SeLFIES Muralidhar Pension Playpen Aug 2024 Final (1).pptx

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1. SeLFI ES : A Simple Innovation To Help the UK Achieve Multiple Goals Presentation to Pension Playpen ARUN MURALIDHAR, PH.D. Georgetown University, Adjunct Prof. of Finance August 28, 2024

2. : Issued Bonds (early 1990s); Manager, Head of Research Pension & Investments Dept (late 1990s) and : MD, Head, FX Research (1999-’07) / : Co-Founder; Manage Institutional Assets; Developed Unique Overlays/Early to Big Data/AI (‘02- Today) Background: All Sides of this Business Focus on Pensions, Asset Management/Pricing/Innovation : Innovations in Pension Fund Management (2001) Rethinking Pension Reform, w ith Prof. F. Modigliani (2004) SMART Approach to Portfolio Management (2011) Fifty States of Gray: An Innovative Solution to the Defined Contribution Crisis (2018) A Nobel Retirement: 3 Nobels, 3 Pillars, 3 Facets of Investment (2024) Also Served on VA Retirement Systems DC Plan Advisory Committee and PGGM AAB Written Two New Books: “Investment Theory and Practice: It’s All ‘Realative’” and “GBI = Gimme Better Instruments” Photo Credit: Princeton Headshots

3. NEST ( of Trouble? ) Global Pension Challenges – Transferring Risk to Financially Unsophisticated Citizens What is a Good Retirement Goal? And How Finance Theory Messed Us All Up…. The Solution = SeLFIES/Retirement Security Bonds RendA + = Brazil’s “Retirement Extra” Innovation SeLFIES = UK Version – Easy to Create 5. Why SeLFIES Are Good for Government, Individuals and Financial Services Industry Agenda – The UK Can Improve Retirement Security Quickly + Cheaply A Simple, Low-Cost Modification to Existing Security Could Quickly Address Many Challenges

4. NEST – An Attempt to Address Uncovered Workers Focused on Accumulation – Decumulation Still a Challenge Wrong Goal - May Lead to More Challenges Than It Was Designed to Solve Auto Enrollment – Has been an issue as leads to more debt! Product Choice – Risky & Fake Sense of Security No Real Decumulation Strategy

5. NEST – Unnecessarily Complex Focused on Accumulation – Decumulation Still a Challenge Cannot Guarantee REAL Retirement Income – Clunky With Gilts Post Retirement Fund Guided Retirement Fund

6. DB Plans Closed/Not Offered to Individuals Many Individuals Not Covered by Any Plan: “Informal Workers” Yet the Goal is: Be Able to Maintain Pre-Retirement Lifestyle until Death Longevity Increasing. Families More Dispersed Need an “Out-of-the-Box” Solution (Easy to Calibrate to one’s Paycheck) DC Plan In UK Will Likely Become Primary Source of Retirement Income CRITICAL FOR NEST AND GOVERNMENT TO ENSURE RESULTS Low Financial Literacy Retirement Security: Challenges Are Global Trend Has Been to Pass Responsibility to Individuals in DC Plans

7. We Care About Retirement Income = Relative Wealth (Not Absolute Wealth) Assumes that “Investors Want to Maximize Utility of Wealth” - We Need Income Sidebar on “Wealth” As Objective Finance Theory Starts With Wrong Objective “If a man is proud of his wealth, he should not be praised until it is known how he employs it.” Socrates “When it is obvious that the goals cannot be reached, don't adjust the goals, adjust the action steps.” Confucius “The future depends on what we do in the present.” Gandhi

8. Risk transferred to Individuals (one lifetime) Complex Decisions transferred to individuals How much to save? How to Invest: What to buy? How much? Rebalancing? How best to decumulate? What annuity to buy? Financial Illiteracy confounds decision-making High Cost from involvement of multiple parties Declining Real Payments with Nominal Annuities DC Pension Plans Have Multiple Challenges But Goal Unchanged: Seek Guaranteed Real Retirement Income; Not Guaranteed Return on Investment!! NEST MUST ADDRESS THIS ISSUE Wrong Goal Bad Financial Instruments Merton, R.C. 2007. “The Future of Retirement Planning.” In T he Future of Life-Cycle Saving & Investing , Z. Bodie, D. McLeavey , and L.B. Siegel (eds.). Research Foundation of the CFA Institute, 2007, Charlottesville, VA. Muralidhar, A. 2019. Can (Financial) Ignorance Be Bliss? Financial Analysts Journal, Volume 75, 2019 - No. 1. Could Lead to Widespread Retirement Problems

9. Accumulation (40 Years from Age 25 to 65) Decumulation (20 Years; Age 65 to 85) ® Problem: No Asset has this Profile/Bridges Time Gap; Annuities Not Flexible Work 40 Years: No Cash Flows Needed Retired for 20 Years: Need Steady Cash Flows Want Standard-of-Living Protection Longevity Risk Adds Complexity Simple Goal: Steady Cash Flow Till Death Guaranteed and Real = Preserve Pre-Retirement Lifestyle Goal = ₤ 60 ,000

