CFD | RIIA Retirement Management Journal (RMJ) Volume 2 ... · •Co-Chair,SeanM.Ciemiewicz,CIMC ... LETTER FROM THE EDITOR. ... The RMA certification is the definitive advanced,

I N S I D E �

LETTER FROM THE EDITOR

PAPERS:

Introduction to RIIA’s MarketInsight Research Program

PAPERS REGARDING SUPPLY:

Getting From There to Here – AHistory of the DTCC/RIIA Relationship

The DTCC Analytic Reportingfor Annuities Service: A Primer

on the Possibilities

Getting Income Annuities Readyfor Primetime – Creating

a Market Value

Income from Assets:The Promise of the Future

PAPERS REGARDING DEMAND:

How Financial Institutions CanHelp Their Customers to Remain

Healthy, Wealthy and Wise

Defined Contribution RetirementPlan Participants on Retirement

What Happened to My Retirement?

Can We Predict Long-RunEconomic Growth?

VOLUME 2, NUMBER 2SUMMER 2012

RIIA’s Market Research Insight Issue

www.RetirementManagementJournal.org

RIIA provides the space, discussions, communications, research, education andstandards that derive from its unique perspective – the View Across the Silos – to helpinvestors, distributors and manufacturers in the financial industry transition fromInvestment Accumulation to Retirement Management and Income Protection.

The Retirement Management Journal ,a publication of the Retirement Income Industry Association,is devoted exclusively to retirement-income planning andmanagement.

© 2012 Retirement Income Industry Association3

Copyright © 2012 Retirement Income Industry Association®. All rights reserved. No part of this publication may be reproduced in any form or by any means without the prior writtenpermission of the copyright holder. This publication is designed to provide accurate information in regard to the subject matter covered. It is sold and/or distributed with the understandingthat the publisher is not engaged in rendering legal, accounting or other professional services. The publisher is not held liable for any inaccuracies in this journal.

T A B L E O F C O N T E N T S

THE RETIREMENT MANAGEMENT JOURNALSM VOLUME 2, NUMBER 2SUMMER 2012

L E T T E R F R O M T H E E D I T O R4 Editor’s Comments

by Robert J. Powell, III

P A P E R S5 Introduction to RIIA’s Market Insight Research Program

by Elvin Turner

This paper introduces the RIIA Market Insight (RMI) research program,which is designed to help industry leaders grow their businesses ina changing retirement market through the use of market intelligenceconcerning firms’ sales, customers, distributors, competitors and theirown strategies.

P A P E R S R E G A R D I N G S U P P L Y11 Getting from There to Here – A History of the DTCC/RIIA

Relationshipby François Gadenne and Adam Bryan

This paper details the vision of the two organizations that believetransaction data, beginning in the annuity industry, could be transformedinto insightful reports for industry executives.

15 The DTCC Analytic Reporting for Annuities Service: APrimer on the Possibilitiesby Elvin Turner and Andrew Blumberg

This paper presents practical ways that the Analytic Reporting forAnnuities program can be used to give users a unique andunprecedented view of their own business as well as the market forannuity products, allowing them to discover key trends and identifyopportunities.

23 Getting Income Annuities Ready for Primetime – Creatinga Market Valueby Gary Baker

The Income Annuity Standards and Readiness Working Committeeis defining the infrastructure and methodology that will makeannuitization data and market valuation available across the market.

27 Income from Assets: The Promise of the Futureby Larry Cohen and David Blanchett

To facilitate the conversation among financial manufacturers,distributors, regulators, associations, financial professionals and allparties interested in better understanding and serving consumers’retirement income needs, Morningstar has partnered with RIIA to lookat the balance sheets of pre-retired and retired households to betterunderstand their retirement income situation.

P A P E R S R E G A R D I N G D E M A N D33 How Financial Institutions Can Help Their Customers to

Remain Healthy, Wealthy and Wiseby Anand S. Rao, Ph.D, and Ron Mastrogiovanni

Considering that healthcare will be the largest single expense for mostretirees, and in light of the fact that themajority of people inadequatelyprepare for retirement, there is a huge need for informed professionalguidance, including on various on-the-shelf investment options thatcan cover out-of-pocket healthcare expenses.

39 Defined Contribution Retirement Plan Participants onRetirementby Ronald L. Bush

This paper examines the attitudes and behavior of defined-contribution plan participants regarding retirement, their perceivedretirement readiness, expected sources of retirement income and theirinterest in an in-plan guaranteed retirement income option.

45 What Happened to My Retirement?by Larry Cohen

Retirement is a middle-class problem. The wealthy and the poor haveno problem with retirement: The wealthy will retire, the poor won’t –no problem! But, for the vast number of those in themiddle, the other79%, retirement is a real problem– and the questions of if, when andhowwe retire are huge unknowns.

53 Can We Predict Long-Run Economic Growth?by Timothy J. Garrett

It can be a challenge to plan now for inflation-adjusted economic growthover coming decades. This paper argues that there exists an economicconstant that carries through time which can help us to anticipate themoredistant future: global economicwealthhas a fixed link tocivilization’stotal capacity for power production; the ratio of these two quantitieshas not changed over the past 40 years that statistics are available.

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Welcome to the Summer 2012 issue of the Retirement Management

Journal. This issue marks a departure from the previous issues in that it

represents the launch of RIIA’s first-ever research/data book. As you will

read, this issue features the work of the RIIA research committee, which is

led by Elvin Turner.

Elvin, in his role as director of research for RIIA, worked tirelessly on soliciting and editing the

papers for this issue, which features ground-breaking reports and updates on initiatives that are

certain to change the retirement-income space for many years to come.

For instance, this issue introduces the RIIAMarket Insight (RMI) research program, which is designed

to help industry leaders grow their businesses in a changing retirement market through the use of

market intelligence concerning firms’ sales, customers, distributors, competitors and their own

strategies. Created by leading research and consulting firms in the retirement industry, the RMI

program widens the view of market leaders and gives them actionable data in a number of areas.

This issue also features the vision of two organizations – RIIA and DTCC – that believed that

transaction data could be transformed into insightful reports for annuity industry executives. In

this issue, you’ll read the result of that vision, DTCC’s “Analytic Reporting for Annuities.”

And, you’ll read about a novel initiative in which more than 40 financial service organizations are

working together to solve a long-standing problem – creating a standard for the market valuation

of an income annuity (or any annuitized asset).

Plus, there’s a paper from Timothy Garrett, a professor at the University of Utah, who answers the

question: Can we predict long-term economic growth? We won’t spoil the end; you’ll have to read

the paper to find out.

So, that’s just a taste of what you’ll read in this issue. We hope that you enjoy our latest edition of

the Retirement Management Journal. As always, think of us as a place to advertise your message.

Our publication is now reaching thousands of financial advisers who hold themselves out to be

retirement-income specialists. Plus, it’s read by leading executives frommany firms and organizations.

And lastly, let us know if you would like to distribute the pdf version of the Retirement

Management Journal to your constituents. Regular and Associate Members of RIIA are able to

distribute the Retirement Management Journal to all employees and advisers in their system as a

member benefit.

All for now and all the best,

Robert J. Powell, III, Editor & Publisher, [email protected]

RETIREMENT MANAGEMENT JOURNALVOLUME 2 , NUMBER 2 – SUMMER 20 12

A PUBLICATION OF RI IA• www.riia-usa.org• For reprints, contact: Deborah [email protected]

EDITOR & PUBLISHER• Robert J. Powell, III

ART DIRECTOR & CREATIVE TEAM• Robin Taliesin, Raven Creative, www.raven2.com

GOVERNANCE COMMITTEE• François Gadenne, CFA®, RMAChairman of the Board & Executive Director, RIIA®

• Bruce E. Wolfe, CFA®Managing Director, Allianz Global Investors

• Robert J. Powell, III

ACADEMIC PEER REVIEW COMMITTEE• Chair, Michael Zwecher, Ph.D.Author, Retirement Portfolios: Theory,Construction and Management

• Co-Chair, Rick Miller, Ph.D., CFP©

Founder, Sensible Financial Planning andManagement, LLC

• Co-Chair, Philipp Hensler, Ph.D. cand., CEFAExecutive Vice President, OppenheimerFunds

• Co-Chair, Michael Finke, Ph.D., CFP®Associate Professor and Coordinator PersonalFinancial Planning, Texas Tech University

PRACTIT IONER PEER REVIEWCOMMITTEE• Chair, Dana Anspach, CFP®, RMAPrincipal/Financial Advisor, Sensible Money, LLCand Writer, About.com: Money Over 55

• Co-Chair, Sean M. Ciemiewicz, CIMC©, AIFA©, RMAManaging Partner and Financial Consultant,Retirement Benefits Group™

AT-LARGE PEER REVIEW COMMITTEE• Co-Chair, Clifford J. Jurdi, MS CFP®, ChFCPrincipal, Clifford J. Jurdi, CFP®, CHFC andInvestment Adviser Representative,Commonwealth Financial Network

• Co-Chair, Janet Maus, Ph.D., CFEd, CSAPresident, Branch Financial Strategies

FOUNDING SPONSOR• Allianz Global Investors

www.RetirementManagementJournal.org4

THE RET IREMENT MANAGEMENT JOURNAL SM

LETTER FROM THE EDITOR

VOLUME 2 , NUMBER 2

© 2012 Retirement Income Industry Association®5

This paper introduces the RIIA Market Insight(RMI) research program, which is designed to helpindustry leaders grow their businesses in achanging retirement market through the use ofmarket intelligence concerning firms’ sales,customers, distributors, competitors and their ownstrategies. Created by leading research andconsulting firms in the retirement industry, the RMIwidens the view of market leaders and gives themactionable data in a number of areas.

The RMI program is an important resource designedfor this unique period of time in the history of theretirement income industry. This is a time whensenior managers need to focus on traditionalproducts and services which have been around foryears. The issues related to these mature productsoften involve the firm’s ability to honor thecommitments made over the many years aroundinvestment return, benefits and professionalservices; these are the supply issues. Yet managersalso need to focus on meeting the emerging needsof soon-to-be-retired Boomers. These needs

challenge our industry to design products andservices around still evolving servicerequirements and to determine how investments canbest be structured to meet lifestyle needs. Theanswers to these questions require a deepunderstanding of customer demand.

Participating in the RIIA RMI program allowssponsoring companies to explore these issues ofsupply and demand and to determine how the useof various distribution channels impacts theanalysis. We seek to enable our sponsors to quicklysee the new opportunities unfolding in the marketbefore those opportunities become commonknowledge. As we launch our program we have theability to analyze certain annuity distributionchannels and product offerings in depth. We planover time to include in-depth analysis regardingother products and services.

RIIA Market Insight Household AnalysisThe RMI initiative is a research program thattranscends traditional product and organizationalsilos bringing together industry leaders, researchersand their collective data to create a 360-degree viewof consumer households who buy and rely upon thefinancial services industry’s products and services.

At the heart of the RIIA research platform ishousehold segmentation based on age andfinancial assets. We segment the non-retiredhouseholds based on where they are in relation toretirement. As a result, the US householdpopulation is shown in four life-stage cohort

Introduction to RIIA’s Market InsightResearch Program

BY ELVIN TURNER

ELVIN TURNERMANAGING DIRECTOR

TURNER CONSULTING LLCRESEARCH DIRECTOR

RETIREMENT INCOME INDUSTRYASSOCIATION



categories: Starters, Builders, Pre-retired andRetired. These cohorts are delineated by the age ofthe household’s primary head as follows:� Starters – Under Age 35� Builders – Ages 35 to 49� Pre-Retired – Ages 50 to 64� Retired – 65 or older

In addition to relevant life stages, the segmentationlooks at the levels of wealth of the varioushouseholds. Our ability to look at the assets andincome of households by segment allows us toevaluate the very different financial situations of thehouseholds. In order to evaluate a resourcecomponent in each of these cohorts the RIIAsegmentation divides each age group into fourlevels of wealth based on their total household assets.This is a form of financial ‘triage’ where manyhouseholds in the top “wealth” market segment arefully able to achieve their goal to retire, mosthouseholds in the bottom “marginal” segment will

be unable to even consider retirement, and mosthouseholds in the “mass middle” and “affluent”segments require further focus and major changesin course. For each segment, we want to add adelineation to separate those that, with reasonableguidance and assistance, should be able to achievesome semblance of their retirement goal from theremainder who will need radical intervention in orderto even come close to their objectives.

� The first level is the top 5% of households ineach cohort. Any household whose mean totalassets places them in the top 5% for that cohortis assigned to this resource level which we call“Wealthy”

� The next resource level is set at the nexthighest 15% of households in each cohort,which we will call “Affluent”

� As the majority of households are reputed tohave inadequate savings the next resource levelis the next 50% of households in each cohort,

F IGURE 1 : RMI QUANT I F I CAT ION OF VALUE S IN THE R I IA CUSTOMER SEGMENTAT ION MATR I X

VOLUME 2 , NUMBER 2

which we call the “Mass Market”� The final level is the bottom 30% of households

in each cohort who have the lowest level ofassets, whom we call “Marginal”

This segmentation of households relates to the RIIACustomer Segmentation Matrix that is presented inthe RIIA Market Analyst (RMA) certificationprogram. The graphic in Figure 1 (on the previouspage) shows these connections.

Using these connections we identify the averagefinancial assets of households by segments andcompare the assets to the same households’ meanannual disposable income (the income remainingafter a household’s fixed expenses are paid). Wherepre-retired and retired households are moving intothe years where a portion of their incomes come fromtheir assets, this analysis becomes an extremelyuseful measure of the households that areconstrained, over-funded or under-funded. Our

ability to make connections like these amonghousehold wealth-age categories increases thepower of this analysis for leaders in financialservices firms. The deeper insights into theircustomers help them make wiser strategic decisions.Further, we can apply these insights to particulartypes of firms and markets because we usemultiple research firms, who are each an expert intheir field, and carry them through an over-archinganalysis that uses a series of focused insights to paintthe larger picture. The next section provides thedetails of the over-arching research program.

RIIA Market Insight Research ProgramThe RMI program draws insights from researchfirms in four areas of the customer experience: (1)household financial profile (income, assets, etc.)now, (2) household financial profile in the future,(3) household experience with financial products,distributors and companies, and (4) householdexperience with their investments. We present the


F IGURE 2 : R I IA MARKET INS I GHT PROGRAM



multiple insight perspective in Figure 2 (on theprevious page), where the insights surround thetarget households in a 360-degree view of thecustomer market segments.

The Research Firms and Their ExpertiseIn the RIIA RMI research platform we divide the

vendors into those that look at household demandand those that look at the industry supply offinancial products and services. SBI and PwCpresent research and insight regarding the issues inthe household experience that influence the demandof financial products. Morningstar and DTCCpresent research and insight regarding the productsand services offered by financial services firms thatimpact the supply of such products and servicesoffered to household segments. Other vendorsprovide more focused analysis around theirdatabases that enhance our ability to understanddemand and supply for most types of industry firms.

The roles of vendors that analyze demand andsupply issues are shown below.

Partner Research Firms with Expertise in HouseholdDemandThree research partners provide data and insight thatrelate to households’demand for financial products:

Strategic Business Insights (SBI) providesinformation on households’ current financialprofiles, including their current ownership offinancial products, average incomes, financial andnon-financial assets and debts. SBI provides thisinformation for each of the nine householdsegments.

In addition, SBI integrates information from theBureau of Labor Statistics’Consumer ExpendituresSurvey (CEX) which provides informationregarding household spending.

PricewaterhouseCoopers (PwC) takes theinformation provided by SBI and projects it into thefuture.As a result, their data will provide informationon households’future financial profiles, including theirfuture ownership of financial products, averageincomes, financial and non-financial assets anddebts. PwC also provides this information for each ofthe nine household segments.

F IGURE 3 : FOUR AREAS OF FOCUS

AREA OFFOCUS FIRM EXPERTISE

Household Strategic SBI has a commerciallyfinancial Business available database thatprofile Insights describes the financialnow (SBI) – profiles of U.S. households.

Larry Cohen This data is presented by theRIIA age and asset segments.

Household Pricewater- PwC has proprietary programsfinancial houseCoopers that can project currentprofile LLP (PwC) – financial profiles of U.S.in the Anand Rao households into the future.future PwC’s data can help us

describe the future retiredworld of households that arecurrently pre-retired.

Household Depository DTCC’s database currentlyexperience Trust tracks flows of annuitywith Clearing contracts, database isfinancial Corporation extremely versatile and hasproducts, (DTCC) – a growing ability to showdistributors Adam Bryan/ views of annuity data not& companies Andrew currently available in the

Blumberg market.

Households Morningstar, Premier firm presenting dataand their Inc. – on investment offerings inInvestments David the US. With this firm’s

Blanchett involvement in the RMI,we now have the ability tolook at household investmentsfrom an income provision andsustainability point of view.

