Introduction to Financial Planning Tools

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Introduction to Financial Planning Tools

  1. 1. Insurance and Actuarial Advisory Services August 5, 2006 Introduction to Financial Planning Tools 2006 IABA Annual Meeting
  2. 2. Agenda • Financial Planning Tools Overview • Focus on the Retirement Planning Market • The New Planning Paradigm • The Actuary’s Role • Questions 2 August 5, 2006
  3. 3. Financial Planning Overview 3 August 5, 2006
  4. 4. Circle of Life (Financial Planning Style) Initial Meeting Gather Information Annual Check-up Perform Analysis Create Action Plan Financial Planning Tools Drive the Analysis, Hence the Action Plan 4 August 5, 2006
  5. 5. Key Planning Events • Key events individuals typically plan for – Purchase of home – Children – College – Retirement – Death • Different tools for each event Retirement planning currently incorporates the simplest advice and tools 5 August 5, 2006
  6. 6. Focus On the Retirement Market 6 August 5, 2006
  7. 7. Understanding the Current Basis for Analysis of Retirement Plans • “Retirement Planning Software” – LIMRA, SOA, INFRE, a 2003 report • “Retirement Income: Positioning for Success” – Cerulli Associates, a 2005 report • “The Forrester Wave™: Financial Planning Software, Q2 2005”, a 2005 report 7 August 5, 2006
  8. 8. The Baby Boomers are Coming • 77 million baby boomers – The leading edge of the wave is turning 60 – Behavioral finance says they will be different • Consumption oriented • Goal oriented • More income • More debt • Three distinct groups – Low Wealth – Middle Wealth – High Wealth 8 August 5, 2006
  9. 9. An Uncertain Retirement Market • Individuals are on their own – Defined benefit plans – 401(k) – Social Security • Expected lifetimes increasing • Uncertain financial markets 9 August 5, 2006
  10. 10. During the Accumulation Phase • Goal: Save $X by age Y • Planning Assumptions – Contribution rate – Investment returns • Simplified assumptions are ok – Time is on your side • Worse case scenario – work an extra year 10 August 5, 2006
  11. 11. During the Decumulation Phase • The standard goal: Never run out of money • Current Planning Assumptions – Investment Returns – Time Horizon – Inflation – Expenses • Currently simplified assumptions • Worse case scenario – who knows? 11 August 5, 2006
  12. 12. The Proof is in the Pudding • The “silent” retired received this advice – Retired in the mid-1990s – Advice and planning consisted of • Individual investments (perhaps) • Asset allocation (more likely) • Recommended withdrawal percentage (most definitely) – First, suffered through market turmoil from 1999 • Asset base was halved – Then, advised to reduce withdrawal rate by more than half to the current “safe” level of 4%! “Planning” like this fails to add value 12 August 5, 2006
  13. 13. The Majority of Planning Tools Remain Rooted in Accumulation Thinking • Investment risk is THE major risk considered • Other risks are treated simply or ignored • Target dates and amounts are the focus • “Yes/No” answers • Single solution A “Safe” Withdrawal Rate Remains the Typical Strategy Continued… 13 August 5, 2006
  14. 14. The Majority of Planning Tools Remain Rooted in Accumulation Thinking • Some tools still – Use fixed rates of return and inflation • Virtually all tools – Pick a planning horizon or a specific age of death – Fail to consider the impact of lifestyle or health – Fail to consider order of death risk • Even the best tools fail to reflect – Catastrophic health risks – Product performance 14 August 5, 2006
  15. 15. The New Planning Paradigm 15 August 5, 2006
  16. 16. The New Planning Paradigm Will Recognize Risk Appropriately • Mortality Risk – Order of death – Longevity A good retirement planning tool • Investment Risk – Market Risk addresses all of – Interest Rate Risk these risks, as well • Inflation Risk as solutions to mitigate them. • Health Care Costs • Long-term Care Costs “Retirement Planning Software” – LIMRA, SOA, INFRE, a 2003 report 16 August 5, 2006
  17. 17. Retirement Analytics™ Demonstrates that “Other” Risks Need to be Recognized Projected Retirement Plan Success Rates 100% 100% 87% 90% 80% 70% 65% 55% 60% 50% 40% 30% 20% 10% 0% Plan to Life Reflect Variable + Variable Expectancy Market Risks Mortality Health Care Costs 17 August 5, 2006
  18. 18. Key Tenets of an Effective Platform in the New Paradigm • Holistic in Nature – Wealth – Needs – Risks • Realistically captures the elements of risk related events – Timing, likelihood, and severity of the risks • Provides a true decision-making framework • Agnostic • Allows for product demonstration NOT illustration 18 August 5, 2006
  19. 19. Product Illustration vs. Value Demonstration • Traditional sales illustration not adequate • Need to show how consumer is better off, or not, with a specific product • Need to show how multiple products/strategies/solutions can interact 19 August 5, 2006
  20. 20. Traditional Sales Illustration - Longevity Age Cash Flow • Illustration of cashflows 65 $ (58,000) 66 $ - • Measure of value typically 67 $ - IRR 68-82 – To age 85 – 0% 83 $ - – To age 95 – 8% 84 $ - – To age 105 – 9% 85 $ 35,000 86 $ 35,000 • A difficult sell – IRR to 87 $ 35,000 expected lifetime is 0% 88 $ 35,000 89 $ 35,000 90 $ 35,000 91+ $ 35,000 20 August 5, 2006
  21. 21. Value Demonstration - Longevity • Demonstration of Value • Measure of value: – Success rate – Estate value at death – Shortfall Measures • Ability to show multiple strategies and solutions 21 August 5, 2006
  22. 22. Value Demonstration - Longevity • Female – age 65 • $500,000 Conservatively invested • Initial income goal of $25,000 (5% SWP) • Company offering longevity insurance - $35,000 kicking in at age 85 – cost $58,000 Longevity - 5% SWP Longevity Aggressive Success Rate 65% 73% 82% Estate @ Death $ 268,061 $ 240,800 $ 588,459 Total Average Shortfall $ 294,296 $ 101,408 $ 139,799 Years of Shortfall 6 8 9 Shortfall Per Year $ 47,570 $ 15,208 $ 18,492 22 August 5, 2006
  23. 23. The Actuary’s Role 23 August 5, 2006
  24. 24. The Actuary’s Role • Risk Champions • Tool Selection • Product Development and Marketing 24 August 5, 2006
  25. 25. Why Actuaries? • Unique knowledge for modeling: – Mortality risk – Catastrophic health risk • Ability to design, utilize products to mitigate risks • Need to bring risk management techniques to these individuals 25 August 5, 2006
  26. 26. Summary • Current financial planning tools for retirement are not adequate – Simplified, if any approach to key retirement risks – Lack of product integration with planning • Good financial planning tool – Holistic – Demonstrate value of products/solutions/strategies – Directly compares strategies – Provides information used to make decisions • Actuaries must act to help their companies capture the opportunity. 26 August 5, 2006
  27. 27. Questions For More information contact: Chad Runchey chad.runchey@ey.com 27 August 5, 2006
  28. 28. ERNST & YOUNG LLP Retirement Analytics™ offered for sale by: ©2005 Ernst & Young LLP. ERNST & YOUNG PRODUCT SALES LLC All Rights Reserved. 1559 Superior Avenue Ernst & Young is Cleveland, Ohio 44114 a registered trademark. (800) 726-7339 © 2005 Ernst & Young Product Sales LLC www.ey.com www.eypsllc.com

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