Because interest rates on government-issued securities have increased significantly since the beginning of the year and implied investment returns on immediate annuities have also increased, we have decided to increase the default assumptions used in the AFPs for future:
- Investment returns on Floor Portfolio assets to 4.5%,
- Investment returns for Upside Portfolio assets to 7.5% and
- Annual rates of inflation to 3.5%.
The yield on the IRS 10-year constant maturities has increased by about 150 basis points since the beginning of the year and, as discussed in our post of May 18, 2022, implied yields on immediate annuities has also significantly increased. Therefore, we have decided to increase the default assumptions for the above three assumptions used in the AFP workbooks by 150 basis points each from 3%, 6% and 2% respectively.
Note that we have maintained approximately the same assumed “real” rates of return on Floor and Upside Portfolio assets of 1% per annum and 4% per annum respectively.
You are not required to use the default assumptions. They are provided to give you our best estimate of future experience over your lifetime planning period. To override the default assumptions, simply click on the “Default” box in Column D and select “Override.” Then type the override assumption in column F. So, for example, if you wanted to see what the impact of using the new default assumptions is, you could enter the old assumptions as override assumptions and compare the results with the results produced by the new assumptions.
The new investment default investment return on Floor Portfolio assets of 4.5% is less than the implied interest rate for immediate annuities for retirees aged 70 and younger as discussed in our post of May 18, 2022 but it is greater than the implied interest rate for immediate annuities for retirees aged 75 and older. As discussed in our post of April 11, 2020, older retirees may wish to use a more conservative (lower) interest rate assumption for Floor Portfolio assets.
As discussed in our post of March 20, 2022, more conservative users may want to use a higher inflation assumption to reflect expectations of temporary or longer-term higher levels of inflation.
We will continue to monitor general interest rates and implied rates of returns in immediate annuity contracts to see if additional changes in the default economic assumptions used in the AFP may be warranted. We have not made similar changes to our other spreadsheets, but you can change the default assumptions in those workbooks by using the override feature discussed above.
