks enable investors to better understand the risk and return dimensions of the underlying securities that make up the market index. Some of the most well-known index providers include Standard and Poor (S&P), Dow Jones, Morgan Stanley Capital International (MSCI), Russell and FTSE Group.
THE ASSET CLASS SPECTRUM
While the future returns and volatility of asset classes are unknown, historical data provides investors with some insight into the level of returns earned and the risks associated with each asset class.1 Examining historical data helps investors to predict possible future scenarios. To better understand relative returns and risks over different time periods within the estimated 13-year period, Figures 4.1 and 4.2 show the five-year rolling returns and standard deviations for each of the major asset classes.
INVESTMENT VEHICLES AVAILABLE TO INVESTORS
The market value of an ETF is determined relative to the market values of the individual securities that make up the basket. Because ETFs are equivalent to buying or selling a security directly linked to an underlying index, these products represent an alternative to investing in index funds managed by professional investment managers.
THE ACTIVE VERSUS PASSIVE DEBATE
STRATEGIES FOR INDEX TRACKING AND TRACKING ERROR MANAGEMENT
Full replication involves a passive portfolio manager holding each stock in the index in the same weight as the target benchmark index. Stratified sampling relies on estimates of the variances, covariances and correlations of returns for index securities, so that the subset of securities selected in the index-mimicking portfolio will exhibit similar risk/return characteristics to the benchmark.
ISSUES IN INDEX TRACKING AND MANAGEMENT
Another factor likely related to tracking error is the index funds' volatility in pension asset allocation69. Overall, changes in the composition of the index are also expected to cause tracking error.
EXTERNALITIES IN INDEX FUND MANAGEMENT
Retirement wealth and lifetime earnings variability
This chapter extends the literature by focusing on the relationship between household retirement wealth and lifetime income variability of workers. In what follows, we first briefly review previous studies of retirement wealth profiles for older Americans and describe the nature and extent of retirement savings.
PRIOR STUDIES
Third, we explore whether retirement wealth is more strongly related to income variability per se, holding constant other demographic, social, and economic characteristics of workers and their families, and also whether retirement well-being is particularly sensitive to income fluctuations at particular points. in the work life cycle. Finally, we demonstrate how these EV measures are related to measures of retirement wealth, holding constant other socioeconomic factors, health status, and preferences in a multivariate statistical analysis.
DATA, RESEARCH DESIGN AND METHODS
We also show that both EV measures vary by lifetime earnings levels, as proxied by AIME quintiles. In both the symmetric and asymmetric Retirement wealth and lifetime earnings variability 83 Table 5.1 Earnings levels and variability measures for HRS respondents.
EARNINGS VARIABILITY AND RETIREMENT WEALTH
Total wealth: Total family wealth = pension wealth + social security wealth + financial wealth + net housing wealth. Retirement wealth is more sensitive to income variability for unmarried individuals than for married households.
DATA APPENDIX
How have older workers responded to scary markets?
Jonathan Gardner and Mike Orszag
The next section presents a review of the literature on asset allocation and retirement date choice and is followed by an overview of Watson Wyatt's study design.
SCARY MARKETS
This relates to quoted market rates of 11 per cent, 9.2 per cent and 7.7 per cent respectively. In the United Kingdom, investing half the portfolio in bonds would have reduced losses from 42 percent to 25 percent.
OVERVIEW OF THE LITERATURE
They conclude that the asset market boom of the late 1990s resulted in a 3 percent decline in labor market participation among the survey participants. The asset market boom in the US in the late 1990s resulted in returns of more than 20 percent per year.
DATA AND SURVEY
Second, web-based surveys make stronger assumptions about respondents' literacy and technical skills. However, recent evidence has also suggested that web-based surveys provide more accurate reports than a traditional telephone interview (Chang and Krosnick 2003.
WHICH INDIVIDUALS SUFFERED THE MOST?
The average change in the value of savings in the sample is estimated at -17.0%. In contrast, we see no statistically significant difference in the change in savings between those with fixed and those with flexible retirement dates.
HOW HAVE SCARY MARKETS AFFECTED RETIREMENT PLANS?
Financial engineering for Australian annuitants 1
Susan Thorp, Geoffrey Kingston and Hazel Bateman
RETIREMENT INCOME STREAMS: A REVIEW
We then sketch the theoretical framework needed to construct retirement income streams with consumption thresholds. Vested pensions offer flexible income streams, but there are limits on the amount and timing of withdrawals.
