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The Challenge of Planning for Longer Retirement
Joan Bozek, senior vice president of investment products, shares how Prudential used its vast expertise to create Day One funds.
P&I Content Solutions Group Sponsored Investment Insights | October 14, 2013
Joan Bozek Senior Vice President, Investment Products, Prudential Retirement
Joan Bozek: The real challenge in saving for retirement is not preparing for that first day of retirement. The real challenge is preparing for all the days to come. After all, there's no target date for how long one can live in retirement. With Americans enjoying longer, healthier lives, one in four people age 65 will see their 95th birthday.
In designing its Day One target-date suite of funds, Prudential focused on just that and has drawn on its vast expertise across the organization. Unique perspectives from life insurance, annuities, retirement, investing, and recordkeeping—plus behavioral analysis on 850,000 participants—all have provided insights to create a target-date fund suite to help Americans be better prepared for retirement.
P&I: Describe how you designed Prudential's Day One target-date funds.
Joan Bozek: Prudential has been focused on retirement planning for most of its history, and we are a company with a deep understanding of longevity and a focus on providing lasting income streams to individuals. People are living longer. People need to make smarter decisions about their investments. They want cost-effective products and they want it to feel real to them. So we wanted to offer a strong target-date fund suite that combines all that we know about retirement, investing, longevity and our behavioral finance research that you can see in our Day One campaigns, all to inspire participants to prepare for retirement.
We brought our retirement and investment groups together to apply our unique perspective on helping people save in order to have an income stream when they retire. The Day One target-date funds were built based on proprietary research and the analysis of real participant savings rates and employer contributions of over 850,000 plan participants to help make our assumptions as realistic as possible. We brought in our concepts and understanding of longevity from our annuity and life insurance groups. We brought in our investment culture that combines investment strategies and vehicles and are cost competitive. But most important, we brought in a humanizing approach, for our glidepath design, we believe that the initial equity allocation in the more distant years should be higher than average to provide for potential growth for those whose retirement is far away. Then for the Day One Funds, our glidepath gets significantly more conservative 10 years prior to retirement when the “Retirement Red Zone” concept is incorporated and the allocation is shifted out of equities at a more significant pace. Since developing the “Retirement Red Zone” concept in 2005, we have conducted multiple research studies to examine both the effects of the markets on Retirement Red Zone investors, as well as investor behavior. The proprietary research continues to confirm that losses in this time period can have a significant impact on an investor's ability to retire when planned and live comfortably throughout retirement.
Finally, our asset allocation is different from many competitors', and uses our behavioral research to help determine the various equity and fixed-income strategies, plus adds a non-traditional component with private real estate, commodities and TIPS (Treasury Inflation-Protected Securities) to achieve further diversification, offer a low correlation to stocks and bonds and have the potential to moderate portfolio risk.
P&I: What experience did you draw on?
Joan Bozek: We're able to look at retirement through a number of different lenses. So we've looked at it as an annuity provider. We've looked at longevity as a life insurer. We've looked at it as a record keeper. We've looked at it as an investment powerhouse. Our strength is having the full suite of expertise and information and the ability to sit down and pull it all together.
We have a long history in the defined benefit ( DB) business and we understand people's need for monthly income. We also have an active history in the defined contribution (DC) world of watching participants' savings rates, investment patterns and withdrawal rates. So from a pure plan perspective, our understanding of both DB and DC plans and practices puts us in a unique position and has given us relevant data to harvest and work with. We study participants' behavior, and in response we apply fundamental investment concepts—the type of vehicle, active and passive management, both traditional and more progressive asset allocation theories, and our philosophy on how asset allocation improves overall investment results.
P&I: The glidepath is a critical element. How is the Day One Funds' glidepath determined?
Joan Bozek: It's based on liability-related relative optimization. We analyzed a number of points around the efficient frontier of investing, using Monte Carlo simulations. We discounted those liabilities over 150,000 real returns over a participant's life. And we looked at the probability of achieving specific investment goals that were assigned for each stage of a participant's life and how that probability increases as a participant grows older. Of course there were a lot of assumptions that we factored in, like cash flow, income replacement, and, of course, longevity. We anticipate participants attaining age 95. All of this is factored into how we think about meeting all of the days in retirement. For example, we assume a 78% income replacement ratio based on an individual earning $60,000 and retiring at age 65. We make some other assumptions around social security benefits and what income would need to be available from other sources. Our views on investments, longevity, retirement plans, Retirement Red Zone—all influence the mechanics of how this came together. It's a very thoughtful process, and it's ongoing.
P&I: Describe the investment components and income guarantee.
Joan Bozek: We created a new version of a core-satellite investment strategy that combines an efficient blend of passive, active and risk controlled active management. The fundamental asset classes, like the S&P 1500, are in general passively managed. But the funds don't simply invest in the indices, and forgo potential of active management alpha. The funds have a fundamentally stronger, risk-controlled practice. To enhance performance, we use both fundamental and risk controlled active strategies where we think we can achieve alpha, which includes large, mid and small asset classes as well as non-traditionals like real estate, commodities, and TIPS. Further addressing longevity risk and tail risk, we provide a companion suite of Day One Incomeflex Target Funds, with a more aggressive glidepath, designed specifically to be used with our in-plan guaranteed minimum withdrawal benefit product. So even if the underlying market value of an account should go to zero, the monthly benefit that is fixed at the first withdrawal remains in place. So that's what we think is so unique about bringing together all the disciplines of retirement, investing, longevity, and asset allocation skills that we have across the organization.