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VOLUME 2 , NUMBER 2


HealthView Services (HVS) is contributing to theanalysis on the demand side. HealthView Servicesis a data analysis and technology firm with aretirement cost analysis software which filled a keyvoid in the financial planning process bypioneering the industry`s first income flooringanalysis tools. It is being used by some of theworld`s largest brokerage firms, annuity providersand life insurance companies. HVS’ modular-based suite of interactive calculators is customizedand branded for institutions and is designed toseamlessly integrate into an existing adviser-facing or customer-facing web-based reportingsystem. HVS will partner with PwC to projectpre-retiree health care costs into their retirementyears. A paper by Ron Mastrogiovanni, fromHVS, and Anand Rao, from PwC, is included in thisissue of the RMJ.

Research Partners that Provide Research Regardingthe Supply of Products and Services Offered toFinancial Services CustomersProviding the supply side of the analysis are:

DTCC is an industry-owned clearinghouse thatclears and settles the vast majority of securitiestransactions in the United States. In 2011, $1.7quadrillion of securities transactions passed throughits operations. Also in 2011, its insurance businessunit processed over $156 billion in annuity inflowsand outflows. DTCC launched AnalyticReporting for Annuities last year – an onlinepremium flow aggregation and reporting service.This service is a key offering of the RMI program.A paper regarding the DTCC service is publishedin this issue of the RMJ.

Morningstar, Inc. is a leading provider ofindependent investment research with aninternational clientele across North America,Europe, Australia and Asia. The firm provides datato a variety of customers on more than 380,000investment offerings, including stocks, mutual

funds and similar vehicles. Morningstar is analyzingthe income producing characteristics of household’sportfolios for the RMI program. A paper by DavidBlanchett, of Morningstar, and Larry Cohen, of SBI,is published in this issue of the RMJ, as well.

Sagence Group is a consulting firm whoseprincipals have the unique ability to understand andanalyze challenges and opportunities frommultiple perspectives, ask the right questions anddrive strategic change in the financial servicesindustry. They bring a cross-functional view withexpertise in operations, finance, sales and marketing.Sagence is analyzing annuity sales and distributiontrends for the RMI program.

Gallant Distribution Consulting (GDC) is aresearch firm with deep expertise in thedistribution trends in the retirement market. The firmconducts independent and syndicated leadershipresearch on various research trends impacting themarketplace. GDC will work together with Sagenceto analyze annuity distribution trends.

CANNEX is a data collection and analysis firm thatcompiles data and calculations about a variety ofguaranteed annuity products and makes thatinformation available to subscribers. Their coreexpertise in the U.S. market includes SinglePremium Immediate Annuities (SPIA’s), DeferredIncome Annuities (DIA’s), Fixed DeferredAnnuities (SPDA) and Living Benefit Guaranteesfor Deferred Annuities products. CANNEX bringsinsight to the RMI program regarding all aspectsof the fixed annuity market.

BrightworksPartners is a research-based consultingfirm focusing on product, service and distributionissues in retail and institutional financial services. Theyhave deep expertise in advisory work and theinstitutional retirement markets. Brightworks bringsinsight to the RMI program regarding all aspects ofthe institutional retirement markets.

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Community Senior Capital is a firm thatspecializes in providing liquidity solutions for olderAmericans. Dan Osterhout, the principal of thisfirm, chaired the National Reverse MortgageLenders Association’s Product Development andCapital Markets Committee. This firm bringsinsight to the RMI regarding the use of reversemortgages in the retirement market.

Ernst & Young (E&Y) is a global leader inassurance, tax, transaction and advisory services.Its worldwide staff of 152,000 people is organizedinto a globally-integrated professional services entitywith deep and broad expertise across industries. Theinsurance organization within E&Y works with theRMI program focusing on the ability of theinsurance industry to support the retirement incomeneeds of current and future generations.

ConclusionFor the leader who has aggressive business plans,sponsorship of the RMI program will bring new anddifferent views into the retirement markets. Thispowerful research platform will enable anindustry leader to have a broader view of theirstrategic opportunities through the structured useof household and market analysis. The RMIprogram does not replace a strategic businessanalysis, rather it aligns top research firms withanalysts in a structure that surfaces and thenfocuses on opportunities in the retirement market.Leaders who sponsor the RMI program will havea wider strategic view than they have ever hadbefore. They will be able to make the connectionsand create value propositions that fulfill theirretiring customers’ unformed desires. �

Mr. Turner can be contacted at [email protected] or by calling 860-242-4878.


Stay on the cutting edge of the Retirement-IncomeIndustry’s latest thinking, research & innovation.

Single or institutional subscriptions available for non-RIIA members � Paper reprints availableFor RIIA associate or regular members: Take advantage of a member benefit – you are entitledto distribute the electronic version of the Retirement Management Journal to your constituents.Please contact Deborah Burkholder at [email protected] for more information.

VOLUME 2 , NUMBER 2


The pages that you are about to read unfold thevision of two organizations that believed thattransaction data could be transformed intoinsightful reports for annuity industry executives.This paper discusses the DTCC organization, itsAnalytic Reporting for Annuities Program, the RIIAviews of the DTCC data and your opportunity toreceive additional information.

The DTCC OrganizationThrough the operating facilities and data centers ofits subsidiary companies around the world, TheDepository Trust & Clearing Corporation (DTCC)automates, centralizes and standardizes thepost-trade processing of financial transactions for

thousands of institutions worldwide. With close to40 years of experience, DTCC is the premierpost-trade infrastructure for the global financialmarkets, simplifying the complexities of clearance,settlement, asset servicing, global data managementand information services for equities, corporate andmunicipal bonds, government and mortgage-backed securities, derivatives, money marketinstruments, syndicated loans, mutual funds,alternative investment products and insurancetransactions. In 2011, DTCC processed securitiestransactions valued at approximately US$1.7quadrillion. Its depository provides custody andasset servicing for securities issues from 122countries and territories valued at US$39.5 trillion.DTCC’s global OTC derivatives trade repositorieshold records on more than US$500 trillion in grossnotional value on transactions across multipleasset classes globally.

DTCC’s Insurance & Retirement Services (I&RS),launched in 1997, is the division that processesannuity and insurance transactions for theindustry. I&RS is the central messaging connectionfor annuity and life insurance transactions, enablinginsurance companies to provide broker/dealers withdaily financial transaction information. In 2011,I&RS processed approximately $156 billion inannuity transactions.

The creation of DTCC’s Analytic Reporting forAnnuities Program was motivated by a corporate-wide initiative to leverage existing data withinDTCC to realize efficiencies for the financial

Getting From There to Here – A History of theDTCC/RIIA Relationship

BY FRANÇOIS GADENNE AND ADAM BRYAN

FRANÇOIS GADENNE,CFA®, RMASM

CO-FOUNDER, CHAIRMAN AND

EXECUTIVE DIRECTOR


ADAM BRYANMANAGING DIRECTOR

INSURANCE AND RETIREMENT

SERVICESTHE DEPOSITORY TRUST &CLEARING CORPORATION



industry. Given the industry demand, I&RSconducted a comprehensive needs analysis with itsusers and also worked with RIIA. Based on theanalysis, Adam Bryan, Managing Director ofI&RS, initiated the development of an onlineapplication to transform millions of bits of data intoinformation that would provide a unique view ofthe annuity market to allow users and customers tosee trends, helping them in identifyingopportunities and make decisions for theirbusinesses.

The Analytic Reporting for Annuities ProgramDTCC’s Analytic Reporting for Annuities serviceis an online solution that helps insurancecompanies and broker/dealers better understand theirbusiness and business relationships. It allowsusers to view their market share, rank themselveswithin a carrier, understand their relationships withcarriers or broker/dealers, rank partners andproducts and use benchmarking information to gaina new understanding of their market and positioning.

Unlike other services, DTCC’s Analytic Reportingfor Annuities uses information extracted fromactual transactions processed by NationalSecurities Clearing Corporation, a DTCC subsidiary.DTCC offers a free one month trial of AnalyticReporting to management at insurance companiesand broker/dealers that process transactions throughDTCC’s Insurance & Retirement Services. I&RSalso provides online and on-site demonstrations. Atrial or meeting can be arranged by contacting yourI&RS Relationship Manager. A listing of theRelationship Managers can be found athttp://www.dtcc.com/products/insurance/team.php.

More information about Analytic Reporting isavailable at www.dtcc.com/analytics.

The RIIA ViewsThrough the relationship with RIIA and DTCC,RIIA members will have the added benefit of newbenchmarking views of the annuity distributionmarket, such as seeing annuity activity bydistribution channel and product type, as well as byqualified and non-qualified plans. DTCC and RIIAare working together to develop a series ofbenchmarking reports for RIIA member companiesthat will be accessible for download from the RIIAwebsite. The work of developing these views willbe undertaken by a working group of financialservices companies through our newly formed RIIAMarket Insight Advisory Board.

The RIIA Views listed at left are an initial list ofpotential views. The group will take this list and testit with companies and distributors in order to gaugeindustry interest and incorporate industry input. Thegroup will then work with writers, graphicdesigners and systems associates to craftcutting-edge presentations that give senior leaderswithin companies and advisory organizations clearcompelling snapshots of their industry that conciselycommunicate the important messages that liewithin the data; these views will be insight pieces

F IGURE 1 : R I IA V I EWS AND THE I R OB J E CT I V E S

POTENTIAL RIIA VIEWS STRATEGIC QUESTIONS

Inflows, outflows and net • What is the production of annuityinflows organized by insurers business by insurers and specificand annuity products – annuity products?the benchmarking view • Which annuity products are

infusing inflows into insurers’businesses?

Inflows, outflows and net • What is the production of insurersflows by distribution channel by distribution channel?– the benchmarking view • Which channels are infusing

inflows into insurers’ businesses?

Inflows, outflows and net • What is the production of insurersflows by type of market- by market?retail, contributory IRA, • Which markets are infusingIRA Rollover, 401(k) – inflows into insurers’ businesses?the benchmarking view

VOLUME 2 , NUMBER 2

that can first be read and digested by seniorleaders and then passed on to associates and evenmore senior leaders and board directors. Since thedata is so powerful, the presentations do not needto be complex. The RIIA Views will be designedso that senior stakeholders who only periodicallyreview the annuity business can understand thetrends that frame their company’s position andenable their business opportunities. While these

high-level presentations may not answer everyquestion, at least one will not feel compelled toquestion every answer. These presentations replaceconjecture and opinion with market facts and candirect your further analysis into the truly importantareas that impact your business.

The starting list of potential RIIAViews is as shownin Figure 1 (on previous page). �

Knowledge is power.BE THE HERO.The RMA certification is the definitive advanced, professional financialdesignation designed specifically to help advisors and other financialprofessionals provide better retirement income solutions.

ACT TODAY! To enroll or get more information about the RMA program, go to: riia-usa.org/rma

It is a rigorous educational and ethics training curriculum that focuses on the key concepts

and practical applications of retirement-income planning and management.

The RMA curriculum fills a critical gap in available advisor training for retirement-income

planning that is not met by other formal training programs or professional designations; it

is designed to complement these other programs rather than replace them. Other benefits

include:

� Extend your education through complementary entry and discounts to

select RIIA meetings & conferences and a monthly webinar series

� Network with retirement industry leaders and innovators

� Access proprietary materials and research/surveys through RIIA

Knowledgedrives business:Gain a competitiveadvantage by educatingyourself about the new,cutting-edge retirement-income planning financialmodels.

©2012 American Century Proprietary Holdings, Inc. All rights reserved. CO-ADV-76108 1208

P R O F ITS W ITH A

PURPOSEAt American Century Investments® we offer our clients an alternative to many traditional investment companies. As a privately-controlled fi rm, our independence lets us take a long-term view in the best interest of our clients. We focus exclusively on managing money and apply a time-tested, fundamentally driven approach to investing.

But it’s not just our commitment to superior long-term performance that makes us unique. Through our company’s ownership structure, more than 40% of our profi ts fund research for the prevention, treatment and cure of gene-based diseases such as cancer, diabetes and dementia. Since 2000, American Century Investments has directed more than $900 million to the Stowers Institute for Medical Research. It’s what we call “profi ts with a purpose.”

americancentury.com. | stowers.org

P R O F ITS W ITH A

PUR POSE

VOLUME 2 , NUMBER 2


On June 20, 2011, the Depository Trust &Clearing Corporation (DTCC) Insurance &Retirement Services (I&RS) division launchedAnalytic Reporting for Annuities. AnalyticReporting is an online information solutioncontaining aggregated data from transactionsprocessed by I&RS. Because it is based ontransactions and not surveyed data, AnalyticReporting gives users a unique and unprecedentedview of their own business as well as the marketfor annuity products, allowing them to discoverkey trends and identify opportunities. Withupdates approximately two to three weeks aftereach month-end, Analytic Reporting allows usersto assess their business and access industry

intelligence to understand and improve their placein the market. The application provides actionableinformation and intelligence to supportmanagement decisions about sales, salesmanagement, marketing and product offerings.

Analytic Reporting provides a turnkey technologysolution through an online interface, availableanywhere, anytime. Users do not have to store ormanage the data, and they don’t have todevelop applications or run SQL queries to obtainthe information and intelligence they need fordecision making. An ID and password are all thatis needed to access the information, putting it atthe fingertips of business intelligence analysts,marketing and sales managers, product managersand senior executives.

What differentiates Analytic Reporting from otherofferings is the fact that the information is basedon actual transactions processed for the industryby National Securities Clearing Corporation(NSCC), a DTCC subsidiary, anchoring thereporting in reality. The information covers alltypes of annuity transactions across variouschannels, products, insurers and consumers, thussupporting the ability to meaningfully interpretand compare results across different segments ofthe market.

The rest of this article provides examples fromAnalytic Reporting for Annuities that highlightsome of the types of information it places at thefingertips of decision makers. They illustrateinformation that is critical to understanding acompany's competitive position. The catalog ofuses presented here is not comprehensive – the

The DTCC Analytic Reporting for Annuities Service:A Primer on the Possibilities

BY ELVIN TURNER AND ANDREW BLUMBERG

ELVIN TURNERMANAGING DIRECTOR

TURNER CONSULTING LLCRESEARCH DIRECTOR


ANDREW BLUMBERG

DIRECTOR, ANALYTIC

REPORTING FOR ANNUITIES

BUSINESS INITIATIVEDTCC INSURANCE &RETIREMENT SERVICES



data can be used in nearly unlimited ways to meetthe specific needs of different business purposes.

Over time RIIA will create a series of on-goingpresentations, called “RIIA Views” that presentinformation from Analytic Reporting forAnnuities in innovative and useful ways. Forpurposes of the presentations in this article, somefictional industry data was included in order tocomplete the presentation without using anycompany’s confidential information and to showthe DTCC information in proper context. Wherefictional data is used, its use will be noted. In allother cases the data used is derived from actualmarket transactions.

Top 10 Insurers Annuity Sales by Gross Flows,Redemptions and Net FlowsThe information shown here representstransactions processed by DTCC that occurred inthe insurers’ non-captive channels. According toa reliable industry source annuity sales throughnon-captive channels account for about 75% oftotal annuity industry sales. DTCC does notcurrently capture all annuity activity in non-captive channels. However, Analytic Reportingdoes provide a strong view of non-proprietarydistribution channels. In 2011, DTCC I&RS

processed over $156 billion in annuitytransactions for over 124 carriers and 128distributors.

Figure 1 (above) presents the top 10 insurersranked by inflows processed by DTCC for the fullyear of 2011. Inflows for the top insurers rangefrom $13.1 billion for MetLife to $2.4 billion forPacific Life. outflows for eight of the top tencompanies are lower than their inflows, rangingfrom a high of $4.4 billion to a low of $700million.

Net flows (inflows minus outflows) ranged from$11.2 billion to negative $1.5 billion.

Net flows can vary among companies for a varietyof reasons which will be further analyzed by RIIAand DTCC, including:� Product Type – Sales growth and persistency

may differ based on the mix of fixed vs.variable annuities. Fixed annuity contractsoften have surrender charges or market valueadjustments that discourage redemptions;while variable products have surrender charges,they sometimes do not discourage contractholders from surrendering their contracts if the

F IGURE 1 : IN F LOWS , OUTF LOWS AND NET FLOWS FOR TOP 10 INSUR ER S

JANUARY, 201 1 THROUGH DECEMBER , 201 1 – IN B I L L IONS

Carrier Inflows Outflows Net FlowsMetlife Investors USA Insurance Company 13.1 -1.9 11.2Jackson National Life Insurance Company 10.6 -2.8 7.8Pruco Life Insurance Company 9.0 -0.7 8.3The Lincoln National Life Insurance Company 6.6 -4.4 2.2Riversource Life Insurance Company 5.3 -0.8 4.5Nationwide Life Insurance Company 5.2 -3.3 1.9Western National Life Insurance Company 4.0 -2.9 1.1Transamerica Life Insurance Company 2.8 -2.9 -0.1John Hancock Life Insurance Co(Usa)/Group Pension 2.5 -1.2 1.3Pacific Life Insurance Company 2.4 -3.9 -1.5

"Inflows, outflows and net flows calculated from transactions processed by DTCC Insurance & Retirement Services. Note that notall industry transactions are processed by DTCC."

