Sunday, June 24, 2012

Single Best Answer?

A mainstay of multiple-choice test instruction is the admonition to select the “single best answer.” Now, generally there really is only one valid answer, but there are times when the questions posed are sufficiently imprecise, or the potential answers specific, that more than one response is viable.That’s where the test architect can always fall back on their notion of “best” answer– because, even if a credible argument can be made for an alternative, it’s a lot easier to grade when there’s only a single, pre-determined result.

When it comes to projecting possible outcomes in situations where there might be hundreds, perhaps thousands, or even millions of different results, it’s not uncommon to pick a single point to focus on.For example, projections in financial analysis might use the most likely rate of claim, the most likely investment return, or the most likely rate of inflation, whereas projections in engineering analysis might use both the most likely rate and the most critical rate.That choice provides a point estimate, one that ostensibly provides a best single estimate for purposes of analysis.

The downside of this approach, of course, is that it does not fully cover the fact that there is a whole range of possible outcomes, some more probable, some less.The alternative, a stochastic modeling, doesn’t just pick a single likely result, but uses random variations to look at what a broad range of conditions might be like.It does this based on a set of random outcomes, projects results, and then repeats with a new set of random variables.In fact, this process is repeated thousands of times.
When the modeling is done, you can look at a distribution of outcomes – and with that not only consider the most likely estimate, but what ranges are reasonable as well.It is, quite simply, a more complete and realistic assessment of potential outcomes, because, unlike so-called “deterministic” models that rely on picking a single point of experience, it includes a wide range of possibilities.

Deterministic models can predict outcomes under a few economic and demographic scenarios but don’t generally present a distribution of the wide range of scenarios that could arise from different combinations of economic and demographic variable values. Only stochastic models – like that embodied in the EBRI Retirement Security Projection Model® (RSPM) - can measure the "risk" of their performance measure values, because stochastic models, using Monte Carlo methods, are based on probability distributions.Said another way, stochastic modeling brings into account the volatility and variability of experience that are part of living in the real world.

Those deterministic models may offer a “single” answer, but life is rarely that simple – and projections that attempt to help us make better decisions about the future needn’t be.

-Nevin E. Adams, JD
1.The EBRI Retirement Security Projection Model®(RSPM) simulates 1,000 alternative retirement paths for each household to explicitly model investment, longevity and stochastic healthcare risks (i.e., nursing home and home healthcare costs).

2.More information on stochastic versus static/deterministic modeling can be found here.

Sunday, June 17, 2012

”Macro” Management

Last week, Senate Finance Committee Chairman Max Baucus (D-MT) outlined his overall goals for comprehensive tax reform, noting that he planned to use both the Domenici-Rivlin debt reduction plan and the fiscal recommendations of the president's Simpson-Bowles Commission(1) as the “starting points for full-scale tax reform,” citing the former in commenting that “‘Everything must be on the table' when it comes to tax and entitlement reform."  The New York Times last Monday reported a “Push for a Fiscal Pact Picks Up Speed, and Power,” even as other published reports suggested that lawmakers would look to defer those votes until after the November elections.

Those headlines echoed the sense that EBRI CEO and President Dallas Salisbury outlined last month to the EBRI board of trustees at their spring meeting—a sense that broad-based tax reform would be the focus of Congress, with fiscal issues driving a focus on the macro impact of policies rather than the micro outcomes that might result.  While there’s an acknowledgement that the “devil’s in the details,” there is also a growing sense that sweeping change is needed, and that—whatever the potential negative effects at the micro level, enacting change would be supported because it was seen as “best for the nation and the economy.”
Salisbury cited a meeting at which a senior congressional staffer noted that when Congress did act, it would include changes in the tax treatment of retirement plans—“we just can’t tell you what.”  Later at that same meeting, a more senior official made it even clearer that those issues would be part of the equation, going so far as to outline about a half dozen specific provisions under consideration.   Salisbury highlighted as “the most telling words in that senior staffer’s presentation” that “the biggest roadblock to meaningful action toward a rational retirement policy was “inter-industry competition”—the competition of firms within the retirement plan industry lobbying for different provisions, all of which carry a cost to the federal government, but with no one willing to suggest ways to pay for their proposals. 
“If there is a message,” Salisbury noted, “it is that whatever the government is willing to spend on retirement in the future is less than they are now willing to spend.”  Not that there isn’t interest in broader policy objectives, such as increasing the number of individuals covered by retirement programs; however, the sense is that the expense to the government of any new initiatives (such as “automatic” IRAs) would have to come from current tax preferences for other programs.  “It’s less than a zero sum game,” Salisbury told the group.
Salisbury cited the comments made by Jim VandeHei, executive editor of Politico, at another recent event, who spoke of a dynamic of policy and party volatility in the near-term, with, at the extreme, control of at least one house of Congress changing every two years for the next decade.  VandeHei noted that with the electorate so polarized, at the margins, he expects the presidential election in a number of states to be decided by extremely narrow margins, such as 1,000 to 4,000 votes.  Moreover, because of the primary process, the extremes rule in both political parties.  The resulting political polarization means that fiscal constraints dominate all discussions on Capitol Hill.
Salisbury noted that proposals to reduce Social Security, the sole source of retirement income for 37 percent of today’s retirees—or Medicare—will widen the current retirement savings gap, as will any reduction in retirement plan tax preferences, or that of workplace-based healthcare programs.  “That diminishes an individual’s ability and/or willingness to retire—and that has an impact on employers, and workforce management,” he noted.  That also means less capacity in the retired population to consume goods and services—a potentially critical factor in the nation’s future economic growth as well.

