LIVING ANNUITY CRISIS: FACT OR FICTION? Hamilton van Breda March - PowerPoint PPT Presentation

LIVING ANNUITY CRISIS: FACT OR FICTION? Hamilton van Breda March 2018 CONSISTENCY IS THE ONLY CURRENCY THAT MATTERS. Explore more at consistency.co.za

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IS THERE A LIVING ANNUITY CRISIS? Fees Longevity Investment returns Investor behaviour 60 60 100 100 60 100 Years old Years old Source: Prudential Investment Managers Slide 3

Typical scenario for “Silent Generation” & “Baby Boomers” 12 YEARS 47 YEARS 19 YEARS Education Employment Retirement Investment Phase Withdrawal Phase 0 18 18 65 65 84 84 LIFE Years Years old Years old Years old old INVEST : WITHDRAWAL RATIO = 2.47 Source: GenRe; US Social Security Administration Slide 4

Typical scenario for “Generations X & Y” 16 YEARS 26 YEARS 38 YEARS Education Retirement Employment Investment Phase Withdrawal Phase 0 86 86 22 22 60 60 LIFE Years Years Years old Years old old old INVEST : WITHDRAWAL RATIO = 1.46 41% REDUCTION Source: GenRe; US Social Security Administration Slide 5

WHY IS THE RETIREMENT AGE 65 IN MOST DEVELOPED COUNTRIES? Overall life expectancy at birth 90 Japan Australia 80 USA 70 SA Retirement age 60 50 40 30 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: Tim Kastelle (University of Queensland Business School) & Berkeley Demography Slide 6

COUNTRIES BY LIFE EXPECTANCY Male life expectancy at birth Female life expectancy at birth 95 90 93.5 85 88.5 87.8 87.6 86.1 Age 85.3 85.8 85.1 85 85.4 80 85.6 82.3 81.7 81.6 80.9 80.7 80.6 80.3 80.3 75 79.9 70 Monaco Japan Singapore Macau ( China) San Marino Iceland Hong Kong ( China) Andorra Switzerland Guernsey Source: The US CIA published the following life expectancy data in its World Factbook.(2016) Slide 7

SOUTH AFRICA’S IMPROVING LIFE EXPECTANCY Assumptions of expectation of life at birth without AIDS and fertility Male Female 74 72 70 72 72 72 68 71 71 71 71 71 71 70 70 70 70 66 70 69 69 64 62 65 65 65 65 64 64 60 64 64 63 63 63 63 63 62 62 62 58 56 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: STATS SA Slide 8

TYPICAL RETIREMENT PLANNING PARAMETERS

TYPICAL RETIREMENT PLANNING PARAMETERS Reduce Reduced Higher Typical Retirement Planning Base Save drawdown exposure to exposure to Parameters plan more rate growth assets growth assets Pre-retirement investment term 30 30 30 30 30 Retirement savings % 15% 15% 22.5% 15% 15% Drawdown rate 7% 5% 7% 7% 7% Growth rate in retirement 4% 4% 4% 1% 6% (Net Real Return p.a.) Replacement ratio 60% 43% 90% 60% 60% Years to running out of money 21.3 39 21.3 15.8 30.4 Source: Prudential Investment Managers Slide 10

BALANCING THE REAL RISKS 25 20.98 Sequence & 20 Behaviour Risk Balancing returns and risk 15 10 5 3.02 2.01 0 Dec-77 Dec-87 Dec-97 Dec-07 Dec-17 Longevity Risk Equity 7.9% per year Bonds 2.8% per year Cash 1.8% per year Source: Prudential Investment Managers Slide 11 Cumulative returns on SA assets classes in real terms 1977 to 2017 (40 years) R1 invested

SEQUENCE OF RETURN RISK

TWO IDENTICAL INVESTORS R4.0m R3 601 375 R3.5m R3.0m JOE JANE Investment Value • R2 681 423 Same investment term R2.5m • Same salary and growth • Same contribution rates R2.0m • Same asset allocation Same 5% p.a. average real return R1.5m R1.0m R.5m R.0m 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 Investment Start Date Source: Prudential Investment Managers, GMO Slide 13

SEQUENCE OF RETURN RISK Different order of annual returns over 25-year investment term 30% 25% 20% Annual Returns 15% 10% 5% 0% -5% -10% -15% Starting High Smooth Starting Low Source: Prudential Investment Managers Slide 14

EXAMPLE 1: R100 000 LUMP SUM INVESTMENT Different journey, but same end result R3m R2m R1 729 472 Investment Value R2m R1m R1m R0m 0 5 10 15 20 25 30 Investment Term Smooth Starting High Starting Low Source: Prudential Investment Managers Slide 15

EXAMPLE 2: R50 000 p.a. REGULAR INVESTMENTS Sequence of returns matter when there are cash flows during investment term R20m R17 391 255 R16m Investment Value R12m R9 097 171 R8m R5 444 482 R4m R0m 0 5 10 15 20 25 30 Investment Term Smooth Starting High Starting Low Source: Prudential Investment Managers Slide 16