VOLUME 2 , NUMBER 2

contract holders believe that they are movingto a superior investment brand. However, inextended low interest rate environments suchas we are now experiencing, fixed contractsmay be less attractive and subject to beingsurrendered. Variable contracts are sometimesmore difficult to sell during bear markets. RIIAwill look at sales and persistency patterns forcompanies with similar fixed and variablebooks of business.

� Distribution Channel Selection – Carrierssometimes find that the persistency of theircontracts differ by distribution channel,regardless of product type. Some carriersoffer different products through differentchannels, which likely contribute to differentrates of redemption. But whether the samecontracts or different contracts are offered,persistency by channel is an important metricfor companies to track. RIIA will measureredemptions as a percentage of gross sales bychannel.

� Market Type – The type of market (qualifiedvs. non-qualified) into which the annuity is soldhas a direct impact on the ability of the com-pany to retain assets and grow sales. Forexample, redemptions are typically lower in thequalified markets since the employers’plan pro-vision may not allow employees to withdrawtheir assets until certain triggering eventsoccur. This benefit is counterbalanced by theability of an entire plan to leave the companyif an employer decides to retain another com-pany to manage the plan. In some cases theredemptions of a company experiencing highsponsor turnover may be higher than those ofa retail-focused annuity company. Redemptionsare redemptions, but entirely different analy-sis is required for qualified and non-qualifiedsales. RIIA will measure sales and redemptionpatterns by type of market.

Looking at information from Analytic Reporting

in Figure 2 (above, right), the data shows thatqualified plan accounts have much lower outflowsthan non-qualified accounts. Qualified planaccounts made up over 90% of positive net flowsin 2011.

In addition, the data shows a trend of increasinginflows into qualified plan accounts anddecreasing inflows into non-qualified accounts,and that gap has been widening. Looking at thetwo account types with the greatest inflows, wecan see that qualified accounts are attracting over60% of inflows, while the share of inflows going


F IGURE 2 : NON-QUAL I F I E D SAL E S A S A PERC ENTAGE OF

QUAL I F I ED SAL E S

F IGURE 3 : ANNU I TY IN F LOWS BY ACCOUNT TYP E

into non-qualified accounts has dropped to under40%. The chart in Figure 3 (on previous page)shows the trend.

From an insurance carrier’s perspective, theretention of assets under management is veryimportant. Seeing where the money is going andwhere the assets are sticking helps industryparticipants organize and manage their efforts.

Top 10 Insurers Annuity Sales by Inflows andMarket ShareFigure 4 (above) presents the top 10 insurers’inflows and outflows, and their market shares as apercentage of total inflows and outflowsprocessed by DTCC in the full year 2011.Annuity market inflows are highly concentrated,with the top 10 insurers capturing 68% of inflows.The top three insurers – MetLife, JacksonNational and Pruco – had higher inflows andmarket share than the bottom 101 insurers.

Interestingly, annuity outflows are not as highlyconcentrated among the top 10 insurers, withthose companies only accounting for 38% of totaloutflows. The top three insurers – MetLife,Jackson National and Pruco – accounted for 36%of inflows and 8% of outflows.



F IGURE 4 : IN F LOWS , OUTF LOWS AND NET FLOWS FOR TOP 10 INSURER S

FUL L YEAR , 201 1 – IN B I L L IONS

Market MarketCarrier Inflows Share Outflows Share

Metlife Investors USA Insurance Company 13.14 15% -1.94 3%Jackson National Life Insurance Company 10.58 12% -2.80 4%Pruco Life Insurance Company 9.01 10% -0.69 1%The Lincoln National Life Insurance Company 6.61 7% -4.44 7%Riversource Life Insurance Company 5.28 6% -0.80 1%Nationwide Life Insurance Company 5.18 6% -3.35 5%Western National Life Insurance Company 4.03 4% -2.91 4%Transamerica Life Insurance Company 2.83 3% -2.87 4%John Hancock Life Ins. Co(Usa)/Group Pension 2.52 3% -1.17 2%Pacific Life Insurance Company 2.40 3% -3.92 6%All Others 28.69 32% -41.41 62%

90.27 -66.29


F IGURE 5 : NET FLOWS FOR TOP 10 INSURER S

THROUGH JUNE , 201 1 – IN B I L L IONS ($B)

Carrier Net FlowsMetlife Investors USA Insurance Company 11.20Jackson National Life Insurance Company 7.78Pruco Life Insurance Company 8.32The Lincoln National Life Insurance Company 2.17Riversource Life Insurance Company 4.48Insurer No. 6 1.84Insurer No. 7 1.13Insurer No. 8 (0.05)Insurer No. 9 1.36Insurer No. 10 (1.53)All Others (12.72)

TOTAL 23.97

"Inflows, outflows and net flows calculated from transactions processed by DTCCInsurance & Retirement Services. Note that not all industry transactions areprocessed by DTCC."

VOLUME 2 , NUMBER 2

© 2012 Retirement Income Industry Association19

Analytic Reporting allows users to drill in to thedata not only by company but also applying othercriteria like product, account type and geography.That helps insurance companies focus andtarget their wholesaling activities for greatesteffectiveness.

Top 10 Insurers Annuity Sales by Net Flows andMarket ShareFigure 5 (on previous page) presents the top teninsurers ranked by net flows processed by DTCCin the full year 2011. The results shown in thischart are the logical extensions of the countertrends operating between inflows – heavilyconcentrated among the top 10 insurers – andoutflows, which are under-represented among thetop insurers. The concentration among topinsurers with inflows becomes even moreconcentrated with net flows. The top threeinsurers – MetLife, Jackson National and Pruco –account for the bulk of the total net flows. This ismassive concentration among a relatively fewdominant insurers.

Single Insurer Inflows by GeographyFigure 6 (above, right) presents the inflowsprocessed by DTCC for a single insurer for thefull year 2011 by the geographic location of thecontract-holders who brought that insurer’s non-qualified annuity product. The chart lists the topten states, ranked by the level of inflows, and thenprovides one number for the combined inflows ofthe other states. Even looking at geography, thesales for this insurer are concentrated, withaverage gross sales of $231 million per state forthe top ten states vs. average sales of $42 millionper state throughout the rest of the country. Whilethe absolute amount of inflows in other statesexceeds the inflows in the top ten states, the topten states are extremely productive geographicareas for this insurer.

In Figure 7 (at right), the RIIA geographic overlayis applied to this fictional insurer’s inflows. Eachof the top ten states is assigned to one of six

F IGURE 6 : IN F LOWS FOR A S INGL E INSUR ER BY GEOGRAPHY

FUL L YEAR , 201 1 – IN MI L L IONS

Owner State InflowsCalifornia $ 527Florida $ 349Texas $ 283Pennsylvania $ 253New Jersey $ 208Illinois $ 150Ohio $ 149Michigan $ 142Virginia $ 124Massachusetts $ 120Rest of states $ 1,703

This data is for illustration purposes only.

F IGURE 7: IN F LOWS FOR A S INGL E INSUR ER BY GEOGRAPHY

RIIA GEOGRAPHIC OVERLAY, FULL YEAR , 2011 – IN MILL IONS

NORTHEAST MID-WESTNJ $208 PA $253MA $120 OH $149

IL $150MI $142

Total $328 Total $694Average $164 Average $174Avg. all Insurers $54 Avg. all Insurers $83

SOUTHEAST SOUTHWESTVA $124 TX $283FL $349Total $473Average $237Avg. all Insurers $100 Avg. all Insurers $91

WEST COAST NORTHWESTCA $527Avg. all Insurers $118 Avg. all Insurers $27

This data is for illustration purposes only.

geographic segments around the country. Inflowsare summed in every segment and then anaverage inflow number is calculated. The analysishighlights superior results as groups of states andlarge geographic regions like California andFlorida are shown on a comparable basis.

While the inflows for this fictional insurer areinteresting, the data that could compel someaction is the comparison of those numbers to theaverage inflows for all insurers in the regions.Therefore the average inflows for each statedivided by the number of states in the region isincluded. Benchmarking an individual company’sinflows against overall trends in each region givesa true measure of performance, region by region,and lets company planners know where help isneeded and resources should be allocated.

Single Insurer Annuity Inflows by Market TypeFigure 8 (at left) presents the annuity inflows fora fictional single insurer processed by DTCC forthe full year 2011 by the type of market – retail,contributory IRA, IRA Rollover, 401(k), etc. Thischart is, in effect, a profile of this insurer’s DTCCbook of business across the markets. Differentcompanies can use this profile in different ways.Some insurers have objectives for specificmarkets. They, for example, may want to grow theRollover IRA business and may want to see theavailable inflows for that market. Other insurersmay just want to measure their currentperformance against the competition.



F IGURE 8 : IN F LOWS , GROSS F LOWS S INGL E INSUR ER BY

MARKET TYP E , THROUGH FUL L YEAR , 201 1 – IN B I L L IONS

One OneInsurer’s Insurer’s

Account Type Inflows Sales Share+ IRA $7.8699 60%+ Non-Qualified $4.8122 37%+ ROTH IRA $0.1514 1%+ SEP-IRA $0.1496 1%+ Money Purchase Plan $0.0871 1%+ 412I Inherited IRA Plan $0.0549 -+ Non Qual Stretch Plan $0.0093 0.071%+ 401(k) $0.0001 0.001%+ 403(b) $0.0009 0.007%+ Simple IRA $0.0001 0.001%15 Others $30 0%TOTAL $7,769 100%

"Inflows calculated from transactions processed by DTCC Insurance & RetirementServices. Note that not all industry transactions are processed by DTCC."

F IGURE 9 : VAR I AB L E ANNU I TY CONTRACTS

FUL L YEAR , 201 1 – IN B I L L IONS

In Out NetCompany Variable Annuity Flows Flows FlowsJackson National Perspective II 05/05 $ 5.98 $ (0.75) $ 5.23Jackson National Perspective L-Series $ 3.53 $ (0.51) $ 3.02Metlife USA Series VA $ 6.02 $ (0.40) $ 5.62Metlife USA Primelite IV $ 1.50 $ (0.18) $ 1.32Nationwide Destination B $ 2.28 $ (0.05) $ 2.23Prudential Pru Premier Retirement VA B Series $ 4.00 $ (0.10) $ 3.90Prudential Pru Premier Retirement VA L Series $ 2.73 $ (0.06) $ 2.68Prudential Pru Premier Retirement VA X Series $ 1.28 $ (0.03) $ 1.25River Source RAVA 5 Advantage Variable Annuity $ 4.10 $ (0.05) $ 4.05River Source RAVA 5 Select Variable Annuity $ 1.33 $ (0.01) $ 1.31


VOLUME 2 , NUMBER 2


Annuity Contracts Inflows, Outflows and Net FlowsThe final two charts in this article track insurersand their leading contracts. Figure 9 (on previouspage, bottom, left) presents the inflows, outflowsand net flows of the top 10 variable contractsprocessed by DTCC for the full year 2011. Notethat top contracts are concentrated among top-selling companies, with four insurers, JacksonNational, MetLife, Prudential and River Sourceoffering at least two contracts in the top 10 sellers.

Also noteworthy among the top selling contractsare the relatively modest outflows, resulting in netflows ranging from 86% to 99% of inflows.

Figure 10 (below) presents the inflows, outflowsand net flows of the top ten guaranteed contractsprocessed by DTCC for the full year 2011. Notethat top fixed contracts also are concentratedamong top selling companies, with New York Lifeand Western National claiming six of the top 10selling fixed contracts processed by DTCC.

Similar observations can be made about outflows.The modest outflows result in net flows in manycases being at least 80% to 90% of inflows. In atough interest rate environment for fixed annuities

managing guaranteed product lines to thislow measure of outflows is a noteworthyaccomplishment for these insurers.

ConclusionUsing information from DTCC’s AnalyticReporting for Annuities Service, executives caneasily access intelligence on their business and themarket that will help them make better decisionsand that will be invaluable to their businesssuccess. Using this service, executives can watchthe competitive landscape unfold before their eyesand respond strategically. Of course, once thistype of insight is available to some firms, nocompany will want to be left behind. Goingforward, firms will want this level of insight inorder to introduce new annuity product designsand other financial products through differentdistribution channels.

Analytic Reporting provides a paradigm shift inthe way firms will be able to analyze theirbusiness. From tracking success of sales seminars,product design, and wholesaler effectiveness firmswill be able to make more rapid decisions andmodify their strategy while trends occur, not sixor eight months later. Add to this the

F IGURE 10 : IN F LOWS , OUTF LOWS AND NET FLOWS OF TOP 10 CONTRACTS ,GUARANTE ED ANNU I TY CONTRACTS , FU L L YEAR , 201 1

NetCompany Fixed Annuity Inflows Outflows FlowsNew York Life NYL Secure Term Fixed Annuity II $ 1,180 $ (1) $ 1,179Symetra Custom 7 $ 1,102 $ (168) $ 934Western National WNL Chase Stable Growth 5 Yr $ 741 $ (73) $ 668New York Life New York Life Preferred Fixed Annu $ 442 $ (302) $ 140Pacific Life Pacific Frontiers II $ 369 $ (13) $ 356Western National Clnts Prefrd Choice 5/3 Yr Gty $ 321 $ (60) $ 262Western National WNL Flex 7,3 Yr Gty $ 315 $ (107) $ 208Genworth Financial SecureLiving Adv Pro NY Fxd Annty $ 227 $ (10) $ 217Protective Life Prosaver Secure II Fixed Annuity $ 226 $ (8) $ 217New York Life Select 5 $ 204 $ (27) $ 177




segmentation information RIIA provides and youhave a way to analyze the market on a macro andmicro level.

The annuity market is presenting opportunitiesgreat and small for firms that know where to look.Now, these companies can gain the informationthey need to analyze their situations and seize theopportunities that arise.

For more information about the AnalyticReporting for Annuities and RIIA’s custom views,please contact DTCC Insurance & RetirementServices at 888-382-2721 or via email [email protected].

RIIA is offering member companies and others theopportunity to join or sponsor the working groupwhose participants will take the lead ondeveloping a variety of new views of thisinformation and expand even further the ways inwhich this intelligence can be used in otherproduct lines such as mutual funds.

For more information about RIIA’s custom viewsand sponsoring the working group, please contactElvin Turner, RIIA Research Director at 860-212-7281 or [email protected]. �

Except where noted, all data presented in thispaper comes from Analytic Reporting forAnnuities from the Insurance & RetirementServices of National Securities ClearingCorporation, a DTCC Subsidiary. Visitwww.dtcc.com/analytics for more information orcontact your I&RS Relationship Manager.

About DTCCDTCC, through its subsidiaries, provides clearing,settlement and information services for equities,corporate and municipal bonds, government andmortgage-backed securities, money marketinstruments and over-the-counter derivatives. Inaddition, DTCC is a leading processor of mutualfunds and insurance transactions, linking fundsand carriers with their distribution networks.

All names of DTCC and its affiliates, and theirproducts and services, referenced herein are eitherregistered trademarks or servicemarks of, ortrademarks or servicemarks of, DTCC or itsaffiliates in the U.S. or elsewhere. Other names ofcompanies, products or services appearing in thispublication are trademarks or servicemarksof their owners. The Analytic Reporting forAnnuities Service data presented in this article iscopyright and owned by Insurance & RetirementServices of National Securities ClearingCorporation, a DTCC Subsidiary. Such data maynot be used as input data in the creation orcalculation of any index, value or other work andsuch data may not be used to create any financialinstrument or investment product that is based on,or seeks to match the performance of, valuesincluded in such data.

DTCC and RIIA are not affiliated.

VOLUME 2 , NUMBER 2


There are more retirement planning tools andconcepts available to the financial adviser than everbefore. However, many struggle with whichconcepts and products to use as more of their clientscome to them for advice on how to generate cashflow from the savings they have beenaccumulating for decades. When supporting agrowth and accumulation objective, most advisershave the advantage of relying on planning conceptsthat have existed for some time (e.g., modernportfolio theory) as well as products that aresomewhat easy to evaluate and manage for theirclients (e.g., mutual funds). However, shifting fromsavings to cash flow generation can be likemoving from basic math to advanced calculusconsidering that you have to account for a numberof additional customer needs and risks beyondwhat’s going on with the market.

