A study by the SDA Bocconi School of Management “Consumer protection and the design of the default option of a pan-European Personal Pension Product”, shows benefits for consumers of life-cycle investment as a PEPP default option.
The study is a useful academic contribution to the debate on whether the PEPP should offer a default investment option with a financial guarantee, or whether the default option can rely on a life-cycling technique consisting of reducing the proportion of risky assets in the PEPP portfolio as retirement approaches.
Backed by a variety of economic arguments, the study concludes that the inclusion of life-cycle investment strategies as default option in the PEPP is economically desirable for consumers, who would benefit from superior returns and comparatively low risk compared with bonds, over a long investment horizon. The study also illustrates the advantages of life-cycle investment solutions in terms of risk mitigation and performance enhancement.
The study conducted a series of simulations based on historical returns data for the period 1969-2012, which was marked by the two oil shocks, and increasing and decreasing interest rates and inflation rates, and for the period 1992-2012, characterized by falling interest rates and inflation rates. The first period is referred to as the “old normal” and the second as the “new normal”.
The study presents strong evidence of the robust level of capital protection offered by life-cycle strategies:
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Under the “old normal”, the majority of savers in a life-cycle strategy can expect a real rate of return greater than 5.9% over a 40-year accumulation period, compared to only 3.3% in a product with a guarantee.
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Under the “new normal”, the majority of savers in a life-cycle strategy can expect a real rate of return greater than 5.1%, compared to only 1.2% in a product with a guarantee.
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Shortening the length of the accumulation period does not alter the results significantly. By way of illustration, under the new normal scenario, the real return of the guaranteed strategy reaches 1.4% in 50% of the cases, compared to 5.8% for life-cycle strategies.
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Life-cycle strategies ensure that 99.9% of the savers end up with an accumulated pension wealth greater than the inflation-adjusted capital invested, under both a 40- and 20-year accumulation period.
The study also clearly demonstrates that the emergence of the “new normal” economic and financial landscape after the global financial crisis, coupled with the Solvency II constraints, has had a significantly adverse impact on the returns offered by life-insurance products offering a financial guarantee.
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