Pension formulas derived hundreds of years ago

Posted by Moshe A. Milevsky  Mon Jun 4 2012

York University professor Moshe A. Milevsky teaches at the Schulich School of Business. His latest book is The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas behind Planning Your Retirement Income (Wiley, May 2012).

It is interesting to note that the issue of pensions and the risk involved in planning were thought of over three hundred years ago.

In the 17^th century, the state was facing problems not unlike the ones faced by Ford and other companies and governments today. The King awarded pensions for service to the Crown and many members of the clergy, as an example, had been promised lifetime payments. 

In 1672, the government established a pension for retired Royal Navy officers and by then British insurance companies were offering annuities to people of all ages, but were charging a flat price, regardless of age.

The City of London was the centre of business in the British Empire and it gradually dawned on the business community that these promise to pay involved risks. But nobody had an accurate idea of exactly how much risk and so they turned to the scientific establishment for help.

The problem made its way to the Royal Society — think of it as a supreme council of scientists — and then to Edmond Halley who spent most of his life gazing at the stars. 

He attacked the problem in a careful and novel way. And much to his credit he came up with the first known procedure for properly valuing a pension or lifetime annuity. 

He wrote an article which was published in 1693 by the Royal Society’s Philosophical Transactions and provided the equation he had used, along with the first reliable mortality table.

His equation is still used and taught to insurance actuaries today. More, importantly, it is an equation every Canadian should be aware of as they approach their retirement years.

Halley’s main scientific insight was to combine interest rates, mortality rates and age, to arrive at an equation for the value of a pension annuity. 

He properly established that the younger you are — all else being equal — the more valuable and expensive is the corresponding pension annuity. More importantly, the lower the prevailing interest rates — such as they are today — the more valuable is your pension. In fact, you might be surprised to learn how valuable that pension can be. 

Think about it. If you can retire on a full pension paying 80 per cent of your salary at the age of 55, the value of your benefit can be in the millions of dollars.

Here is yet another application of Halley’s methodology and equation, which is relevant to all Canadians. 

Although Old Age Security might only pay $550 per month, its present value at the age of 65 — and in today’s ultra low interest rate environment — might be as high as $115,000. There is much at stake in the debate around reforming OAS.

Halley’s equation and methodology for valuing pension annuities is now ubiquitous and intertwined with all retirement decisions. In my opinion, it is one of the seven most important equations for retirement planning.

So, when it comes to the Ford plan (In order to lighten its pension load, the Ford Motor Co. announced recently that it is offering 90,000 retired engineers and office workers the choice of continuing to receive a monthly pension or take a lump-sum buyout from the Ford plan)  pensioners, I would suggest that every one of them find an actuary — or at least an astronomer — who is familiar with Halley’s equation, so they can figure out whether the deal is worth it or not.

The other six minds behind calculations for retirement and the questions you need to consider

In addition to Edmund Halley’s equation for valuing pension annuities, here are the people behind six other important retirement calculations.

Present and future value: If I have $1,000,000 in my nest egg, earning 5 per cent per year, for how many years can I afford to withdraw $100,000 before the account is emptied? It’s obviously more than 10 years because of the interest rate, but how much longer? 

Italian mathematician Leonardo Fibonacci (circa 1170-1250) derived the equation still in use today. He also wrote the world’s first financial mathematics textbook.

How long will I live? The odds of a 75-year-old living to 80 are obviously greater than an 18-year-old living to 80. British actuary Benjamin Gompertz (1779-1865) figured out the exact ratios and the law of mortality underlying this calculation. 

Gompertz was a self-taught mathematician, because at that time as a Jew he was not allowed to attend university. He eventually became president of Britain’s prestigious Royal Society.

How much can I spend? Yale University economist Irving Fisher (1867-1947) was the first to properly factor inflation into the equation, as well as the notion that you spend less as you age to help answer the question of how much to spend.

How much risk can I take? MIT professor and Nobel laureate Paul Samuelson (1915-2009), whose economics textbook is well known to undergraduates, described the optimal asset allocation between the risky stock market versus safe cash, taking into account all your capital.

What am I worth? Wharton business school insurance scholar Solomon Huebner (1882-1964) pioneered the technique for properly measuring and insuring human life value and he emphasized the role of legacy in financial planning. So, you want to leave $100,000 to the grandkids. How much will that cost you today?

Will my plan work? Russian mathematician Andrei N. Kolmogorov (1903-1987), state hero of the communist Soviet Union, created the mathematical framework that determines the probability your retirement income plan is sustainable.

What is a little part time job?

It’s commonplace for older people say they’d like a little part-time job when they retire. But just how small can that job be?

A press release issued in April by MGM Advantage reveals how today’s retired workforce spends over 300 million hours a year in part-time work. In terms of the total retirement population this equates to 9%, which is over 1 million people. Of this group, 832,000 are aged 65 and over and 278,000 are between 55 and 64.

All well and good and interesting. However, looking at how that work is broken down reveals the findings to be, frankly, somewhat bizarre.