As retirement-income concepts have evolved, so hasthe awareness of certain products and programs thatcan be deployed for elderly clients. Depending uponthe type of adviser – and their amount of

experience – they may rely more on packagedprograms or products that provide a range ofoptions or they will want to take on moreresponsibility to manage a broader portfolio of rawmaterials themselves. With the introduction of moreproduct allocation concepts for retirement income,these raw materials often include both investmentand insurance products. The insured productswithin these concepts can range from whole lifeinsurance to immediate annuities. Interestinglyenough, there has been a growing interest in thelatter by certain financial advisers. Thanks to anumber of factors including training and certificationprograms (like RIIA’s RMA), academic whitepapers and advances with marketing and educationthat help get through some of the behavioralfinance concerns, income annuities have becomea product that is being considered by morepractitioners. Even as insurance carriers shift theirstrategies and product mix to coincide with today’smarket realities, many have placed a renewed focuson immediate annuities as a basic offering that cancompliment a portfolio of products sold to themarket.

So the big question still remains. If incomeannuities make logical sense for consumers,advisers and manufacturers, why isn’t there abroader adoption? The sale of income annuities hasactually grown over the last year in comparison toother annuity products, but theoretically thisgrowth should be larger.

The answer lies with the fact that income annuities

GARY BAKERPRESIDENTCANNEX USA

Getting Income Annuities Ready for Primetime –Creating a Market Value

BY GARY BAKER



Where do immediate annuities fit in RIIA’s client segmentation matrix?

So why will advisers’ jobs be more complex for these customers? For one thing, customer needs andrisks vary depending on the overall financial situation of the retiree, not just the financial performanceof a particular product. We look at household need using tools like the RIIA Customer SegmentationMatrix, which is shown at right.

The Matrix shows three segmentsof customers – High Net Worth,Affluent and Mass Market – inone of three different financialsituations – Over-funded,Constrained or Under-funded.Inside each of the boxes arestrategies for dealing with eachcustomer, given their financialsituation. RIIA trains advisers onhow to use this chart, but sufficeto say here that every time you see“Productized Income Planningand Risk Pooling” in a box, youshould think of these types ofhouseholds as potential candidatesfor an income annuity product.

The situations differ by the comparison of the money that a customer’s needs to fund their retirementlifestyle to the financial assets that they have at their disposal. Customers who have an abundance ofassets providing more than enough income to fund their retirement lifestyle are considered Over-funded.Customers who have nowhere near enough assets to provide the retirement income necessary to fundtheir retirement lifestyle expenses are considered to be Under-funded. Consumers in the middle who canhave the assets with proper planning of varying intensity are considered “Constrained.” The strikinginsight of the chart is that customers at any level of wealth can be Constrained, requiring some level ofretirement-income planning. Advisers who offer income products can profit from understanding howthese insights affect their business and their prospecting opportunities.

In the chart when the Mass Market households are constrained, the analysis will show what incomes,assets, liabilities and budgets contribute to those constraints. Likely the Mass Market constrainedhouseholds have very different numbers than the constrained Affluent and High Net Worth households.The difference in the financial situations of households that are considered constrained can yieldtremendous insights into the different products and services that should be offered to the differenthouseholds.

Some insightful adviser may ask, “How can immediate annuities fit into such an analysis? They have nomarket value.” That observation was true…until today.

By Elvin Turner

2010 Client Segmentation MatrixRIIA’s Client Segmentation Matrix is based on the Household 360

VOLUME 2 , NUMBER 2


are still a square peg in the round hole of anadviser’s practice. Even at the consumer level, thereis still an informational void in helping an individual(and their adviser, if they have one) make abuying decision – similar to what Morningstarintroduced back in the 80s in the form of starratings to assist the evaluation process. But unlikemutual funds, guaranteed products are often soldand not bought since it takes a conversation or twowith an adviser to get the consumer comfortable inmaking a commitment to a long term position inreturn for that guarantee. Fundamentally, an incomeannuity (or any insurance product for that matter)can be a pain to deal with operationally comparedto investments and does not necessarily fit therevenue and service model around which advisershave grown their practice. These issues becomemore pronounced as product allocation conceptscontinue to place income annuities together withinvestments in a retirement income portfolio.Ultimately, this product has every right to be“mainstream” when managing retirement objectivesfor a client, but there are business barriers that stillget in the way.

In December 2010, a number of financial serviceorganizations came together to discuss ways toaddress some of these operational barriers andconcluded that the first one to tackle would be thatof market valuation. As a result, a workingcommittee was formed to tackle this initiative underthe sponsorship of RIIA with representatives fromover 40 organizations including manufacturers,distributors and service providers.

Addressing market valuation would cut across manyelements of the operational problem and potentiallyhave a tangible impact to adoption. One of thebiggest issues relating to valuation (or lack thereof)is that the assets used to purchase the incomeannuity disappear. They disappear from a client’sconsolidated statement, but most importantly, theydisappear from the AUM report for the adviser –

the primary scorecard for how well they areserving the market. Considering that certainincentives and recognition revolve around AUM,you can imagine how sensitive some firms are tothis issue. They know that the adviser should notbe penalized for doing the right thing for theirclients.

Historically, insurance carriers have been able tocalculate certain types of values for annuitizedcontracts whether it’s a statutory reserve foraccounting requirements or a commutation valueas defined as part of the product itself. However,distributors ultimately demand something thatwas more reflective of (and changed with) themarket – similar to all the other products andholdings they support. Previously in cases wherea carrier would provide a market value – orreplacement value – it was always a proprietarycalculation. Moving forward, there was a strongpreference for establishing an industry standard sothe working committee started to work together todefine a common methodology for marketvaluation as well as the technical requirements tomake it readily available.

The name Income Value was the identifier agreedto for this standard and the methodology wouldcover any annuitized asset regardless of the sourceincluding assets from deferred annuity contracts aswell as deferred income contracts otherwise knownas longevity insurance. In practice, Income Valueis defined as the actuarial present value ofremaining benefits from an annuitized contract.Agreeing to this definition was the easy part of theprocess. The tougher part was determining thecommon discount rate used for the presentvaluation as well as the mortality projections.

The working committee evaluated a number ofoptions relative to a discount rate ranging from theuse of the U.S. Treasury yield curve to the spot rateyield curve produced by the IRS for pension



valuations. After considerable analysis, it was feltthat the discount rate(s) used should be reflectiveof the pricing and experience of insurancecompanies when supporting these types ofguarantees in the market. In other words, the useof a yield curve that was specific to the insuranceindustry segment of the U.S. market. So a processwas identified where an Income Annuity YieldCurve would be derived on a daily basis and madeavailable to insurance carriers who would ultimatelymanage the valuation calculation for all of theirannuitized contracts. Similar to other processes inthe investment world (e.g., the Lipper BondIndex), the top income annuity payout rates fromacross the market would be compiled and averagedfrom which a spot rate curve would be re-engineeredand formatted. CANNEX Financial Exchanges hadagreed to build and manage this process.

On the mortality side, the working committee agreedon the most common mortality tables (A2000) andimprovement scales used today and to keep anyprojections static.

All together, this resulted in a valuation thatwould be the same regardless of the carrier thatholds the guarantee. The transmission of this newstandard will be accommodated through thePositions and Valuations (POV) file formatsupported by the DTCC starting in the fall of 2012at which time the first group of carriers anddistributors will start implementation.

As a result, the industry will have a valuationstandard that can be applied in many ways. Fromwhat we know today, the most immediate use willbe for AUM reporting at some of the distributionfirms. As part of a survey conducted across theindustry about a year ago on valuation, there isvirtually a 50/50 split as to whether or not

distributors will make this value available on a clientstatement. Some do not want to give theimpression that income value is a cash value thatcan be accessed at any time. For those that wouldapply this value to client reports, a commondisclosure statement was also developed by theworking committee from which firms can take andmodify based on their own legal and compliancerequirements.

Related to external reporting, there has also beensome demand by fee-based practices to use such avalue for the billing of their services. This makessense since many Certified Financial Planners(CFPs) prefer the use of non-packaged products andwould actually consider the use of an immediateannuity over that of a deferred annuity. Someregistered investment advisers have recognized thatthe placement and management of an incomeannuity within a broader retirement portfolio is aviable service that aligns with their practice and canbe operationally consistent with how they bill onalternative assets held away.

Finally, there are also some more advanced uses ofincome value that could be incorporated withfinancial planning tools as well as certain taxtreatments when these types of contracts areowned and held by certain entities.

Overall, solving for a standard market valuation isjust one of a number of items that need to beaddressed to help increase the use and adoption ofthese types of guarantees in the market. Goingforward, the committee has agreed to convene onan annual basis to review the adoption of thestandard and identify any modification that wouldneed to occur from time to time as the environmentwarrants. �

VOLUME 2 , NUMBER 2


Retirement is becoming increasingly real andimminent to many Americans. Unlike pastgenerations, where many households could relyon pensions to provide most of their retirementincome, many more among today’s (andtomorrow’s) retirees are facing the prospect offunding retirement on their own. This creates ahuge burden on retirees who are forced not only todetermine how much they need to save in order toachieve a successful retirement, but also how togenerate income and deal with the associatedrisks. This is a complicated task andunderstanding the differences in households andthe solutions they are seeking is perhaps evenmore complex.

Many households entering retirement will stepinto the asset-based world, deriving a large shareof their incomes from their investment portfolios.

In order to help industry stakeholders betterunderstand their customers, Morningstar haspartnered with the Retirement Income IndustryAssociation (RIIA) to look at the balance sheetsof pre-retired and retired households to betterunderstand their retirement income situation. Inparticular we will focus on the average amount ofincome that households will receive and theregularity, predictability and dependability of thatincome stream.

Morningstar will use data from RIIA’s RetirementTypology, a segmentation based on relevant lifestages and meaningful levels of wealth. Thetypology divides U.S. households into 16cohesive, consistent, and mutually exclusivesegments. The analysis looks at nine of the16 segments that have the most wealth and arenearest to the retirement years. Figure 1 (below)shows the number of households in each of theRIIA segments.

Morningstar’s ability to look at the assets andincome of households by segment allows it toevaluate the very different financial situations of

Income from Assets: The Promise of the FutureBY LARRY COHEN AND DAVID BLANCHETT

LARRY COHEN

VICE PRESIDENTDIRECTOR, CONSUMER

FINANCIAL DECISIONS (CFD)STRATEGIC BUSINESS INSIGHTS(SBI)

DAVID M. BLANCHETTHEAD OF RETIREMENT

RESEARCH

MORNINGSTAR: INVESTMENT

MANAGEMENT DIVISION

Starters Builders Pre-retired Retired TotalUnder 35 35<50 50<65 65+ All USHHs

Marginal 7.2 11.0 11.8 8.2 38.2

Mass Market 12.0 18.5 19.7 14.0 64.1

Affluent 3.6 5.5 5.9 4.2 19.2

Wealthy 1.3 1.8 2.0 1.5 6.6

Total 24.1 36.8 39.4 27.8 128.0

Age of Household Head Nine Segment Focus of RIIA

Source: SBI’s 2010-2011 MacroMonitor

FIGURE 1: MARKET SIZE OF THE RETIREMENT TYPOLOGY (MILLIONS)



the households. In order to evaluate a resourcecomponent in each of these cohorts the RIIAsegmentation divides each age group into fourlevels of wealth based on their total householdassets. See Figure 2 (at left) for a breakout of theasset levels for each segment.

One goal of the Morningstar analysis is to performa sort of financial ‘triage’ where we will likelydetermine that many households in the top Wealthmarket segment are fully able to achieve their goalto retire and most households in the bottomMarginal segment will be unable to even considerretirement without a considerable change incourse. Further, most households in the MassMarket and Affluent will require considerableassistance and careful planning to reach theirobjective. For each segment, we want to add adelineation to separate those that, with reasonableguidance and assistance, should be able to achievesome semblance of their retirement goal and theremainder who will need radical strategies in orderto even come close to achieving their objectives.

Using this analysis we can quantify theconclusions shown in the RIIA Matrix in Figure 3(on the following page). For example, the RIIAMatrix shows that there is a proportion of MassMarket, Affluent and High Net Worth householdsthat are under-funded, constrained and over-funded relative to their retirement incomeobligations. The Morningstar analysis will enableus to quantify the household financial situationsthat place them in those segments. In the chartwhen the Mass Market households areconstrained, the analysis will show what incomes,assets, liabilities and budgets contribute to thoseconstraints. It is likely the Mass Marketconstrained households have very differentnumbers than the constrained Affluent and HighNet Worth households. The difference in thefinancial situations of households that areconsidered constrained can yield tremendousinsights into the different products and servicesthat should be offered to the different households.

Segment

Starters

Builders

Pre- Retired

Retired

Age

Under age 35

Age 35 to 49

Age 50 to 64

Age 65+

Financial Asset Rangefor the Household

$475,000 or more

$1.2 million or more



The Wealthy - The first level is the top 5% of households in each cohort. Anyhousehold whose mean total assets place them in the top 5% for that cohort isassigned to this resource level which we call Wealthy.

Segment

Starters

Builders

Pre- Retired

Retired

Age

Under age 35

Age 35 to 49

Age 50 to 64

Age 65+


$230,000 to $475,000

$540,000 to $1.2 million

$730,000 to $1.9 million

$900,000 to $2.62 mil.

The Affluent - The next resource level is set at the next highest 15% of householdsin each cohort, which we will call Affluent.

Segment

Starters

Builders

Pre- Retired

Retired

Age

Under age 35

Age 35 to 49

Age 50 to 64

Age 65+


$14,000 to $230,000

$75,250 to $540,000

$104,000 to $730,000

$157,000 to $900,000

The Mass Market Households- The next resource level is the next 50% ofhouseholds in each cohort, which we call the Mass Market.

Segment

Starters

Builders

Pre- Retired

Retired

Age

Under age 35

Age 35 to 49

Age 50 to 64

Age 65+


Under $14,000

Under $75,250

Under $104,000

Under $157,000

The Marginal Households - The final level is the bottom 30% of households ineach cohort who have the lowest level of assets, whom we call Marginal.


FIGURE 2: ASSET RANGES OF THE HOUSEHOLDS IN RIIA AGE-WEALTH SEGMENTS

Figure 4 (at right) provides differences betweenhousehold segments in assets and net worth acrossthe three groups. Affluent households typicallyhave approximately four times more net worththan the Mass Market while the Wealthy typicallyhave more than 10 times the net worth of the MassMarket. Not only are there significant differencesin the total net worth within each segment but alsoin the types of assets that combine to create networth. Home equity is much closer within eachage range when compared to investible assets. Forexample, while the home equity of the Wealthy65+ segment is only three times as large as theMass Market 65+ segment, the investable assetsare approximately 17 times larger. This hassignificant implications on potential fundingsources for retirement income and will be a keypoint in our analysis.

For each of the nine segments we show threecategories of assets: Financial, Investable andTotal assets. Total assets represent all the holdingsof the households. However, while Financial andInvestable assets are two major components ofTotal assets, they are not the only components.

VOLUME 2 , NUMBER 2


F IGURE 3 : R I IA’S 2010 CL I ENT SEGMENTAT ION MATR I X I S BAS ED ON THE HOUS EHOLD 360

FIGURE 4: ASSETS AND NET WORTH OF RIIA MARKET

SEGMENTS (MEAN AMOUNTS IN THOUSANDS)

35<50 AGE GROUP SEGMENTMass Market Affluent Wealthy

Total financial assets $68 $271 $1,078Total investable assets $40 $168 $774Total assets $267 $757 $2,498Home equity $66 $174 $280Net worth $125 $510 $2,135

50<65 AGE GROUP SEGMENTMass Market Affluent Wealthy

Total financial assets $130 $594 $1,928Total investable assets $87 $425 $1,636Total assets $344 $1,161 $3,530Home equity $106 $273 $454Net worth $245 $990 $3,336

65+ AGE GROUP SEGMENTMass Market Affluent Wealthy

Total financial assets $178 $897 $3,120Total investable assets $167 $821 $2,920Total assets $418 $1,567 $5,414Home equity $171 $344 $523Net worth $366 $1,417 $5,204




Figure 5 (above) shows all the components ofTotal Assets for a household with two spouses.

The calculation of Total household assets is fairlystraight forward: retail assets plus definedcontribution assets plus real estate plus hardassets equal Total assets. The importance ofFigure 5, particularly for a financial adviser, isprofound. First of all, advisers should quicklyrealize that the investable assets they aremanaging are only part of the total resources thata household has available to fund retirement. DCplan assets and all the other tangible assets likereal estate, businesses and collectibles may bebeyond the reach of the adviser right now, but onlyfor the current moment in time. Over time anddepending on the households needs, and withsome planning, all assets are fungible andconvertible to investments.

In addition, advisers will realize that only lookingat the assets of one spouse may significantlyunderstate the ability of that household to providefor itself in retirement. While it is much simpler tofocus on one spouse and the accumulation of hisor her assets, the rewards of reaching both spousescan be seen when the couple steps into retirement.Typically, spouses who have accumulated wealthseparately before retirement will spend and saveas one unit in retirement. As new retirees put theirheads together and make consolidation decisions,advisers can lose retail accounts at the suggestionof spouses with whom they have had norelationships to other retail accounts that they didnot know existed. In households with two spouseswho maintain some separation of investments,there easily could be more than one adviser. TheMorningstar analysis will look across financialand investable assets and at the assets of bothspouses.