SEQUENCE OF RETURN RISK Huge variation in investor outcomes, even for same average return 20 000 investor simulation R5m R4m R3.3m Fund value at end R3m R2m R1m R1.0m R0m -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 40-Year Annualised Real Return (50% SA Equity/50% SA Bonds) Source: Prudential Investment Managers Slide 17

WIDE DISTRIBUTION OF OUTCOMES FOR THE 5% P.A. GROUP Simulated outcomes: 5% real over 40 years 18.0% 16.0% 14.0% Distribution of outcomes UNLUCKY 20% LUCKY 20% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% R1.03 R1.26 R1.50 R1.74 R1.98 R2.22 R2.46 R2.70 R2.94 More Millions Source: Prudential Investment Managers Slide 18

TWO IDENTICAL INVESTORS Income received R3m R3m R2 393 040 R1.68m Investment Value R2 120 441 R2m R2m R1m R1.53m R1m R0m 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 JOE JANE Investment Start Date Source: Prudential Investment Managers Slide 19

EXAMPLE 3: R50,000 p.a. (5%) REGULAR WITHDRAWALS Sequence of returns matter when withdrawing income during retirement R20m R16m Investment Value R12 714 974 R12m R5 409 088 R9 224 701 R8m R4m R768 201 R0m 0 5 10 15 20 25 30 Investment Term Smooth Starting High Starting Low Source: Prudential Investment Managers R1m retirement funding Slide 20

WHAT CAN YOU DO TO MITIGATE SEQUENCE RISK? Define the Contribute more Diversify between Take a valuation- problem correctly in the asset classes sensitive Reducing volatility accumulation A balanced portfolio approach to vs. minimising the phase can reduce both active asset probability of Enables lower the volatility of allocation running out of and/or flexible returns and the money in drawdown in severity of negative retirement retirement return periods, without significantly impacting total returns Source: Prudential Investment Managers Slide 21

IF YOU HAVEN’T STUDIED FOR YOUR EXAM BUT STILL PITCH UP TO WRITE IT “By failing to prepare, You are preparing to fail.” Benjamin Franklin Slide 22

LIVING ANNUITY GOING THE DISTANCE Base case: 4% real return R14m R6m R12m Annual Salary/Income R10m Salary increasing by Income increasing by Investment Value R4m 6% inflation 6% inflation R8m 15% retirement allocation 60% replacement ratio 4% real return (4% real return) R6m R2m R4m R2m R0m R0m 30 35 40 45 50 55 60 65 70 75 80 85 Age Annual Salary Retirement Value Investment Value Retirement Income Source: Prudential Investment Managers Slide 23

LIVING ANNUITY GOING THE DISTANCE Reduce growth assets post retirement: 1% real return R18m R4m Annual Salary/Income Investment Value R12m 1% real return R2m R6m R0m R0m 30 35 40 45 50 55 60 65 70 75 80 85 Age Annual Salary Retirement Value Investment Value Retirement Income Source: Prudential Investment Managers Slide 24

LIVING ANNUITY GOING THE DISTANCE Increase growth assets post retirement: 6% real return R25m R4m R20m Annual Salary/Income Investment Value R15m R2m R10m 6% real return R5m R0m R0m 30 35 40 45 50 55 60 65 70 75 80 85 Age Annual Salary Retirement Value Investment Value Retirement Income Source: Prudential Investment Managers Slide 25

DON’T GIVE UP GROWTH IN RETIREMENT R16m R12m Investment Value R8m 86% R4m 14% R0m 30 35 40 45 50 55 60 65 70 75 80 85 Age Money under the mattress Retirement Value Retirement Value Source: Prudential Investment Managers Slide 26 Assumption 4% real return p.a.

THE VALUE OF GROWTH ASSETS Income (7%) Investment value (after income) R1,200k R16m R12 289 337 R13 610 253 R15m R1,000k R14m R800k R13m R600k R12m R400k R11m R200k R10m R0k R9m 03 05 07 09 11 13 15 17 03 06 09 12 15 18 SA MA Income (after income) SA MA Low Equity (after income) Source: Morningstar, ASISA and Prudential Investment Managers Slide 27

FUND FLOWS FOLLOWING SHORT-TERM PERFORMANCE R15m R25bn Investment Value (After Income) R14m R20bn R13m R15bn R12m R10bn R11m R5bn R10m R0bn R9m -R5bn 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 SA MA Income (after income) SA MA Low Equity (after income) Source: Morningstar, ASISA and Prudential Investment Managers Slide 28

HOW PRUDENTIAL CAN HELP YOU Income (7%) Investment value (after income) R1,600k R23m R17 037 479 R13 610 253 R1,400k R21m R1,200k R19m R1,000k R17m R800k R15m R600k R13m R400k R11m R200k R0k R9m 03 05 07 09 11 13 15 17 03 06 09 12 15 18 SA MA Low Equity (after income) Prudential Inflation Plus Fund (after income) Source: Morningstar, ASISA and Prudential Investment Managers Slide 29