Stochastic modeling of post-retirement financial planning

Date of Completion

January 2003


Gerontology|Mathematics|Economics, Finance




Today more people than ever before attain retirement age due to increased longevity and earlier retirements. Future retirees will bear a larger responsibility for ensuring their own well-being in retirement. Personal financial planning at the retirement stage becomes an important issue. There are some special risks in retirement that call for careful planning. ^ There is an expanding universe of retirement and financial planning software and Internet sites available to the public. But financial planning software programs in general suffer from limitations. Most do not recognize all the many uncertainties facing households and they deal with risk in a deterministic way. They focus on saving for retirement rather than planning at retirement. Insurance products are seldom offered as investment options in these programs. ^ This dissertation takes into account the characteristics of post-retirement life and identifies various risks at retirement. We utilize a variety of insurance and investment products to deal with risks and achieve financial objectives. Our model focuses on seeking the best asset allocation strategy for the post-retirement financial planning problem. It analyzes the usage of long-term care insurance and life annuities and investigates the impacts of various factors on the optimal allocation strategies by using Monte Carlo Simulation techniques. ^ We find that long-term care insurance is a valuable hedge against the risk of morbidity. We define both a self-annuitization strategy and an annuitization strategy. We assume that the same type of fund is being used for these two strategies, and study the different patterns of estates over time. Annuitization is usually better than self-annuitization for estate creation and liquidity. These results have important implications on new product and marketing strategies for payout annuities. ^ We conclude that optimal allocation strategies vary considerably and are neither trivial nor intuitive. Insurance products should be given more consideration when a post-retirement financial planning model is being developed. A stochastic approach should be taken to capture various risks at the post-retirement stage. ^