F IGURE 5 : THE COMPONENTS OF TOTAL ASS E T S

CombinedType of Asset Assets Held by Spouse One Assets Held by Spouse Two Household Assets

Investable Assets •Checking, Savings, Cash •Checking, Savings, Cash Combined retail•Mutual funds •Mutual funds investments, HSAs and•Annuities •Annuities trust investments of•Stocks and bonds •Stocks and bonds both spouses•Options •Options•CDs •CDs•Other retail investments •Other retail investments•Balances held in health savings accounts •Balances held in health savings accounts•Assets in trusts, 529’s, UTMA’s, •Assets in trusts, 529’s, UTMA’s,Custodial Accts. Custodial Accts.

+ Financial Assets •Investable assets •Investable assets Combined financial•401(k), 457 and/or 403(b) assets •401(k), 457 and/or 403(b) assets assets

+ Home Equity Real estate equity, with home equity in many cases is held jointly by both spouses. Combined real estateMay include the primary home, vacation homes, and investment real estate. equity

+ Non-financial Businesses, furniture, autos, boats, Businesses, furniture, autos, boats, Combined tangibleAssets collectibles, and other tangible assets collectibles, and other tangible assets assets

= Total Assets Investable + DC Plans + real estate equity Investable + DC Plans + real estate equity Combined Total+ tangible assets in spouse’s name + tangible assets in spouse’s name Assets

VOLUME 2 , NUMBER 2


Assets only tell one part of the story when itcomes to retirement, since some “assets” that areused to fund retirement are not typicallyconsidered as “assets” when thinking about networth, for example Social Security. While eachretiree’s Social Security benefit could be viewedas the mortality weighted net present value offuture cash flows, these are not included in anindividual’s typical “balance sheet.” There may beother sources of income and assets as well. As theconcepts underlying RIIA’s RMA program layout, in addition to financial assets, an advisershould consider the household’s human and socialassets as well.

Different segments will have different types ofincome that affect the advice advisers may giveconcerning the most suitable products to helphouseholds reach their retirement income goals.Figure 6 (at right) provides information about thesources and amount of income that RetiredAffluent households receive during retirement.

When considering income it’s important to thinkabout the “type” of each income source. Forexample, there are guaranteed income sourcessuch as defined benefit, Social Security or privateannuity payments. Households with high levels ofguaranteed income are unlikely to need additionalsources of guaranteed income (i.e., they’re lesslikely to purchase an immediate annuity). Thesehouseholds would be better served with advice onhow to manage their assets to best meet theirretirement income goals (or possibly their legacygoals).

This analytical framework enables us to map thebehaviors and financial holdings of households ineach segment to the financial products andservices that serve their financial needs. At a basiclevel, we can see how well providers havepenetrated various market segments. Also,attitudinal data about goals, preferences, risk andretirement will help explain the decisionshouseholds have made and what they may do in

the future.

As part of RIIA’s RMI program, Morningstar willanalyze the various investment- and product-related sources of income, characterize thesesources of income based on the level ofconsistency (e.g., periodic or guaranteed),compare and match types of incomes with thevarious expenses faced by a retiree and evaluatethe sustainability of the assets pools over time forthe households in each of the nine RIIA marketsegments. This research will provide financialservices firms with a better understanding of

FIGURE 6: INCOME SOURCES AND TYPE FOR RETIRED AFFLUENT

HOUSEHOLDS

AverageTRADITIONAL INCOME Amount TypeWages, salaries, commissions, tips $46,000 PeriodicNet self-employment, business $18,000 Periodic oror farm income Sporadic

AverageINVESTMENT INCOME Amount TypeInvestment income (net) $26,000 Periodic

Interest and dividend income $17,000 PeriodicNet income from investment real estate $44,000 SporadicCapital gains from sale of prop. or securities $9,000 SporadicIncome from royalties and partnerships $13,000 Sporadic

AverageRETIREMENT INCOME Amount TypeSocial Security or Suppl. Security Income (SSI) $24,000 GuaranteedRetirement payments or pensions fromprevious employer $35,000 GuaranteedPrivate annuity distributions $17,000 GuaranteedGovernment payments $19,000 GuaranteedIRA or Keogh distributions $24,000 Sporadic401(k), 403(b) or 457 distributions $17,000 Sporadic

Average“RIGHT PLACE, RIGHT TIME” INCOME Amount TypeInheritance $19,000 SporadicTrust income $14,000 SporadicContrib. from persons not living in household $12,000 SporadicOther $31,000 Sporadic



specific households’ retirement-income needs andtheir decision-making processes. The ability tounderstand and then target specific householdgroups will enable firms to identify, design, andoffer compelling and effective retirement-incomesolutions for specific customer segments.

So what is the promise of the future? We see threemajor positive outcomes from our work. First, wewill be able to size the current flow of retirementincome coming from the total assets of retiredAmerican households. Second, we will be able tocompare and contrast the households in thedifferent RIIA market segments, showingretirement income potential from the wealthiesthouseholds to those of more modest means.

Finally, we will be able to put our work in thecontext of different, multiple sources of income –investments, Social Security, pensions, etc. All ofthese will then be used to inform the potential forgenerating retirement income from the pre-retiredmarket segments. Together these calculations willhelp financial institutions and advisers to beprepared to meet today’s and tomorrow’s retiredhouseholds’ income needs. �

To contact Mr. Cohen: email [email protected] orcall 609-378-5044.

Mr. Blanchett can be reached at [email protected] and 859-492-5637.

All submissions will be eligible for the Thought Leadership Awards. Sponsored byAllianz Global Investors, the Thought Leadership Award program promotesadvanced research that expands the body of knowledge in retirement-incomeplanning and management. The winning entry for each Thought Leadership Awardwill receive $5,000. Members of the Academic Peer Review Committee serve as thejudges for the academic award andmembers of thePractitioner Peer Review Committee serve as thejudges for the practitioner award.

The Retirement Management Journal is presently seeking papers authoredby practitioners and academicians for upcoming issues of the RMJ.

Please contact editor & publisher, Robert Powell,at [email protected] more information.

For submission deadlines, please

refer to the Author’s Guidelines link

on the RMJ homepage, at:

www.retirementmanagementjournal.org

SM

VOLUME 2 , NUMBER 2


Outliving one's assets is the greatest fear for mostpre-retirees and retirees, and the steady shift inretirement funding responsibility – fromgovernment and employers to individuals – hasexacerbated this fear in the U.S. and the rest of thedeveloped world. This is occurring simultaneouslyas the number of retirees is set to reach historicallyhigh levels thanks to:� Demographic Changes: As Baby Boomers

turn 65 (to the tune of 10,000 per day), anincreasing proportion of the population will bedependent on a shrinking working population.The number of people aged 65 and over in USis set to increase from 37 million in 2005 to 81million by 2050.1

� Life Expectancy Changes: Improvementsin child health, sanitation and medical advanceshave steadily increased the life expectancy ofthe population in U.S. and other developedcountries. In the U.S., the average male lifeexpectancy at age 50 has increased from 23years in 1950 to 29 years in 2007. During thesame time period, the average female lifeexpectancy at age 50 increased from 27 to 33.2In other words, the average U.S. life expectancyis now 79 for men and 83 for women.

� Increasing Healthcare Costs: Heart diseaseand stroke, the first and third leading causes ofdeaths in the U.S., account for more than a thirdof all deaths. The total costs for these diseaseswas $444 billion or one of every six dollarsspent on healthcare in U.S.3

For most people, the only greater fear thanoutliving their assets during retirement is that thecosts of deteriorating health will drain theirretirement nest eggs. Last-year-of-life expensesconstituted nearly 22% of all medical and 26% ofall Medicare expenditures, and can be as high assix times the average for the rest. From 1992 to1996, mean annual medical expenditures (1996dollars) for persons aged 65 and older were$37,581 during the last year of life vs. $7,365 fornon-terminal years.4

The increasing number of people over 65, andrising medical costs – especially during the last yearof life – provide life insurers the opportunity toeducate customers and the general public about

How Financial Institutions Can Help Their Customersto Remain Healthy, Wealthy and Wise

BY ANAND S. RAO, PH.D, AND RON MASTROGIOVANNI

ANAND RAO

PRINCIPALPRICEWATERHOUSECOOPERS

FINANCIAL SERVICES ADVISORY

PRACTICE

.

RON MASTROGIOVANNI

PRESIDENT AND CHIEF

EXECUTIVE OFFICER

HEALTHVIEW SERVICES



medical costs during retirement and help them plantheir retirement income. At the same time, they willhelp many pre-retirees and retirees come to thepainful realization that their savings will beinadequate and they will have to reduce theirstandard of living – perhaps significantly – inresponse.5

Here are some sobering realities:� Federal entitlement programs face financial

challenges. The Congressional Budget Office(CBO) currently estimates that, withoutstructural reform, entitlement spending (SocialSecurity, Medicare and Medicaid) andinterest payments will absorb 100% of federalgovernment revenues by 2025.

� According to the 2011 Annual Report of theBoards of Trustees of the Federal HospitalInsurance and Federal Supplemental MedicalInsurance Trust Fund, Medicare is expected tojump from $522.8 billion in 2010 to $932billion in 2020 – a 78% increase in only 10years!

� People are living longer than they used to. Thecurrent mortality rate for the United States is78.7 and will rise to 81.3 by 2032. The longerpeople live, the greater the strain on Medicare.

� A recent report from Credit Suisse estimates thathealthcare comprises 33% of expendituresfor people over 60, dwarfing food and housing(23%).

� Since the passing of the Affordable Care Actand the Modernization of the Medicare Act,Parts B and D are now means-tested. Forsubscribers, this means that higher incomesequal higher premiums.

� Premiums also vary by state of residency.Where one retires may increase out-of-pocketexpenses by as much as 30%.

Challenges Facing MedicareThe birth of Medicare in 1965 brought, as WinstonChurchill once described, "the magic of averages

to the rescue of millions." While providingaffordable healthcare to the elderly was certainlya noble endeavor, and has worked well for the mostpart over the past five decades, the programsimply cannot continue to cover the recentastronomical rise in healthcare costs or the 78million Baby Boomers turning 65 (approximately10,000 per day) who will be entering the systemover the next 20 years. Accordingly, in the not-too-distant future, Medicare subscribers are likely to seereduced benefits and/or increased premiums (mostlikely, both); the vast majority of Boomers aresimply unprepared for the increasing out-of-pocketexpenses that await them in retirement.

Public ConcernsSurvey after survey indicates retiring Americans aredeeply troubled by what lies ahead. According tothe most recent “Affluent Insights Survey”conducted by Merrill Lynch, for the third year ina row, Americans cite rising healthcare costs as theirgreatest concern in retirement, and many areembracing the concept that budgeting forhealthcare expenses must become the foundationof the planning process; unfortunately, mostfinancial plans never address what healthcare inretirement will actually cost. Medicare paymentsend up being an afterthought – a line item in theexpense column during the planning process. Thismay be why the vast majority of Americans areunder the assumption that Medicare is actually free(or at least extremely affordable). Ultimately,additional out-of-pocket expenses, including co-payments, uncovered medications, eye exams,dental care, podiatry and so on, can consume thesavings of unprepared retirees.

Moreover, healthcare expenses increaseexponentially in the final two years of life, mainlybecause of the cost of assisted living facilities andnursing homes. It is estimated that 70% ofindividuals over 65 will need some level of long-term care,6 and average expenditures can range from

VOLUME 2 , NUMBER 2


Crunching the Numbers: A Case Study

John and Mary live in Ohio, are both 55, and have been married for 25 years. They have two children out of college and aremeeting with an adviser to consider their future retirement options. Both of them are still working and receive healthcarebenefits through their respective employers. Their combined yearly income is approximately $160,000, and they plan to retire atage 65. Mary is healthy, but John has high cholesterol, a poor diet, and no regular exercise regimen. Based on John’s lifestylechoices, he is likely to live to age 85, five fewer years than Mary.

The financial services industry has traditionally relied on an arbitrary planning number, usually 95 or 100, when projectingfuture costs. Generating a more precise planning number – one that is tailored to an individual’s disease-state and lifestyle choices– will help create plans that focus on specificclient needs. However, we advocate usingcalculations that are more directly applicableto individual client circumstances. Whenarmed with a fairly accurate picture of lifeexpectancy, advisers can begin to assesshealthcare costs; this is especially importantbecause Medicare is now means tested, andboth income level and state of residency willaffect projections.

If John and Mary want to sign up for theabsolute basic Medicare coverage (Parts A, Band D) and remain in Ohio, whose Medicarecosts are at the U.S. median, then they willstill be responsible for up to $415,840 of out-of-pocket healthcare costs throughoutretirement. However, notice how costsincrease as the income and residencyvaluables are inserted.*

There would be a substantial increase if thecouple is in the highest income bracket inFlorida, one of the most expensive states toretire. These figures may seem extraordinary,but they are very real. If this evidence doesnot compel advisers to discuss healthcarewith their clients, then long-term care should.

The earlier that people begin the discussion,the less the initial investment needs to be.Accordingly, if we return to John and Mary’soriginal number of $415,840, which willafford this middle-class couple basicMedicare coverage, an initial outlay of$120,000 invested in a stable product yielding6% will cover those expenses.

MAGI State Medicare Parts +MediGap + Dental,Level A, B, and D Plan Vision, Hearing

Under$170,000 OH $415,840 $750,400 $857,080Under170,000 NJ $417,170 $804,920 $946,710$170,000 -$214,000 OH $576,095 $910,655 $1,017,355$170,000 -$214,000 NJ $577,897 $964,647 $1,107,437

* Data provided by HVS Financial.

MAGI State Medicare Parts +MediGap + Dental,Level A, B, and D Plan Vision, Hearing

Above$428,000 FL $1,312,809 $1,700,599 $1,842,349


MAGI State Medicare PartsA +OneYear TotalLevel B, D,MediGap of Long-

Dental, Vision, TermCareHearing (Each)

Under$170,000 OH $857,080 $797,371 $1,654,451Under170,000 NJ $946,710 $1,210,750 $2,157,460$170,000 -$214,000 OH $1,017,355 $797,371 $1,814,706$170,000 -$214,000 NJ $1,107,437 $1,210,750 $2,318,187Above$428,000 FL $1,842,349 $882,776 $2,632,762




$20,000 to $150,000 per year in out-of-pocketexpenses in today’s dollars.

How Life Insurers Can HelpConsidering that healthcare will be the largestsingle expense for most retirees, and in light of thefact the majority of people inadequately preparefor retirement, there is a huge need for informedprofessional guidance, including on various on-the-shelf investment options that can coverout-of-pocket healthcare expenses.

While some firms are beginning to forge ahead inthis domain, their estimates for what is necessaryto fund healthcare – in some cases – are not backedby medical or actuarial data and sometimesproject figures far below the experience of thecustomers of financial advisers. In order forconsumers to have some idea of how muchmoney retirees need for health-related expenses,a more accurate computation – one based onclients’ individual health histories – would help allconcerned.

Industry professionals can adapt by learning thebasics of Medicare and utilizing actuarial-backeddata to accurately project longevity, healthcarecosts throughout retirement and long-term care.By doing so, advisers will be able not only to fullyserve retirees by addressing their number oneconcern, but also to increase business bymotivating clients to invest in stable off-the-shelfproducts that finance their healthcare throughoutretirement. This long-term solution to healthcarecosts will inevitably increase wallet share,aggregate accounts and improve investorconfidence.

There is some hesitation among individualadvisers to accept this new role, becausenavigating the Medicare bureaucracy to inform

clients about healthcare expenses in retirement canbe daunting. However, advisers can moreeffectively meet client needs by simply becomingfamiliar with basic features of the program andremaining up-to-date on legislative changesrelated to healthcare. Advisers can demonstratetheir concern for clients by asking about theirhealth history and medicines they currently take.Such an inquiry would reveal if a client’sprescription costs are reaching thedoughnut hole, in which expenses are fully out ofpocket.

Conclusion: Helping Clients, Benefitting AdvisersThese numbers are not meant to scare clients, butto help insurers engage them in the veryimportant conversation of saving for healthcarecosts. By providing them with this information,advisers will help clients answer vital lifestylequestions, such as “Should I wait to retire?” and“Will retiring to a certain state be too expensive?”This proactive approach will help retirees makeinformed decisions about embarking on theirgolden years confidently and securely.

