Dynamic, Not Static, Projections Serve Clients Best
Static projections of retirement assets mislead clients badly.
Good practice involves taking uncertainty into account. To do this, you need to make dynamic projections using scenarios of possible investment performance.
Explaining the consequences of uncertainty in an understandable way is challenging, of course. But its also worthwhile. So, lets go ahead and explore how to communicate dynamic projections–and learn something about variable annuity guaranteed living benefits along the way.
Our case study: Danny is age 45 and wants to achieve a life income from a VA starting at age 65. The more income, the better, but Danny feels if the income is less than $2,000 a month it will be painful. At present, he has a $100,000 lump sum to put to work toward this goal.
Well look at using: 1) a VA that is 100% invested in equities; 2) a VA that splits its investments 40/60 between fixed and equity accounts; and 3) a VA with a guaranteed living benefit (GLB). Well make dynamic projections on many stock market scenarios, and look at how to communicate this to Danny.
Here are the assumptions for this analysis:
Fixed account return: 5% (A full study would involve projecting fluctuations in interest rates, also.)
Average gross annual stock market return: 10%
Expenses and fees in variable annuity: 1.50%
Annual volatility of stock market: 15%
Monthly income per $1,000 at retirement: $7.00
Charge for GLB: 50 basis points
GLB benefit: Premium at 4% rollup of interest to age 65
Number of stock market scenarios: 2,000
Now, how do we explain 2,000 scenarios to Danny? We could order several trees to be chopped down so we can give him a 2,000-page report. Or maybe condense it all into a graph with 2,000 lines?
A more serious suggestion is to graph the distribution of results (the result being the income Danny would get at age 65).
The chart shows such a distribution (“bell curve”) for the VA thats 100% invested in equities. It is astounding to contemplate how widely results can vary! Clearly, this VA approach has high risks for Danny.