THEORETICAL FOUNDATIONS
If the returns are independently and identically distributed, so that Z˜Pand at+1 are uncorrelated, then the investor only looks at the next period when making a decision. Their CPPI decision rule determines exposure to the risky asset at a constant multiple of the marginal value between the current and underlying assets, W – Wˆ.
SIMULATION OF CONSUMPTION AND WEALTH STREAMS
As the time horizon expands, consumer insurance policy becomes more relevant to individuals' portfolio choices. After allowing for random withdrawals from the risky asset allocation, the consumption and wealth paths become sharp, and thus so do the portfolio weights of the HARA investor, whose allocations adjust period by period.
OPTIONS TO DELAY ANNUITIZATION
Smoothing investment returns
Anthony Asher
THE MANAGEMENT OF RISK
Estimates of the long-term real rate of net return range from about 1 percent to 5 percent per year. The first condition would require pay packages to be adjusted for the value of the pension benefits that accrue.
CURRENT METHODS OF SMOOTHING
In the long run, the capital premium means that investing in shares results in lower pension costs. However, they believe that equalization necessarily requires the discretion of the fund management body to ensure fairness and solvency.
A NEW ALGORITHM
The forward price of the asset should therefore be the current market price plus interest for the period. TU–kh must be determined, as it is the number of new units to be awarded with respect to the additional premium.
CREATING ALTERNATIVE INSTRUMENTS
The expected interest rate used would be higher because of the systemic risk involved. This method yields a rate of return somewhat higher than the dividend yield plus the growth rate of the dividend index.
AN ILLUSTRATION
P01* dy0/(Long-term dy) = actuarial value (8.6) The conclusion that can be drawn from this development is that the actuarial value is an approximation of an average of futures contracts. The results do not appear to be particularly sensitive to adjustments in the smoothing term, real returns, or formula.
OTHER ISSUES
Ansett’s superannuation fund: a case study in insolvency
Shauna Ferris
The Ansett case was the first major test of Australia's solvency law and clearly exposes a number of shortcomings in the law. We then tell the story of Ansett's collapse and its impact on the pension fund.
AUSTRALIAN SUPERANNUATION LEGISLATION AND FUND SOLVENCY
Traditionally, many employers (including Ansett) have provided benefits in excess of the minimum required under SG legislation. The vested benefits specified in the fund's trust deed were often significantly higher than the minimum benefits required under SG legislation.
Some may strongly encourage the employer-sponsor to make additional contributions to cover the shortfall as quickly as possible. However, the actuary cannot force the employer to make contributions: he/she only recommends.
Over the next few years, investment returns may improve and employers may make additional contributions - the deficits may disappear. The Ansett Trust was the first real test of the SIS legislation – the first trust to be under actuarial management and the first to wind up under the insolvency regulations.
THE ANSETT GROUND STAFF SUPERANNUATION PLAN
The actuary will become responsible for the fund and draw up a plan to return the fund to solvency within five years. If this recovery plan fails, then the fund will be closed and the assets will be distributed in accordance with the priorities set out in the regulations.
WHAT HAPPENED AT ANSETT?
Shortly thereafter, on April 23, 2001, the actuary wrote to the trustees and pointed out that the fund assets were insufficient to cover the total severance benefits - the shortfall was about $84 million. The actuary reported that assets are now well below vested benefits - the amount of the shortfall is estimated at $76 million.
LEGAL ISSUES
Were the Members Entitled to Retrenchment Benefits ?
Were the members of the fund entitled to retrenchment benefits in terms of the rules of the trust deed. All the previous practices suggested that the dismissed members were entitled to the retrenchment benefits without any special declaration.
Was Ansett Obliged to Make Contributions to Cover the Cost of the Retrenchment Benefits?
Does the Superannuation Fund have Priority over Other Debtors, in Claiming Money from the Fund Administrators?
In fact, about half of the employees overall would be better off if the shop stewards won preference. Justice Warren considered this question: were the pension liabilities incurred by the administrators during their period of administration of the company.
FUTURE DIRECTIONS AND CONCLUSIONS
Pension funds and retirement benefits in a depressed economy: experience
Masaharu Usuki
PENSION PLANS IN JAPAN
Taking duplication into account, the total number of participants in TQPPs and EPFs is approximately 15 million, equivalent to 30 percent of total private sector employment. The difference in coverage between pension plans (30 percent) and all pension benefits (63 percent) means that 33 percent of employees are only covered by severance payments with book reserve funding.