Good health is the foundation of a successfulretirement. Without it, the size of homes, worth ofluxury items and length of vacations becomeirrelevant. Thus, institutions and advisers that placehealthcare costs first will ultimately win thebattle to aggregate Baby Boomers’ assets. Theinsurance industry has the products, rangingfrom mutual funds to annuities to life insurance,which can effectively address an issue that willaffect almost all Americans. If advisers integratehealthcare cost planning into their businesspractices, practically all clients will have a goodidea of the financial outlay required to coverinsurance premiums related to medications, testsand doctor visits. �

VOLUME 2 , NUMBER 2

Footnotes:1 US Population Projections 2005-2050, Pew Research Center, February 11, 20082 Today's Research on Aging; National Institute of Aging, Issue 22, August 20113 Heart Disease and Stroke Prevention - At a Glance 2011, Center for Disease Control and Prevention, 20114 Medical Expenditures During the Last Year of Life: Findings from 1992 to 1996. Health Services Research, 2002.5 Insurance 2020:Turning Change into Opportunity, PwC, December 20116 "Long-Term Care Insurance: A Piece of the Retirement & Estate Planning Puzzle." The Prudential Insurance Company of America, 2011

Upcoming issue deadlines:� Volume 3, Number 1, Spring 2013

Reserve ad space by February 1, 2013Ad artwork due by March 1, 2013

� Volume 3, Number 2, Summer 2013Reserve ad space by April 15, 2013Ad artwork due by May 15, 2013

What better forum to promoteyour Retirement-Management Solutions?

Download the Media Kit from the website: www.RetirementManagementJournal.org

Please email: [email protected]

for more information.

The Retirement Income Industry Association'sMarket Insight Research (RMI) Program is proud to announceNational Association of Fixed Annuities as a founding sponsor.

The RMI Program and its research partners thank Kim O'Brien and theentire board of NAFA for their support and commitment of the RMI.

October 4-5, 2012Boston, MassachusettsJoin your peers for a dynamic agenda on the latest developments in the world ofretirement-income planning and management. The RIIA Fall Conference will beheld at the Omni Parker Hotel.

Please contact

Deborah Burkholder,

[email protected],

for more information.

VOLUME 2 , NUMBER 2


Only 33% of employed individuals age 21through 64 participate in a defined contribution(DC) plan.1 Those that do have household income(HHI) nearly double that of the generalpopulation ($90,000 median HHI compared to$50,000); they are much more highly educated(49% with a four-year college degree or bettercompared to 28% of the population at large).2

Altogether, DC plan participants are a favoredgroup, in a relatively good position to plan for andachieve a comfortable retirement. This paper looksat their attitudes and behavior regardingretirement, their perceived retirement readiness,expected sources of retirement income and theirinterest in an in-plan guaranteed retirementincome option. Except as noted, cited data wascaptured in our late 2010 survey of more than1,100 DC plan participants, structured so thatfindings are projectable to the universe of all suchparticipants.

Without question there is an overriding degree of

anxiety and pessimism that is unprecedentedover the period we have been measuring it incomparable surveys since 2000. And that almostcertainly is a legacy of the 2008-2009 economicand financial markets meltdown, the ensuinganemic and “jobless” recovery to date and ageneralized lowering of expectations that seemsto have set in like a cold fog. Job vulnerabilityfeeds the anxiety with 36% of all participants veryor somewhat concerned about losing their jobwithin the next 12 months. Among thepre-retiree group, those age 50+, this rises to 43%(see Figure 1, below).

Economic and employment anxiety leads in turnto deferred retirement dates with 33% of all

RONALD L. BUSHFOUNDER AND PRINCIPALBRIGHTWORK PARTNERS

Defined Contribution Retirement PlanParticipants on Retirement

BY RONALD L. BUSH

F IGURE 1 : Q . -HOW CONCERNED ARE YOU THAT YOU MAY LOS E

YOUR JOB IN THE NEXT 12 MONTHS?

F IGURE 2 : Q . - IN THE PA ST 12 MONTHS HAVE YOU

CONS ID ER ED DE L AY ING YOUR RET I R EMENT B EYOND YOUR

OR IG INA L TARGET AGE , OR HAVEN ' T YOU?

< 50 28% 38% 27% 7%

50+ 17% 40% 30% 13%

Not concerned at all Not very concernedSomewhat concerned Very concerned

< 50 25%

50+ 55%



F IGURE 3 : Q . -G IV EN THE R ET I R EMENT SAV INGS YOU HAVE IN P L AC E R IGHT NOW AND THE RAT E AT WH I CH YOU

ARE ADD ING TO THOS E SAV INGS , WH I CH OF THE STAT EMENTS B E LOW DO YOU EXP ECT W I L L B E TRUE FOR YOU IN

R ET I R EMENT?

F IGURE 4 : Q . -WHAT ' S YOUR B IGGEST F INANC IA L WORRY R IGHT NOW-THE PROBL EM THAT KE E PS YOU AWAKE AT

N IGHT?

You will work at least part time in retirement

You will have to reduce your standard of living

You will have enough money to pay for health care

You will live as well or better as you did when you were working

You will run out of money

You will be able to help out younger family members with tuition or housing expenses

You will be able to leave money to family members or charities

You will be in a position to travel extensively

53%

45%

33%

30%

25%

17%

16%

14%

Just keeping up with your monthly expenses

Saving enough for your retirement

Credit card debt

Long-term care for yourself or your spouse when you need it

Paying college tuition for your kids

Your health care expenses apart from catastrophic illness

The expense of catastrophic illness

Paying the mortgage and taxes on your home

Saving to buy a home

Long-term care for your parents when they need it

24%15%

17%19%

13%16%

7%13%

7%2%

7%15%

5%6%

4%5%

4%0%

3%3%

Total50-64

VOLUME 2 , NUMBER 2


participants saying they have considered withinthe past 12 months delaying their retirementdate beyond the original target age, increasing to55% among participants age 50+ (see Figure 2, onpage 39). Of course, the definition of “retirement”is in a state of flux – 53% of participants expectto work at least part-time in retirement.

Among the most troublesome findings, 45% ofparticipants expect a reduced standard of living inretirement while only 30% expect to live as well

or better as when working (see Figure 3, top, onprevious page).

There is widespread concern about health carecosts and the potential burden of long-term care– people know they are expensive, potentiallycrushingly so, and there is great uncertainty as tohow high is high, what to prepare for and how todo it. These concerns naturally are magnifiedamong the 50+ pre-retiree group of participants(see Figure 4, bottom, on previous page).

F IGUR E 5 : Q . -PEOP L E SAV E FOR D I F F E R ENT R E A SONS . FOR E ACH OF THE SAV INGS OB J E CT I V E S B E LOW, P L E A S E

IND I CAT E TO WHAT EXT ENT I T I S A SAV INGS OB J E CT I V E FOR YOU .

Retirement

Paying down debt

Saving for unexpected expenses apart from health care

Saving for health care expenses

A major purchase or expenditure at some point in the future

A child’s education

62%40%

40%26%

31%29%

25%63%

24%15%

22%12%

Total65+

FIGURE 6: Q.-HOW MUCH ATTENTION DO YOU PAY TO EACH OF THE FOLLOWING ASPECTS OF YOUR

(401(K)/403(B)/457) PLAN?

Your balance

How well each of your funds is performing

How your account is allocated among different types of investments

How much income your account might generate for you in retirement

Information on the investment and administrative fees you pay

41%56%

28%40%

25%31%

21%35%

19%24%

Total50-64

More encouraging, commitment to theimportance of saving for retirement remainsremarkably strong, even among youngerparticipants – 62% of all participants say it is amajor savings objective, rising to 87% amongthose ages 50-64. Of note, among those age

65+, still in the workforce and contributing to aDC plan, there is a dramatic shift in savingsobjectives, with funding health care expensesreplacing retirement as the single most importantobjective (see Figure 5, top, on previous page).

In monitoring various aspects of their DC plan,participants pay the greatest attention to theiraccount balances and fund performance whilepaying least attention to the fees they pay. Weimagine that attention paid to fees will increasein 2012 after implementation of newparticipant-level fee disclosure regulations.Unsurprisingly, those ages 50-64 pay moreattention to everything with the biggest bumpcoming to the retirement income potential of theirplan balances (see Figure 6, bottom, on previouspage).

Across the board, participants expect their DC planto represent the most important source ofanticipated retirement income – that is highestamong 401(k) participants, characterized bylimited defined benefit (DB) plan coverage, andlowest among 457 participants with moreextensive DB coverage from their public sectoremployers (but even 457 participants expect agreater share of retirement income from their DCplan(s) than DB plans (see Figure 7, top, left).

On average, participants are expecting to replace80% of their working income in retirement, in linewith the replacement ratio often used as a rule ofthumb guideline by financial advisers (see Figure8, bottom, left). Ominously, only 17% are “veryconfident” that they will achieve that ratio.

Some 20% of participants would be very interestedin directing at least part of their DC plancontributions toward generating future guaranteedincome. There is greater interest among 401(k)participants, i.e., those without a DB plan (seeFigure 9, top, next page).



Total 401(k) 403(b) 457% % % %

401(k)/403(b)/457 plan or other typeof tax deferred defined contributionretirement savings plan providedthrough your workplace 35 36 31 29

Social Security 22 23 17 13

Income from personal savings, inc.Individual Retirement Accounts (IRAs) 14 15 9 7

Earnings from employment, inc.self-employment 10 9 12 15

Defined benefit pension plan, inc.cash balance plans 6 4 16 19

Fixed or variable annuities youpurchased yourself 4 4 3 2

Income from an inheritance 3 3 3 1

Other retirement plans providedthrough your workplace 3 2 7 11

Income from the sale of yourprimary residence 2 2 1 1

FIGURE 7: Q.-APPROXIMATELY WHAT PERCENTAGE OF YOUR

HOUSEHOLD INCOME IN THE FIRST FIVE YEARS YOU ARE RETIRED DO

YOU EXPECT THIS SOURCE TO PROVIDE?

Total 18-34 35-49 50-64 65+

Average TargetRetirement Income($ in thousands) $84 $85 $88 $75 $82

Average HouseholdIncome($ in thousands) $105 $93 $110 $108 $137

Replacement Ratio 80% 91% 80% 69% 60%

FIGURE 8: Q.-THINKING REALISTICALLY, IN TODAY’S DOLLARS, WHAT

WOULD YOU LIKE YOUR HOUSEHOLD INCOME TO BE IN RETIREMENT?

Interest in an in-plan guaranteed income featureis not much affected when told that there is asignificant extra cost, in this case 1% of accountvalue. Interest is greatest among lower incomeparticipants and declines with rising householdincome. Curiously, interest is greatest amongmid-career participants and declines with age (andproximity to retirement). Several observers havehypothesized that this phenomenon might bedue to the greater availability with increasing ageof a meaningful DB plan benefit, be that an activeplan with a current employer, a frozen plan or alegacy plan with a former employer, however, thedata do not bear this out, suggesting analternative hypothesis: that the closer one gets toretirement the harder and more clear-headed onethinks about these things, leading to theconclusion that the appeal of purchasingguaranteed income within the DC plan holds upless well under a more critical look (see Figure10, bottom, right). �

For more information visit our website atwww.brightworkpartners.com or contact RonaldBush, [email protected], or203-487-2000.

Endnote:1 EBRI, 2009 data2 Current Population Survey, 2009

VOLUME 2 , NUMBER 2


FIGURE 9: Q.-HOW INTERESTED WOULD YOU BE IN CONTRIBUTING TO

AN INVESTMENT OPTION WITHIN YOUR (401(K)/403(B)/457) PLAN

THAT INSTEAD OF ACCUMULATING AN ASSET BALANCE FOCUSES MAINLY

ON GENERATING A GUARANTEED MONTHLY INCOME IN RETIREMENT?

FIGURE 10: Q.-HOW INTERESTED WOULD YOU BE IN CONTRIBUTING TO

AN INVESTMENT OPTION WITHIN YOUR (401(K)/403(B)/457) PLAN

THAT INSTEAD OF ACCUMULATING AN ASSET BALANCE FOCUSES MAINLY

ON GENERATING A GUARANTEED MONTHLY INCOME IN RETIREMENT?

7% 21% 52% 20%

7% 21% 51% 22%

8% 24% 51% 17%

11% 15% 63% 11%

Not interested at all Not very interestedSomewhat interested Very interested

Total

401(k)

403(b

457

7% 21% 52% 20%

4% 24% 53% 19%

8% 16% 52% 24%

5% 27% 53% 15%

57% 17% 16% 10%

6% 20% 52% 22%

10% 26% 49% 15%

Not interested at all Not very interestedSomewhat interested Very interested

Total

18-34

35-49

50-64

65+

< 50

50+

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VOLUME 2 , NUMBER 2


It wasn’t supposed to happen this way.Growing up in the 1950s, I never thought aboutretirement. By the time I got through school, the1960s were over and it was enough to just find adecent job. It took me most of the ‘70s to get areal job with benefits, two weeks paid vacation,health care (not that I cared in my 20s),retirement savings and an annual salary of $6,900.Is it any wonder that when I changed jobs duringmost of the early ‘80s I just took the money outof my retirement plan and didn’t roll it over intoan IRA? I mean, the penalties and taxesreally didn’t amount to anything.

But by the middle of the ’80s, I got serious. Myfather passed away at the ripe old age of 62 and inmy 30s I began to realize that I had to grow up. Imet a girl, got married, had kids and bought myfirst house. I opened an IRA and started to saveenough in my 401(k) to match my employer’scontribution. That’s also when I first started tothink seriously about retirement. But my firstthoughts weren’t that positive. I mean, I was 44when I had my second child, and it wasn’t toodifficult to add 22 years until she got throughcollege and I would be 66, just four years olderthan the age at which my father died. The mostlikely scenario was that I would pass away just

when I finished paying for her college. What Ireally needed was life insurance, not retirementsavings!

During the 1990s I saw real increases in myretirement savings because I had put everythinginto an S&P 500 index fund. Since I wasn’tplanning on making it past my 60s, I figured Icould take plenty of risk. My term life insurancemeant that if something happened to me, my wifeand kids would be OK. I even shifted intoemerging markets in the mid-1990s, just in time tolose a little to the Long-Term Capital debacle. Imanaged to shift it back into an S&P index by theend of the decade, just in time to watch it shrink inthe early 2000’s. It was around 2006 when theequity I had in my house had gone up so much Itook out a home equity line of credit (HELOC) tofix up the house. My wife and I figured we wouldbe staying there while we put the kids throughcollege.

The home repairs cost almost twice the originalestimate and it took nearly a year to finish thework, but by 2007 the place looked great and itsassessed value had gone up more than what wepaid. Sure the taxes were higher, but the waythings were going, by the time the kids were donewith college our house would be worth so muchmore than we owed that we could sell it, pay offall the debt and actually have a decent chunkleftover for jumpstarting our retirement. I beganto imagine what it would be like to retire,assuming I lived that long. I mean, if I could justkeep working four or five years after the kids weregone, I might have a decent retirement. I wouldput it into the market and when it was time toretire, maybe I would buy an annuity orsomething.

LARRY COHEN

VICE PRESIDENTDIRECTOR, CONSUMER

FINANCIAL DECISIONS (CFD)STRATEGIC BUSINESS INSIGHTS(SBI)

What Happened to My Retirement?BY LARRY COHEN



That was the last time I actually thought I mightretire.

You can guess what happened. My house lost over30% of its value – the payments for the mortgageand the HELOC are a huge burden. We can’t seemto qualify for refinancing since my wife lost herjob. That’s not as bad as it sounds because it givesher more time to look after her mother who’sstarted to go downhill. The good news is that myson got into one of the best schools in the country;the bad news is that it’s the second mostexpensive school in the country. Don’t ask aboutmy retirement accounts. They had barely made itinto six figures before the market crashed. Nowthey’re stuck in the high five figures and I movedeverything into bond funds and money markets.My employer is no longer matching anycontributions and I’ve cut back my contributionsto less than 4%. Oh, and now I have to pay for myhealth insurance. My employer says it’s only 40%of the total cost, but my out-of-pocket goes upevery year. I guess I’m still in the middle class as

my income is over $100,000, but we’re eatingmore chicken than steak, more beans thanchicken, and we rarely eat out.

Retirement once seemed almost within reach, butnow it is a distant dream. I don’t have enough foranyone to even be interested in helping memanage my retirement. My plan now is to keepworking until I die. I guess there will be someSocial Security, although the way the politiciansare talking it sounds like I can’t rely on that. Mywife is going to have to keep working – she’s stilllooking for a job. Of course, if I don’t die, it isn’tmuch better. I just get to work longer. The thoughtthat I might have a retirement as a life-of-leisureis long gone.

Does this sound familiar? The fact is thatretirement is a middle-class problem. The wealthyand the poor have no problem with retirement:The wealthy will retire, the poor won’t – noproblem! But, for the vast number of those in themiddle, the other 79%, retirement is a real

FIGURE 1: TOTAL AGGREGATE ASSETS – COHORT TREND

Source: The MacroMonitor. All asset values are adjusted to 2010 dollars.

VOLUME 2 , NUMBER 2


problem – and the questions of if, when and howwe retire are huge unknowns. To make mattersworse, most of the examples of retirement –our parents, media portrayals and financialinstitutions’ marketing – don’t seem realistic givenour resources and responsibilities. We need helpto lay out the real choices, trade-offs,challenges and opportunities that face us (seeFigure 1, on previous page).

