Measures of Retirement Benefit Adequacy: Which, Why, for Whom, and How Much?

Source: Vickie Bajtelsmit, Anna Rappaport, LeAndra Foster, Society of Actuaries, January 2013

From the summary:
The purpose of this study is to provide the basis for estimation of retirement income needs and adequacy. To that end, the researchers have developed a Monte Carlo simulation model of retirement cash flows incorporating a wide variety of risks and uncertainties faced by retirees, including longevity, inflation, investment, health, and long-term care. By varying assumptions, they compare outcomes based on decisions such as expense reduction, mortgage payoff, purchase of annuities and long-term care insurance, delayed and early retirement. They describe and justify the base case assumptions, explain the metrics used for reporting the simulation output, and summarize the alternative scenarios that are simulated. They also provide call -out boxes highlighting practical issues and key findings as well as a list of references that can be a handy source of resources on this topic.

The study describes three different approaches to measuring benefit adequacy from each stakeholder’s point of view as well as their limitations:
• Replacement Ratio – this is most often used by employers in not only designing their plans but also in comparing their plans to those of other employers. The study includes a discussion of the Aon /Georgia State Study, which is widely used and recognized in the U.S.
• Minimum Needs Measure – this is generally used by policymakers. The study uses the Elder Economic Security Index to outline national averages for various household types.
• Cash Flow Analysis – a detailed, personalized cash flow forecast is the best way for individuals to prepare for and manage their retirement needs.