Financial Planning and Risk-return profiles

The importance of funded private or occupational old age provision will increase due to demographic changes and the resulting problems for government-run pay-as-you-go systems. Clients and advisors therefore need reliable methodologies to match offered products and clients’ needs and risk appetite. In this paper, we analyze existing approaches such as sample illustrations and historical backtesting that are often used for comparing and explaining products. We find that the information provided is often insufficient or even misleading. We introduce an alternative methodology based on risk-return profiles, i.e. the (forward-looking) probability distribution of benefits. In a model with stochastic interest rates and equity returns including stochastic equity volatility, we derive risk-return profiles for various types of existing unit-linked/equity-linked products with and without embedded guarantees. We highlight the differences between actual product characteristics and the impression generated by existing approaches and explain the resulting misleading incentives for product developers and financial advisors. * Corresponding author FINANCIAL PLANNING AND RISK-RETURN PROFILES 1