As we approach the end of 2012, there is potential for massive political and economic chaos, Salisbury said, because of the concurrent scheduled expiration of the Bush administration tax cuts, the impact of federal budget sequestration and its automatic spending cuts due to hit at year-end, the end of the (extended) payroll tax “holiday,” and the likely need to approve an increase in the nation’s debt ceiling shortly thereafter.  The sense is that House Speaker John Boehner (R-OH) will have less control in the next Congress than the current one, assuming Republicans maintain the majority in that chamber.  Meanwhile, in the Senate, regardless of which political party wins control, “60 is the new 50”—meaning that a super-majority of votes will be needed to break a filibuster and pass  major legislation..
Salisbury suggested that “it’s all going to happen during the last breathing moments of the current Congress,” reflecting a sense that lame-duck members of the U.S. House and Senate – those who won’t be part of the next Congress - will be willing to cast otherwise politically risky votes in order to make something meaningful happen.  The strategy: Let everything “hit the fan” on December 31, which would, among other things, restore higher tax rates.  At that point, ANY change that reduces those “new” rates can be seen as a tax cut, rather than an increase.  In effect, that means that the current Congress can vote for things on January 2 that would have been tagged a tax hike on December 31, but that on January 2 will be deemed a tax cut. This would all have to occur in the narrow window between the end of the calendar year and the start of the new 113th Congress.  Newly elected (but not yet seated) lawmakers avoid even having to vote, noted Salisbury.  (Incidentally, the New York Times reported on a similar scenario this past week, a month behind Salisbury.)

Salisbury said that the highest probability for this outcome is if the status quo emerges from the 2012 election – the Senate split 50/50, the House remains in GOP control, and President Obama is reelected—“because all three will have a huge stake in things being solved, since they are going to have to live with it over the next four years.”
On the other hand, he noted, if there is a change in the balance of power—such that one party doesn’t have to live with the consequences of it, that the result can be blamed on the other party—lawmakers might defer action.

In any event, Salisbury noted that if the 2012 election produces the “status quo” in party alignments, that by early January, we will not only know what the Supreme Court has decided on healthcare, we may know what the tax status of workplace plans and programs like Social Security and Medicare, and then we can know what we’ll be dealing with.  If action is deferred, there will be no letup from uncertainty.
“The macro, not the micro is driving policy,” Salisbury noted. “This is about saving the economy.”  But with everybody focused on macro, he added, “HR execs will have to deal with the impact on the micro.”  And, with trust in employers very high by both current workers and retirees, “individuals are likely to turn to employers even more than they do today to help them achieve health and financial security, including retirement security.”

- Nevin E. Adams, JD


(1) EBRI has run multiple simulations on these proposals, and their potential impact on retirement savings.  See EBRI Notes, March 2012, “Modifying the Federal Tax Treatment of 401(k) PlanContributions: Projected Impact on Participant Account Balances;”  EBRI Issue Brief #360, July 2011, “Employment-Based Health Benefitsand Taxation: Implications of Efforts to Reduce the Deficit and National Debt;” and EBRI Issue Brief #364, November 2011, “Tax Reform Options: Promoting Retirement Security.”   

Sunday, June 10, 2012

Returns “Engagement”

An acquaintance of mine once remarked, “you can’t solve a savings problem with investment returns.”  Yet, participants frequently focus on the returns of their retirement savings investments.