P&I: How does participants' behavior inform the design of the funds?
Joan Bozek: We do a lot of work with behavioral experts at a number of leading institutions. There is an element of delayed gratification, procrastination, and inertia that we are trying to account for. We know that participants are much more focused on savings and return investing as they get closer to retirement. How can we help them visualize retirement earlier? What do people actually do when they are confronted with the prospect of retiring, changing their lives and not drawing a paycheck? And how can we help them understand it? Too many people make the initial investment in their retirement plan, but then don't look at their statements and don't make any changes to their investment strategy. All of that concerns us, but these are behavioral facts of life that we consider and weigh carefully. When designing a solution, we understand that people generally aren't saving enough and they're not monitoring their progress. So in the Day One Funds, we designed a way that helps them get there.
We analyze behavioral studies on an ongoing basis to apply the right approaches and make ongoing refinements to the glidepath and asset allocations. We know that participants want to be able to come to a decision based on intelligent combinations of a number of factors. We are also launching a website, www.dayonefunds.com which will have a lot of additional information to help plan advisors, sponsors and participants make decisions. More importantly we intend to continue carrying the Day One message to inspire plan participants to think about their day one of retirement and share their success stories.
Joan Bozek: The Prudential Day One Funds are available as insurance company separate accounts under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity
Company (PRIAC), Hartford, CT, a Prudential Financial company.
The Prudential Day One IncomeFlex Target Funds were designed for use with Prudential IncomeFlex Target, an in-plan guaranteed retirement income product, and are available as insurance company separate accounts under group annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT. PRIAC does not guarantee the investment performance or return on contributions to those separate accounts. Availability and terms may vary by jurisdiction, subject to regulatory approvals. Guarantees are based on claims-paying ability of the insurance company and are subject to certain limitations, terms and conditions. Annuity contracts contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Contract form #GA-2020-TGWB4-0805. For more information, participants should access the participant service center or call 1-877-778-2100 for a copy of the Prudential IncomeFlex Target Important Considerations before investing. PRIAC is a Prudential Financial Company.
For the Day One 2010 Fund, performance shown beginning 2/15/2013 represents the actual performance track record. For the Day One 2015 Fund, performance shown beginning 12/16/2011 represents the actual performance track record. For the Day One 2020, Day One 2025, Day One 2030, Day One 2040 and Day One Income Funds, performance shown beginning 8/01/2013 represents the actual performance track record. For the Day One 2035 and Day One 2055 Funds, performance shown beginning 9/6/2013 represents the actual performance track record. For the Day One 2045 Fund, performance shown beginning 8/23/2013 represents the actual performance track record. For the Day One 2050 Fund, performance shown beginning 8/15/2013 represents the actual performance track record. For the Day One 2060 Fund, performance shown beginning 8/13/2013 represents the actual performance track record.
For the Day One 2010 Fund, the Day One 2015 Fund, Day One 2020 Fund, Day One 2025 Fund, Day One 2030 Fund, Day One Income Fund and the Day One 2050 Fund, performance prior to the dates listed above represents simulated performance based on the historical track record of the underlying funds in the fund-of-funds structure, weighted in accordance with the asset allocation of each underlying fund as specified by the Fund's glidepath (“Glidepath Performance”), beginning with the glidepath inception date of June 30, 2009.
For the Day One 2060 Fund, performance prior 8/13/2013 represents simulated performance based on the historical track record of the underlying funds in the fund-of-funds structure, weighted in accordance with the asset allocation of each underlying fund as specified by the Fund's glidepath (“Glidepath Performance”), beginning with the Fund's Inception Date of
May 31, 2013.
Glidepath Performance is adjusted to reflect the fees and expenses of each Fund, and reflects daily rebalancing and annual ratcheting along the Fund's glidepath. Glidepath Performance is based on hypothetical performance results. Unlike the results shown in the actual performance track record of the Funds, as applicable, Glidepath Performance results do not represent actual trading and may not reflect the impact of material economic and market factors, such as lack of liquidity. On September 22, 2010, the QMA Small Cap Blend Enhanced Index Fund sleeve was replaced with the Jennison Small Cap Core Equity Fund. Glidepath Performance for the period beginning with the Glidepath Inception Date and ending on September 21, 2010 represents the weighted actual performance track record of the QMA Small Cap Blend Enhanced Index Fund, and Glidepath Performance beginning on September 22, 2010 represents the weighted actual performance of the Jennison Small Cap Core Equity Fund. On December 7, 2011, the Bache Commodities Total Return Fund sleeve was replaced with the Jefferies Commodity Strategies Fund. Subsequently on April 16, 2012, the Jefferies Commodity Strategies Fund changed its name to the CoreCommodity Strategies Fund. The Glidepath Performance for the period beginning with the Glidepath Inception Date and ending on December 6, 2011 represents the weighted actual performance track record of the Bache Commodities Total Return Fund, and the Glidepath Performance beginning on December 7, 2011 represents the weighted actual performance.
There is no guarantee the Funds will have any value. Past performance is no guarantee of future results. Asset allocation does not protect against losses.
*Data Source: P&I Research Center. Prudential Financial AUM figures as of December 31, 2012.