Unlike 20 years ago, Boomers have more of thetotal (financial, investable, retirement and liquid)assets now. Once you eliminate the top 1% andthe bottom 20%, the 79% that remain (37 millionhouseholds) have $20 trillion in assets with anaverage of $545,000 each. These are the peoplewho really need help, and lots of it, right now. Butthe help they need, and the way they feel aboutfinancial institutions and professionals, is verydifferent from the prior generation and even from10 years ago. Although trust in institutions and/orintermediaries goes up with age, the trend for bothis down over the past two decades. The gap is

larger for the Boomers than their elders. (The gapfor Gen X/Y is even greater, but that’s a story foranother day.)

Real estate may not be the first concern of afinancial adviser (or even the second or third!),but for most households, especially Boomerhouseholds, it remains foremost. On both the assetand debt sides, the home remains the largest partof the balance sheet, despite depressed values. Theweak and degenerating state of the real estatemarket is the primary reason for the currenteconomic malaise and why households havechanged how they look at their retirement. It usedto be that households thought of their home as thenest egg. As you can see from the chart above, theaverage amount of equity that Boomers have intheir real estate peaked in 2006 and has beendeclining ever since. Economists believe that wehaven’t seen the bottom yet. And nearly 60% ofall Boomer homeowners still have debtoutstanding on their homes (see Figure 2, above)!

FIGURE 2: INVESTABLE ASSETS, REAL ESTATE EQUITY & RETIREMENT ASSETS – BOOMERS TREND

Source: The MacroMonitor. All asset values are adjusted to 2010 dollars.



Although their retail investable assets havestagnated since 2006, Boomer households cantake some solace in the fact that their averageretirement assets continue to grow. And, a third ofall Boomer households have a fully vestedpension plan. However, these numbers distort thediversity of desperate situations that Boomers findthemselves in right now. With a small group of theleading edge Boomers either in or rapidlyapproaching retirement, many if not most of theother Boomers are feeling increasingly depressedas their chance at retirement is slowlydisappearing farther and farther into their rapidlyaging futures (see Figure 3, above).

As the oldest Boomers reach 65 years old, the(more successful) leading edge is working less.Since 2006, significantly fewer Boomerhouseholds are working each year with more thanfive million Boomer households already retired.The number of Boomer households that say theyare retired will continue to grow in spite of theeconomy, although the number of these retired

households that are continuing to work, or areseriously thinking about returning to work, isincreasing.

Another demographic shift among Boomers,starting in 2006, is that the number of Boomerhouseholds with dependent children (the type youcan deduct on your income taxes) has droppedsignificantly. Unfortunately, many of these‘children’ are NOT moving out of the home. Andeven among those that have moved out, some aremoving back in while others remain on themonthly ‘pay-rent-al payroll,’ even when it meansthe parents are putting their own retirement injeopardy.

There are other responsibilities, as the chart aboveshows, where Boomer households are becomingfinancially responsible for other adults. It issurprising to learn that less than a third (30%) ofthese dependents are from an older generation.The vast majority (61%) are of the samegeneration as the Boomer household! What’s

FIGURE 3: OTHER BOOMERS’ TRENDS

Source: The MacroMonitor.

VOLUME 2 , NUMBER 2


more, one out of six of these dependant adults isfrom a younger generation. Many of thesedependents will outlive the responsible household.In addition, over a quarter (27%) of all Boomerhouseholds have been separated or divorced (morethan Gen X/Y 14% or the Silent/Greatest 19%)creating complex family structures with additionalresponsibilities that might complicate retirementplans.

Any discussion of how the demographic trendsare different from prior cohorts would not becomplete without acknowledgement that most ofBoomer households have two heads who haveworked or are working – which means twoincomes, two sets of retirement accounts and twodifferent timelines. Of the 55% of Boomerhouseholds with two heads, 65% of the womenand 75% of the men are still working. Men tend tomarry younger women, women tend to live longerthan men and women tend to have more careerinterruptions. All of which suggests that thechances of both heads retiring at the same time is

significantly less than among prior generations. Inaddition, since retirement tends to happen TOpeople more often than people actually retiring ona planned date, many static retirement plans willneed to be adjusted. What can a pre-retiree or anadviser do when so much of the traditionalretirement planning and products were builtduring an era of greater demographic simplicity?

Even if there were an accurate understanding ofcurrent retirement needs, with well-designedproducts and services coupled with readilyavailable expertise, it wouldn’t do much good asBoomers’ trust in financial institutions andprofessionals continues to erode. At the criticaltime when Boomers need even more help, theirtrust in the very places and people from whomthey would get this help has diminishedsignificantly (see Figure 4, above).

All of these trends, some in place for decades,others more recently, have come together at thismoment to necessitate a total redefinition of

FIGURE 4: TRUST IN FINANCIAL INSTITUTIONS & INTERMEDIARIES, COHORT TREND

Source: The MacroMonitor.



retirement. Changing demographics, economicnecessities and increasing life expectancies willforce the majority of Boomers to alter the verynature of retirement. We tend to forget thatretirement was only ‘invented’ in the 1930s as away to encourage older workers to leave the workforce so younger men could find a job. We have analmost identical situation today where theBoomers are doing everything they can to hold onto their jobs while the youngest generation, theMillenials, are having a hard time finding anydecent paying jobs, much less starting a career.

We need to ‘Reinvent Retirement’ to make itpossible for the other 79% of us to retire. The keyfor doing this requires that we answer a familiarquestion, “What do we want to ‘be’ when we growup?” Although they may not have enough savedup to live the retirement life of luxury theyenvisioned, many Boomers do have some assets.Many are physically fitter than their parents wereat this age, affording them the choice ofcontinuing to work or engage in other activities.

And we know that the chances of not outlivingthose assets go up the longer one continues towork and delays drawing them down. Boomersare the most educated cohort (so far) and havespent their lifetime developing various skills andexpertise, so why not try and keep working doingwhat you want, like, enjoy, whatever, as long as itprovides enough income to live on?

There is some urgency to start redefiningretirement now and not wait until things getbetter. First, it is unclear when things are going toget better and time is wasting – every 12 monthswe get one year older. Second, unlike earlier lifestages where one could go into them unpreparedand make it up as they go (and Boomers arenotorious for not preparing for their futures),Boomers’ ability to make decisions is only goingto get worse, until they may not be able to makethem at all (one’s mental abilities tend to declineonce one passes 60-years old). If they don’t havetheir financial lives setup and running smoothly, itis going to be their children’s or the state’s

FIGURE 5: REDEFINED RETIREMENT LIFESTAGES, SILENT/GREATEST VS. BOOMER COHORT TREND COMPARISON

Source: The MacroMonitor. Base=Household head 55 or older with no dependent children at home

VOLUME 2 , NUMBER 2


problem. But the most urgent reason for starting toredefine retirement now is that there is atremendous opportunity to continue to accumulateBoomer assets and generate fees by helping themto navigate the uncharted territory of howretirement is changing (see Figure 5, on previouspage).

The first step on this journey is revolvingretirement. In the new world the vast majority ofBoomers will not go straight to retirement. Theywill transition first into a ‘revolving retirement’phase. The easiest way to think about this lifestage is to imagine the line between pre-retirementand retirement expanded into its own life stage.Households may cross back and forth betweenworking and not working, transition from full timeto part time, downscale their life style, wait fortheir spouse to finish working, pursue otherendeavors, volunteer, hobbies for profit, etc. –whatever enables them to delay having to drawdown their limited resources in full retirement.

Revolving retired households have one foot inretirement and one remaining vocationally active,with their financial needs reflecting aspects ofboth and neither. The fact that this life stage is notstatic but constantly changing creates morechallenges. For example, sometimes theseBoomers may live off their assets and at othertimes they may want to add to their retirementaccounts. Also, many of these revolving retired

may start their own businesses, so they will needplenty of new and different financial services andadvice. Regardless of what they decide to do,these revolving retired Boomers are going to needhelp and lots of it to solve their problems, com-bine existing products and services and bend themto their needs.

The revolving retired segment will grow andeventually dominate the majority of Boomerhouseholds as they travel the economicuncertainties of the next decade and eventuallyachieve a more traditional retirement. The answerto the question, “What Happened to MyRetirement?” is that it grew up. Retirement, as wehave come to know it, was designed for peoplefrom the 20th century, with its shorter lifeexpectancies, structured households, well definedgender roles and well funded pensions.Retirement in the 21st century will have to bedifferent for most of us. Unfortunately, there areno easy answers or pre-established ‘rules ofthumb’ for meeting the revolving retired’sfinancial needs. Those financial institutions andprofessionals who identify, recognize and satisfythe financial needs associated with this new lifestage will find a receptive marketplace andsignificant success. �

To contact Mr. Cohen: email [email protected] orcall 609-378-5044.

VOLUME 2 , NUMBER 2


AbstractFor those concerned with the long-term value oftheir accounts, it can be a challenge to plan in thepresent for inflation-adjusted economic growthover coming decades. Here, I argue that thereexists an economic constant that carries throughtime, and that this can help us to anticipate themore distant future: global economic wealth has afixed link to civilization’s total capacity for powerproduction; the ratio of these two quantities hasnot changed over the past 40 years that statisticsare available. Power and wealth rise equallyquickly because civilization, like any othersystem in the universe, must consume anddissipate its energy reserves in order to sustain itscurrent size. One perspective might be thatfinancial wealth must ultimately collapse as wedeplete our energy reserves. However, we can alsoexpect that highly aggregated quantities likeglobal wealth have inertia, and that growth ratesmust persist. Exceptionally rapid innovation in thetwo decades following 1950 allowed forunprecedented acceleration of inflation-adjustedrates of return. But today, real innovation rates aremore stagnant. This means that, over the comingdecade or so, global GDP and wealth should risefairly steadily at an inflation-adjusted rate of about2.2% per year.

IntroductionOur financial accounts seem to changeunpredictably according to the actions ofindividuals, organizations and governments.Because the range of human behavior can be sodiverse and out of our control, it seems that thereis an exceptionally broad range of future societaloutcomes. Anticipating long-term economicconditions anything more than a year away seemsdaunting at best.

For atmospheric scientists like myself,forecasting future human behavior becomesrelevant where the goal is to provide society withforecasts of climate change. Through thecombustion of fossil fuels, our economicactivities have been slowly increasingatmospheric greenhouse gas concentrations1.Consequent changes in climate patterns remainmodest. But, perhaps several decades from now,global warming will become an important drag oneconomic growth2.

For current and future retirees, the issue is moreabout anticipating inflation-adjusted rates ofreturn for their accounts, sometimes as much as adecade or more ahead. While, diversification canhelp financial portfolios to weather short-termfluctuations in market valuations, the optimalstrategy for the longer term is less clear. Forexample, regardless of investment strategy, BabyBoomers have generally prospered from a risingeconomic tide that has lifted most boats over thepast half-century. Yet many worry that suchextraordinary overall gains cannot persistindefinitely. All tides subside. Broad economicgains can be lost.

Are we confined to hoping for the best but

TIMOTHY J. GARRETT, PH.D.ASSOCIATE PROFESSOR

DEPARTMENT OF ATMOSPHERIC

SCIENCES, UNIVERSITY OF UTAH

PRESIDENTFALLGATTER TECHNOLOGIES

Can we predict long-run economic growth?BY TIMOTHY J. GARRETT



preparing for the worst? Or can we at least planahead for the future by making constrainedpredictions for where our net worth is headed? Ina recent paper, I proposed that we can, providedthat we are willing to take a broader view byconsidering slow changes in the economy as aglobal whole3,4.

A Link Between Economics and PhysicsBy applying physical reasoning I developed anargument that civilization’s fiscal wealth has afixed link to its overall rate of primary energyconsumption, independent of time. Observationsseem to support this hypothesis to a remarkabledegree (see Figure 1, above). For retirees, theimplication is that global wealth will continue torise for as long as power consumption cancontinue to grow. Otherwise, if resources everbecome so constrained that consumption falls,global wealth must enter a phase of collapse.

Before elaborating further on this economicgrowth model, it is worth comparing it to

traditional macro-economic models that focus onhuman labor and creativity as the motiveeconomic forces. Almost all economists treat“human” capital, or labor, and “physical” capitalas two totally distinct quantities. Labor andcapital combine in a complex way to enableeconomic production. A small part of economicproduction is a savings that can be carried into thefuture as added physical capital. But mostproduction is siphoned away by people throughtheir consumption of such things as food andentertainment. Once something is consumed, ithas no potential to influence future economicactivities.

While this model is certainly logical, from thestandpoint of physics, it seems strange because itappears to both ignore and violate the mostuniversal of laws: the Second Law ofThermodynamics. The Second Law is familiar tomany for its statements about entropy production.Perhaps the best known is that the universe, takenas a whole, inescapably slides towards increasingdisorder.

But the Second Law also demands that nothingcan do anything without consuming concentratedenergy, or fuel, and then dissipating it as unusablewaste heat. For example, the Earth “consumes”concentrated sunlight to power weather and thewater cycle, and then radiates unusable thermalenergy to the cold of space.

Like the weather in our atmosphere, all economicactions and motions, even our thoughts, must alsobe propelled by a progression from concentratedfuel to useless waste heat. The economy wouldgrind to a halt absent continued energetic input.Buildings crumble; people die; technologybecomes obsolete; we forget. Civilization mustconstantly consume in order to sustain itselfagainst this constant loss of energy and matter.

So, for example, we as individuals consume theenergy in food at an average rate of about 100

FIGURE 1: THE RATIO OF POWER TO WEALTH

Since 1970, global wealth as defined by Eq. 2 (blue), global power consumption

(red), and the ratio of power to wealth (black). Wealth is referenced to 100

in 1970.

VOLUME 2 , NUMBER 2


watts. This sustains and builds the jointactivities of our brain, heart, lungs and other bodyfunctions. We must keep eating to regenerate deadcells and offset the constant loss of heat throughour skin.

As a whole, civilization is no different, except thatafter centuries of growth, it is rather large andwealthy. Today, sustaining all of our activitiesrequires continuous consumption and dissipationof about 17 trillion Watts of power, or theequivalent of 17,000 one Gigawatt power plants.

We burn fossil fuels, split uranium nuclei and tapthe potential energy in rivers, sunlight and wind.About 4% of this energy sustains our 7 billionbodies. The rest powers our agriculture, buildingsand machines. Once consumed, all energy isultimately dissipated as waste heat. If energyconsumption ever ceased, our machines wouldstop, and we would all die. Certainly, economicwealth would be zero.

Treating the Economy as a Global WholeThe idea that the economy is sustained by powerconsumption has certainly been discussed byothers5. However, there is a particularlybeautiful corollary of the Second Law whoseimplications have largely been missed. This is thestatement that nothing can be isolated: all of spaceand time are linked. Nothing can happenspontaneously, and all actions from the past havesome influence on the present and future. Equally,no sub-component of the universe can becompletely isolated from interactions with anypart of the rest. However, remote or slow theinteractions may be, all parts are connected to andinteract with all others.

The implication for society is perhaps bestexpressed by the Elizabethan poet John Donne,“No man is an island, entire of itself. Each is apiece of the continent, a part of the main.”Through international communications and trade,ourselves, our ideas, education and relationships

all form a vibrantly interacting and changingwhole that is completely integrated with ourtransportation routes, communication networks,factories, buildings and databases.

In other words, all elements of civilization worktogether. No matter how distant, no element ofeconomic production can be isolated from anyother. We are all part of a vibrant organism we callthe global economy. A portion of real productioncannot simply disappear due to "consumption" byhumans, because humans are inextricably linkedto the rest of the organism’s overall structure.

Neither can consumption vanish to history. Rather,power consumption that sustained us againstdissipation and decay in the past, nurtured usforward so that we continue to consume in thepresent. Feeding Ancient Greece sustained anarchitectural tradition that has been carriedforward to the designs of today. Entertainmentconsumed a hundred years ago sustained a culturaltradition that influences our choices today.

A New Model for Economic GrowthIn an economic growth model, the abovearguments are simply expressed by a hypothesisthat “Wealth is Power”. We are sustained by aconsumption of energy. All inflation-adjustedeconomic output must be returned to wealthdefined as human and physical capital combined.

Unlike traditional economic treatments, realproduction can neither be siphoned off to humansalone, nor to the past. It has nowhere else to gobut to “produce”, thereby adding to combinedwealth.

This means that we can consider the current globalGDP as being the “rate of return” on globalwealth. Or, equally, current wealth is theaccumulation of past inflation-adjusted globalGDP. The tie to physics is that wealth is directlyproportional to power consumption. Only whenpower consumption exceeds dissipation can a



convergence of flows allow for civilizationexpansion and a positive inflation-adjustedeconomic output or GDP (see Appendix for themathematical details).