10. Industry Uses the Wrong “Safe” Asset Merton, R.C. 2014. The Crisis in Retirement Planning. Harvard Business Review. July-August 2014, https://hbr.org/2014/07/the-crisis-in-retirement-planning# Current “Safe” Assets Are Risky; Too Much Focus on Wealth vs Income T-Bills/bonds protect principal (wealth), not retirement income (UK 30 Year bonds) Highly Volatile: Annuity/income perspective Current products (either Stock-Bond or Life-cycle Funds) are risky AIU = Annuity Income Units Current T-Bills, Bonds or TIPS are Not “Safe” (nor Guaranteed Returns)

11. Even Inflation-Indexed Bonds Are Risky in DC Plans Cash Flow Mismatch/Reinvestment Risk Assume maturity = 30 years maximum Can only hedge 10 years pre-retirement Do not need coupons when working Do not need Principal repayment Would require 61 additional small transactions to convert to desired outcome Very Cumbersome Process to Buy/Sell (Paperwork) Annuity = Inflexible to Purchase during Working Life Traditional Inflation Index-Linked National Savings Security Cash Flow ( ₤ ) https://www.rbi.org.in/Scripts/FAQView.aspx?Id=99

12. DC Pension Plans: What Do Individuals Want? Cormier, Warren and Pamela Hess. 2023. Profiling Retiree Spending (2022), DCIIA RRC, based on a survey of 2,009 retirees aged 50-75. Clear Preference for Steady, Lifetime Income; Safety and Control Not Guaranteed Return or Target Real Return as in NEST

13. Retirement Bond Idea – Market-based Pricing Price of bond 40 Years 20 Years This stream of cashflow looks very much like an annuity = SAFE ASSET IN RETIREMENT Matches the cash flows in retirement Simple change to existing bond cash flows Coupon = fixed real currency ( ₤ 5/year) Working Life LOW-COST LOW-RISK SIMPLE = JUST 2 QUESTIONS LIQUID KIDS INHERIT Combines in a single instrument Accumulation Compounding Inflation Decumulation

14. SeLFIES = Currency of Retirement 1. S tandard-of- L iving indexed, F orward-starting, I ncom E -only S ecurities ( SeLFIES ) 2. Coupon fixed in real currency = ₤ 10 3. Maturity = Life Expectancy of the Country (say 20 years) 4. Pays on the same date as Social Security payments (RendA+) 5. Linked to appropriate inflation measure – VAT, Per Capita Consumption, CPI 6. Issued in small denominations (RendA+ as low as ₤5 and going to ₤ 1 ) 7. Tradeable 8. Pure Market Instrument: Price = Currency of Retirement Can be issued by HMT or National Saving Scheme (old Postal System)

15. Case Study: Brazil – (Award-Winning) RENDA+ On January 2023, the Tesouro Direto Program launched RendA+, a new bond to complement investors' Retirement from Social Security As of 08/01/2024, the new bond has already reached more than R$ 2.4 billion in outstanding (appx.) 86,990 investors 17,000+ who had not purchased a security from TD before = FINANCIAL INCLUSION All done on a simple app = DIGITALIZATION Can purchase in slices of as little at ₤ 5 at a time = DEMOCRATIZE

16. Global Design – Suggested for Many Countries Countries Can Customize to Their Unique Situation √

17. 17 Your age Age you plan to retire Planned complementary income Amount to invest promptly Source : National Treasury. Available at : https://www.tesourodireto.com.br/ rendamais / , in 20/06/23.  THE APP: TWO SIMPLE QUESTIONS   

18. 18 Source : National Treasury. Available at : https://www.tesourodireto.com.br/ rendamais / , in 20/06/23. THE APP: TWO SIMPLE QUESTIONS

19. SeLFIES – Good for UK Citizens Designed to Work with What People Know Date of Retirement and Target Income Embeds Compounding, Inflation & Decumulation Addresses Financial Competence Effective for Uncovered Workers Too Creates an “Individual DB”; Don’t Need Plan Easy to Track Progress Towards Retirement Goal Simple Math and Easy Calculations Portable Not Tied to Employment Can Be Used “Out-of-the-Box”

20. SeLFIES – Great for UK Government Reduces Risk of Retirement Poverty /Bailouts Cash Flows from Bond = Green/Infrastructure Needs VAT Regime = Government Hedged Boosts National Debt Demand Provides Near-Term Budget Relief Extends Yield Curve = Innovation (Real Annuities, Home Pension etc.) Gender Pension Equity Multiple Benefits for Governments Too ₤

21. SeLFIES – Good for Financial Service Industry Goal of Individuals: Sustainable Retirement Income Buy SeLFIES but Still Have Longevity Risk Goal of Insurance Companies: Profit/Manage Risk Diversify Longevity Risk by signing large number of people Well-Designed SeLFIES For right Maturity, Insurance Cos. would be willing to exchange 1 SeLFIES for Life Annuity paying ₤5 real/year till Death. Price of SeLFIES vs Price of Annuity provides information about Design of Product and Longevity Diversification of Insurance Cos Prof. Merton Presentation at MIT Ideas Exchange, New York, April 2019. See also, Muralidhar, A. 2019. Can (Financial) Ignorance Be Bliss? Financial Analysts Journal, Q1 2019 Volume 75, 2019 - No. 1. Supports Product Innovation

22. SeLFIES : A Win/Win/Win Individuals Retirement income product that meets actual goals and is easy to use Financial Services Industry Improved hedging operations and product innovation Government Lower financial pressures, better cash flow match and potentially fund infrastructure