Worldwide quantitative easing continues to put downward pressure on the Pensions Index
The Alexander Forbes Pensions Index has continued to decline as a result of the current low return environment. According to John Anderson, Managing Director: Research and Product Development at Alexander Forbes, the Pensions Index has shown that members
The Alexander Forbes Pensions Index tracks the change in projected retirement income, since 2002, of a typical member of a Defined Contribution fund. The Index considers three savers, born on 1 January 1972, 1 January 1962 and 1 January 1952. On 1 January 2002, they were 30, 40 and 50 years old respectively and all expected to be on track to have a pension that replaced 75% of their pre-tax salaries when they retired at age 65. So, for each of our savers, their index value was 75 on 1 January 2002.
Index as at 31 March 2013
At 31 March 2013, the Index values for each of the savers, was as follows:
The following graph shows the change in the Index for the three savers since 1 January 2002:
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The following table shows the gains or losses in the Index values over various time periods to 31 March 2013:
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Reasons for the change
Over the period since 2002, investment returns across all asset classes have generally been very good, and higher than what they were projected to be.
Anderson says that despite these good past investment returns, it is the decline in bond yields (and the resulting low expected returns going forward) that has driven most of the decline in the Index over time.
According to Anderson, bond yields impact on the Index in the following ways:
• Firstly, lower bond yields can signal lower investment returns going forward which reduces the amount of capital each of the three members is expected to have when they retire. Consider the graph below which shows how, based on Alexander Forbes’s research, expected long-term real returns across various asset classes are at their lowest levels in over five years.
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• Secondly, the lower real returns on the various asset classes have resulted in a significant increase in the cost of converting retirement capital to an income.
The figure below shows how the cost of converting the accumulated fund value at retirement, for a 65 year old male, into an income stream has increased over time. The result has been a smaller monthly payment. The annuity rates are based on quotations from the market at that time.
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When calculating a member’s expected pension at retirement, several assumptions are required such as future investment returns and salary increases. Anderson explains that the Pensions Index uses the latest market information to set these assumptions. He believes that it is therefore important to not only look at one estimate of your expected pension, but rather a likely range. You, together with an advisor, can work out the best strategy to ensure your pension is on track. This includes:
1. Determining the appropriate contribution rate and investment strategy to provide your desired pension level with the desired likelihood.
2. Looking at other areas that can help improve your expected pension, such as retiring later or supplementing your pension with other income.