Number of hours a week retired people spend in part-time work Number of retired people doing this

1 – 2 hours 402,379
3 – 5 hours 393,021
6 – 10 hours 177,795
10 – 15 hours 56,146
16 – 20 hours 46,788
Over 20 hours 28,072

Over 400,000 retired people only doing 1-2 hours paid work a week? What sort of jobs do they do – and how much do they get paid to make doing any work at all at this level worthwhile?

Unfortunately, MGM Advantage themselves were unable to shed light on this, merely confirming that this was paid work as opposed to “charity work, voluntary work, caring for parents and grandchildren, etc.

The fact that nearly 800,000 older people are working less than 5 hours a week and yet still being considered as part-time workers surely calls into question the role and nature of work past retirement. And, of course, that’s without examining the issue of how many would like to work more – or less.

Source: 

Any views from anyone on what’s going on here?

Previously Important Person

I was intrigued to read this comment: “A former high-ranking media executive I met recently described himself as a new member of the PIP Squad — Previously Important Persons.”

Jobs are important to us, so when we retire we lose  importance and feel we may become invisible in the eyes of the world. If you ask any person you meet what they do and it’s almost certain that if they say they’re retired they will immediately qualify it by adding “but I used to be…..”  In short, they are a PIP.

PIP status isn't linked to grade and salary achieved. A person didn't have to be a big cheese, chairman or professional in their career. Whatever their level, what they were was someone who was important in the eyes of the world by virtue of their place as a contributing, valued individual.

Retirement strips people of that value and recognition. Above and beyond financial reward, it is what drives many to want to keep on working.


Source:

Doorway, what doorway?

So … what am I doing here, anyway?"

Even the most nimble-minded among us have pondered that question after walking into a room with some purpose in mind — to get something, perhaps? — only to blank on what that purpose was. Now a new study suggests that it's the very act of walking through a doorway that causes these strange memory lapses.

"Entering or exiting through a doorway serves as an 'event boundary' in the mind, which separates episodes of activity and files them away ," said lead researcher Gabriel Radvansky, a psychologist at the University of Notre Dame. "Recalling the decision or activity that was made in a different room is difficult because it has been compartmentalized."
n our minds, like in the movies, threshold-crossing signals the end of a scene.

As detailed in the Quarterly Journal of Experimental Psychology, the explanation follows from a series of experiments that probed the relationship between memory and various types of home wandering. First, Radvansky assigned a group of study participants the task of selecting an object from one table and exchanging it for an object at a different table in another room. He then had a second group perform the same task between tables that were an equal distance apart, but in the same room.

The difference in the two groups' performances was "big enough to drive a truck through," Radvansky told Life's Little Mysteries. Despite the simplicity of their task, "people were two to three times as likely to forget what they were supposed to do after walking through a doorway." This suggested that doorways acted as mental blocks, impeding our ability to retrieve memories formed elsewhere.

The finding held true when the participants navigated both real-world and virtual settings.

But was it actually threshold-crossing that caused their memory lapses, or was it simply being in a different environment than the one in which they learned their task? To find out, Radvansky had the volunteers perform another object-exchanging task, but this time, the task required them to pass through several doorways leading back to the room in which they started. As it turned out, their memories failed them in this scenario just as they did in the other threshold-crossing scenarios. "When they went through multiple doorways, the error rate increased," he said. This suggests that the act of passing through doorways, rather than the fact of being in a different environment, kills memory, he said.

So why does this happen? "When we are moving through the world, it is very continuous and dynamic and to deal with it more effectively, we parse things up," Radvansky said. Neuroscientists have begun imaging the brains of people crossing event boundaries and, from these studies, are just beginning to piece together how the brain performs this function. "There are a lot of [brain] areas that light up at different kinds of event boundaries."

Mental event boundaries are useful because they help us organize our thoughts and memories. But when we're trying to remember that thing we were intending to do… or get… or maybe find… they can be annoying.

"I think architects are interested in this research because they want to design spaces that are more effective," Radvansky said. "For example, they might need to consider where you need doorways and where you don't."

Harper attacks on Health care continue

 A must read for people who thought  health care in Canada was safe from Steven Harper's government. Montreal Simon presents a compelling argument about why we have to stop Harper. Here is some of what he has to say about Harper's attack on our Health care. The link to the full post is at the bottom, please read it if you believe that health care in Canada is a right not a privilege.

A shameless surrender to foreign corporations, that will only make it harder for our health care system to deal with the increasing demands of our aging population.   
But of course Stephen Harper doesn't care about that, because he entered politics as the poster boy of the National Citizens Coalition that was founded to destroy medicare. 

And his plan to destroy medicare is by making the provinces too poor to afford it.
That is why he is cutting health care transfers by $36 billion, that's why he is refusing to create any national health programs, that's even the real reason he is sending more prisoners to jail. So the provinces will have to pay more to feed and house them. 
It's his stealth attack on medicare. And although most Canadians are blissfully unaware of this sinister plan, the Health care for Bucks lobby can smell the blood in the air, and all kinds of new organizations are circling Parliament Hill like vultures

http://montrealsimon.blogspot.ca/2012/11/stephen-harpers-stealth-attack-on.html