Consider that during the month of May, major stock indexes like the Dow Jones Industrial Average and the S&P 500 were off 6 percent. But, according to an EBRI analysis, the estimated average 401(k) account balance1 was down less than 3 percent during that same month, both due to the inflow of ongoing contributions and more diversified portfolio holdings.
That determination is based on estimates from the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project—the largest, most representative repository of information about individual 401(k) plan participant accounts. In fact, as of December 31, 2010, the EBRI/ICI database included statistical information on about 23.4 million 401(k) plan participants, in nearly 65,000 employer-sponsored 401(k) plans, representing $1.414 trillion in assets.
Using that database, which includes demographic, contribution, asset allocation, and loan and withdrawal activity information for millions of participants, EBRI has produced estimates of the cumulative changes in account balances—both as a result of contributions and investment returns— for several combinations of participant age and tenure.
While the estimated monthly movements2 are interesting, they aren’t nearly as important as the perspective the database offers on long-term trends. For example, while the financial crisis of 2008 had a significant impact on retirement savings balances, as of June 5, 2012, more than 94 percent of the consistent participants in the database are estimated to have balances higher than they did at the pre-recession market peak (October 9, 2007).
During election cycles, voters are frequently asked “are you better off now than you were four years ago?”  The answer, at least when it comes to consistent participants and their retirement savings accumulations, would seem to be “yes.”
- Nevin E. Adams, JD


1 For “consistent” participants, that is, participants assumed to be in the 401(k) plan at the beginning and end of the specific reporting period.
2 EBRI updates the change in 401(k) balances each month at . Here you will find both a listing of “Cumulative Change”, a projected cumulative percentage change in account balances for consistent participants since the last annual update of the database. Additionally, the monthly rate of change in average account balances is presented for those same individuals. For assistance on interpreting these results, please contact Jack VanDerhei at

Sunday, June 03, 2012

“Better” Pill?

As a growing number of Americans near and enter retirement, concerns about the cost of post-retirement health care expenses loom larger.  In fact, worker confidence about their ability to pay for medical expenses after retirement was just half what they expressed about their ability to pay for basic retirement expenses (see EBRI’s2012 Retirement Confidence Survey). 

Little wonder, since a recent EBRI Issue Brief noted that health-related expenses are not only the second-largest component in the budget of older Americans, they are the only component which steadily increases with age (see “Expenditure Patterns of Older Americans, 20012009”).  

Recognizing the potential financial impact, recent industry surveys have put a figure on the cost of post-retirement health care expense1—a figure above and beyond that of merely living in retirement.  EBRI has gone to great lengths to model the major risks to retirement income adequacy all the way back to the introduction of the EBRI Retirement Savings Projection Model (RSPM)® in 2003, including the incorporation of stochastic health care risks, such as nursing home and home health care costs.2  

The RSPM has incorporated those expenses because, while those events will not be experienced by all retired households, or experienced to the same extent, when they do occur they can have catastrophic financial consequences for a household’s future retirement income adequacy.  Many attempts to model retirement income adequacy either ignore this risk altogether, or just assume that all households purchase long-term care insurance at retirement—the former ignores a significant financial reality, while the latter glosses over reality. 

Indeed, a major limitation of using income replacement rates as an accumulation target is that doing so generally fails to take into account these potentially catastrophic costs.  How much difference does this make?  A recently updated version of the RSPM3 shows that, with the financial impacts of long-term care (nursing home and home health care costs)modeled, 68 percent of single male Gen Xers are projected to have no financial shortfall in retirement. On the other hand, if those long-term care costs are ignored, fewer than one-in-ten would be projected to run short of funds in retirement. Similar results were found for single female and married Gen Xers.

The gaps are even more noticeable if you focus only on the situation of individuals with projected shortfalls in excess of $100,000.  Ignoring long-term care costs, fewer than 1 percent of single male or married Gen Xers are projected to have shortfalls in excess of $100,000; however when you take those costs into account,  approximately 18 percent of single males and 10 percent of families are now in this range, according to the model. The results are even more pronounced for single females, where ignoring those long-term care costs would indicate that fewer than 5 percent are modeled to experience shortfalls of more than $100,000, compared with approximately 34 percent when this reality is factored in.

It’s clear that those long-term care costs can be significant, and can have a dramatic impact on retirement security. 

What’s less clear is why projections of retirement income needs and preparedness  would continue to overlook them.

Nevin E. Adams, JD


(1) For more information, see “The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare,” EBRI Notes,  August 2011, online here  

(2) The Retirement Security Projection Model® (RSPM) was developed in 2003, and in 2010 it was updated it to incorporate several significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans, and the recent crises in the financial and housing markets. EBRI has recently updated RSPM to account for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010.  For more information on the RSPM, check out the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online here.

(3) More information about this update will be published in June 2012 EBRI Notes.