Crucially, this hypothesis is falsifiable. In otherwords, it is sufficiently simple, transparent andeasy to test, that it could potentially be discardedbased on observational evidence. I tested thishypothesis using statistics for world GDP andenergy consumption that are available for eachyear from 1970 onward, together with more sparseestimates for world GDP that extend back to1 AD3.

What these data show is that, for each yearbetween 1970 and 2009, the ratio of powerconsumption to wealth has barely deviated from aconstant 7.1 watts per thousand inflation-adjusted2005 US dollars (Figures 1 and 2). The standarddeviation has been only 3% during aperiod when global power consumption andwealth have increased by 120% and world GDPhas risen 230%. Wealth and power consumptionare not merely correlated, any more than mass andenergy are correlated in the formula E = mc2.Rather, like mass and energy, the ratio of the twoappears to be fixed.

It seems extraordinary, but the implication is thatwe can begin to think of seemingly complexhuman systems as simple physical systems. Our

collective fiscal wealth is an alternative and veryhuman measure of our capacity to power oursociety through the consumption of fuel. Ourtotal assets, including ourselves, our relationshipsand our knowledge, are inseparable from ourcollective capacity to consume our primaryreserves of coal, oil, natural gas, nuclear fuels andrenewables. Both will rise and fall together.

Precision vs. Predictability in Economic ForecastsFor current and future retirees concerned with thelong-term value of their accounts, a link betweeneconomics and physics has some importantimplications. Perhaps most encouraging is that wecan anticipate inertia in global consumption andeconomic growth. Our current consumption andwealth are inextricably tied to past production, butthe past is unchangeable. Absent some sort ofsevere external shock, near-term reductions inenergy consumption and wealth are implausiblebecause they would somehow require civilizationto “forget” its past.

Assuming that economic consumption and growthwill persist in the near term may seem ratherobvious to some. But what may be less wellrecognized is that there are mathematical andphysical constraints to growth. For those who studythe evolution of physical systems, a term that isoften used here is “reddening”. This is a convenientway of expressing that it is the most slowly varying,

FIGURE 2: GLOBAL POWER, WEALTH, GDP AND RATES OF RETURN

For select years since 1970, measured values for the global power consumption (trillion watts), global real wealth (trillion 2005MER

USD), the ratio of power consumption to wealth (watts per thousand 2005 MER USD), global real GDP (trillion 2005 MER USD per

year) and the rate of return on wealth defined by GDP/Wealth (% per year).

1970 1975 1980 1985 1990 1995 2000 2005 2009

Power Consumption (TW) 7.2 8.3 9.6 10.2 11.6 12.1 13.1 15.2 16.1

Wealth (Trillion $) 1118 1202 1303 1418 1554 1710 1889 2097 2290

Power/Wealth 6.4 6.9 7.3 7.2 7.5 7.1 6.9 7.2 7.0

GDP (Trilllion $/year) 15.3 18.4 22.2 25.3 30.2 33.5 39.7 45.7 49.1

Rate of Return 1.37 1.53 1.70 1.78 1.94 1.96 2.10 2.18 2.14

VOLUME 2 , NUMBER 2


low frequency and “red” (rather than blue)components of past variability in a system that moststrongly influence its present behavior.

For example, seasonal temperature trendsnormally have a stronger influence on dailyhigh temperatures than shorter term weathervariability. Or, 20 years of growth throughchildhood and adolescence tends to have a greaterinfluence on our daily food consumption than howmuch we ate yesterday. Surprises can happen, ofcourse. For us, there is always the potential foraccident or a disease. Still, the natural tendencyfor growth is for it to be slow and steady.

Equally, the global economy’s current capacity toconsume and grow has evolved from thousands ofyears of human development, through the creationof subsequent generations, as well as theconstruction of farms, towns, communicationnetworks and machines. While everything doesslowly decay or die, the past can never be entirelyerased. Even our most distant ancestors haveplayed a role in our current economic and socialwell-being. By now, civilization has enjoyed arather lengthy past, and we can count on thisaccumulated inertia to carry us into the future.

Certainly, it is still possible that countries will riseand fall, but globally aggregated economic wealthshould continue to enjoy recent inflation-adjustedrates of return. Even in 2009, during the depths ofthe Great Recession, 2.14% was added to total realglobal wealth (see Figure 2, on previous page),only slightly down from the historical high of2.26% in 2007. And we continue to grow ourpower consumption at similar rates. It is probablya safe bet to assume that similarly high rates ofreturn will persist over the coming decade.

The main point is that persistence in trends is aneffective tool for forecasting, but most especiallywhen applied to highly ”reddened” variables thatare aggregated over time and space. Whenpredicting the evolution of any system, there is

always a trade-off. It is always easier to makeforecasts provided that we are willing to sacrificetemporal and spatial resolution.

Predicting the weather next week can be almostimpossible. But forecasting northern hemisphereaverage temperatures this coming winter isactually quite easy: history is an excellent guide.Similarly, it is very difficult to predict a smallcompany’s stock value next week; butextrapolating trends in globally-aggregated wealthcan plausibly be done for as much as a decadehence.

Innovation and Increasing Rates of ReturnTo reiterate, available statistics show that wealth,when it is integrated over the entire globaleconomy, and integrated over the entire history ofeconomic production, has been related to thecurrent rate of global primary energyconsumption through a factor that has beeneffectively constant over nearly four decades ofcivilization growth. Aggregated civilizationwealth and consumption has inertia, and thereforeits current growth rate is unlikely to cease in ahurry.

Yet the fact remains that the global rate of returndoes change. Historical statistics (shown inFigures 2 and 3) indicate that, over the pastcentury or so, there has been a long term tendencyfor wealth to double over ever shorter intervals.In the late 1800s, doubling global wealth wouldhave taken about 200 years based on then-currentrates of return. Today this takes just 30 years. Asa whole, the world is getting richer faster.

I use the word innovation to describe thisacceleration of inflation-adjusted rates of returnbecause it represents the capacity of civilizationas whole to beat mere inertia. Adjusting forinflation is important here, because it is not alwaysevident that any investment in innovation will payoff. If investing in human creativity does not leadto true innovation, then it is a waste of effort that


could have otherwise contributed to previouslyattained rates of growth. But, real innovationsprovide a jump in rates of return that civilizationcan carry forward into the foreseeable future.

Globally, innovation has come in fits and starts.Figure 3 (above) shows that innovation has hadtwo golden periods over the past two centuries.The first was during the Gilded Age or “BelleEpoque” of the late 1800s and early 1900s, whenresource expansion and technological discoveriesallowed the rate of return to double in just 40years. Then again, in the baby boom periodbetween 1950 and 1970, the rate of return doubledin the remarkably short timespan of just 20 years.

By contrast, both the 1930s and the past decadehave been characterized by much more gradualinflation-adjusted innovation rates. Even thoughglobally aggregated wealth is now doubling morequickly than ever before in history, for the firsttime since the Great Depression, the rate of returnis no longer increasing.

Why has the passage of history been characterizedby economic “fronts” on global scales, with rapidinnovation and accelerating rates of returnultimately giving way to stagnation?

Here again, physical principles can provideguidance. Given that inflation-adjusted wealth andenergy consumption appear to be linked through aconstant, the identical question is asking whatenables energy consumption to accelerate.

Conservation laws from thermodynamics tell usthat rates of innovation and growth should belargely controlled by the balance between howfast civilization discovers new energy reservesand how fast it depletes them6. For example, it iseasy to imagine that access to important new coalor oil reserves in the late 1800s and around 1950allowed civilization to capitalize on human cre-ativity in ways that were previouslyimpossible.

Today, we continue to discover new energyreserves, but perhaps not sufficiently quickly. Weare now very large and we are depleting ourreserves at the most rapid rate yet. Increasedcompetition for resources may be constraining ourcapacity to turn our creativity and knowledge intoreal innovation and accelerated global economicgrowth.

ConclusionsI have described here a constant that links a verygeneral representation of the world’s totaleconomic wealth to civilization’s powerproduction capacity. Because this constant doesnot change with time, physical principles can beapplied to estimate future global-scale economicgrowth over the long-term without having toexplicitly model the exceptionally complexinternal details of people and their lifestyles.

There have been criticisms of this approach,which have stated that “economic systems are notthe same as physical systems, and we shouldn’t


FIGURE 3: A HISTORY OF GROWING WEALTH

Adjusting for inflation, the time for global wealth’s rate of return to double

(calculated as a decadal running mean), vs. the doubling time for wealth itself.

Select years are shown for reference.

VOLUME 2 , NUMBER 2


model them as if they are”7. Yet, civilization isundeniably part of the physical universe. It isdifficult to imagine how we aren’t fundamentallyconstrained by physical laws. At the very least,appealing to physics appears to make the job ofeconomic forecasting more transparent, simpleand scientifically robust.

Here, I have made the argument that recent ratesof return are most likely to persist in such highlyaggregated quantities as the global economy. Wecan make quite distant estimates of future growth,but only if we are willing to sacrifice resolution.While this does not specifically help us to predicttrajectories for individual countries or economicsectors, we might anticipate that slower thanaverage rates of return in one nation or sectorshould be balanced by faster growth elsewhere.

It must be kept in mind that exponential growthtrends cannot continue unabated. Wealth is tied topower production and therefore to resourceconsumption. Sooner or later, civilization mustface up to reserve depletion or environmentaldegradation.

But, for as long as these impacts remainmanageable, we can anticipate that globaleconomic wealth, GDP and energy consumption

will continue to grow at recently observed rates.The qualification is that rates of return are unlikelyto rise as fast as they did in the decades followingthe 1950s. Rather, for time scales significantly lessthan the current wealth doubling time of 30 years– perhaps a decade – the forecasted inflation-adjusted global rate of return should average afairly steady 2.2% per year.

For current and future retirees thinking evenfurther ahead, inflation-adjusted rates of returnshould be guided by whether there is netdepletion or expansion of our primary energyreserves. It might help to think of our energyreserves as the retirement account for civilizationas a whole. Discovering new energy reservestoday expands our collective accounts. Buthaving sufficient reserves for the long-termrequires that we not “spend down” what we havediscovered too quickly. What we consume todaymust be balanced against what we have left toconsume in the future. �

AcknowledgmentsThis work was supported by the KauffmanFoundation, whose views it does not claim torepresent.

A physical model for economic growthThe model for long-term economic growth used hereis based on a core hypothesis, motivated by theSecond Law of Thermodynamics, that energyconsumption is required to power economicactivities, and that all elements of civilization mustbe considered as part of a larger whole. No portionof production can disappear to the past as humanconsumption, with no influence on the future3,4.

Expressed mathematically, all economic

production, once adjusted for inflation, con-tributes to global wealth or capital, so that:

(1)

or, in integral form:

(2)

where C, the inflation-adjusted economic value(or civilization wealth) C is calculated from the

Appendix


time-integral of global economic production (orGDP) Y, adjusted for inflation at 2005 marketexchange rates (MER), and aggregated over theentirety of civilization history. While not describedhere, under this approach, the GDPdeflator is relatedto capital decay in traditional approaches4.

Global economic wealth C is sustained by theinstantaneous rate of primary energy consumptionby civilization a through a constant λ

(3)

Taking a to be in units of watts (Joules persecond), and Y in units of 2005 MER US dollars persecond, available statistics indicate that λ is indeedconstant, with a measured value of 7.1 watts per 1000dollars. The standard deviation over the past 40 yearshas been just 3%.

So, at least over the long-run, sustaining a fiscallymeasurable inflation-adjusted world GDP requires agrowing power consumption. From Equations 1 and3, the production function for the growth model is

(4)

Also, from Equation 3, global wealth C and energyconsumption a must rise at the same rate. This can beexpressed in a variety of ways, all of which followfrom Eqs. 1 to 4:

(5)

While the rate of return η is tied to growth inpower production, it is also an expression of theratio current economic output to the time integralof past economic output, adjusted for inflation.

Productivity and GDP GrowthVery often in economic studies, one sees the ratiof =Y/a, which is termed the “energy productivity”or “energy efficiency” of the economy since itrepresents how well economies turn energyconsumption a into economic production Y. Since

a =λC and η =Y/C, it follows that:

(6)

So, since λ is a constant, the rate of return onwealth is proportional to the economy’s energyproductivity, and only by increasing energyproductivity can the rate of return increase.

When the rate of return increases, this can beinterpreted as a consequence of “real innovation”since, from Eq. 6 it corresponds to greater energyproductivity f . The innovation rate is:

(7)

If innovations improve energy productivity f , thenthey accelerate growth and lead to higher rates ofreturn on wealth. Curiously, from Eq. 3, they alsolead to increasing power consumption a.

The possibility that energy efficiency gains might“backfire” has been hotly disputed, and it iscontrary to what is normally assumed8,9,10. Indeed, itdoes seem quite counter-intuitive that improving en-ergy efficiency leads to more rather than less powerconsumption. But, the system must be considered asa whole. Innovation allows civilization to collectivelyexpand at a more rapid pace into the energy resourcesthat sustain it, and this allows it to produce morepower.

Perhaps the most commonly quoted macro-economic statistic is the real GDP growth rate. In theframework here, this can be expressed very simplyas the sum of the current rate of return, and theinnovation rate or acceleration of the rate of return.

(8)

In fact, since the current productivity arises frompast innovations (i.e, f = ʃ 0

t df/dt′dt′), the historyo finnovation is the sole motivating force drivingcurrent GDP growth.


Appendix, continued

61

VOLUME 2 , NUMBER 2

© 2012 Retirement Income Industry Association®

To illustrate, the mean energy productivity f =Y/abetween 1970 and 2009 was 83 dollars permegajoule, where dollars are expressed ininflation-adjusted 2005 MER units. The mean valuefor the rate of return for energy consumption andwealth, η = λ f , over this period was 1.87% per year.On top of this mean was the trend in η, whichincreased from 1.37% per year in 1970 to 2.14% peryear in 2009. So, the fitted innovation rate for thistime period was d lnη/dt = 0.93% yr−1. This implies anaverage real GDP growth rate for the period of dlnY/dt = 1.87 + 0.93= 2.80% per year. The actualobserved mean was 2.93% per year, a difference ofjust 0.13% per year. Thus, accurate forecasts of globalGDP growth can be inferred knowing only how fastenergy productivity is improving, and withouthaving to explicitly represent nations, sectors, peopleor their lifestyles.

Long-term Forecasting of WealthIf real innovation is positive, then from Eq. 5 and 6,the deterministic solution for the growth of wealth C is

(9)

C0 is today's wealth, and ґη represents thecharacteristic innovation time

(10)

Note that the solution for C(t) condenses to thesimple exponential growth form of C = C0 expηtin the limit that the innovation rate slows to zeroand ґη → ∞. If there is positive innovation,however, then ґη is positive and finite, and wealthgrowth is explosive or super-exponential (i.e. theexponent of an exponent).

While more mathematically cumbersome, afamiliar way of expressing growth is in terms ofdoubling-times. The doubling times δ for wealthC, and the rate of return η, are given respectivelyby δC = ln2/η and δη = ґη ln2.

Effectively δC represents the time it takes forcivilization to double its wealth, assuming currentrates of return hold. Similarly, δη is the time re-quired for the rate of return to double (or δC tohalve), assuming current innovation rates stayfixed. The recent history for these quantities isshown in Figure 2. From Eq. 9, a deterministicsolution for the evolution of wealth is

(11)

Footnotes:1 Raupach, M.R., Marland, G., Ciais, P., Le Quéré, C., Canadell, J.G., Klepper, G., Field, C.: Global and regional drivers of accelerating

CO2 emissions. Proc. Nat. Acad. Sci. 104, 10,288–10,293 (2007). DOI 10.1073/pnas.07006091042 IPCC: Climate Change 2007 - Impacts, Adaption and Vulnerability. Cambridge University Press (2007)3 Garrett, T.J.: Are there basic physical constraints on future anthropogenic emissions of carbon dioxide? Clim. Change 3, 437–455 (2011).

DOI 10.1007/s10584-009-9717-94 Garrett, T.J.: No way out? The double-bind in seeking global prosperity alongside mitigated climate change. Earth Sys. Dynam. 3,

1–17 (2011). DOI 10.5194/esd-3-1-20125 Ayres, R.U., Warr, B.: The economic growth engine. Edward Elgar, Cheltenham, UK (2009)6 Garrett, T.J.: Modes of growth in dynamic systems. Proc. Roy. Soc. A (2012). DOI 10.1098/rspa.2012.00397 Scher, I., Koomey, J.: Is accurate forecasting of economic systems possible? An editorial comment. Clim. Change 3, 473–479 (2011).

DOI 0.1007/s10584-010-9945-z8 Saunders, H.D.: A view from the macro side: rebound, backfire, and Khazzoom-Brookes. Energy Policy 28, 439–449 (2000)9 Polimeni, J.M., Giampietro, M., Alcott, B.: The Jevons Paradox and the Myth of Resource Efficiency Improvement. Routledge (2007)10 Owen, D.: The efficiency dilemma. The New Yorker pp. 78–85 (2010)

Appendix, continued

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