Making every cent count in retirement

The writing is on the wall that more responsibility will fall on individuals to fund their own retirement. The need for better post-retirement solutions to deal with longevity risk is a key concern and challenge facing the Government and the financial services industry, writes Caroline Munro.

The Treasury’s 2010 Intergenerational Report highlighted the extent to which an ageing population would affect government spending over the next 40 years, and the measures taken by the Federal Government to minimise that impact. They include increasing the age pension eligibility, and introducing policies to lift productivity and reduce barriers to work participation. 

But it’s clear the writing is on the wall that more responsibility will fall on the shoulders of individuals to fund their own retirement, and the review of Australia’s retirement savings system is an obvious indicator.

Unlike other retirement savings systems overseas, Australian retirees do not have to take an income stream. However, some sort of soft compulsion is not out of the question as pressure on Budget mounts and as super account balances grow. The spotlight is also widening to include assets held outside of super, like the family home.

The financial services industry may still be holding back on product innovation until the details of the Government’s superannuation and financial advice reforms become clear. But there is no doubt that great challenge and opportunity lie ahead for super funds, insurers, and fund managers and advisers as the need for post-retirement products continues to grow.

 Australia falling behind

Although the retail sector has shown an increased interest in innovating around retirement products over the last few years and more industry funds have looked to provide post-retirement solutions, Australia is falling behind other countries.

According to the second Melbourne Mercer Global Pensions Index 2010, Australia fell from second to fourth place, partly due to a lack of retirement income products that dealt with longevity risk. 

A number of research reports over the last six months have revealed that Australians are feeling increasingly unprepared for retirement. A survey conducted by the Australian Institute of Superannuation Trustees (AIST) in conjunction with Russell Investments revealed that more than half of members in each of the age groups over 46 years felt their super balance was low and that time was running out. 

Some 31 per cent were not confident their retirement income goals were on track. According to the Association of Superannuation Funds of Australia (ASFA) report, Spotlight on Super Policy Issues (December 2010), 67.3 per cent of super members indicated they were concerned that their superannuation savings would run out before they die.

The challenge of managing funds increases in retirement due to rising food, fuel and pharmaceutical costs. Further data released by ASFA recently revealed that compared to the previous quarter, retirees will need more than $600 extra each year to live comfortably in retirement. 

Government reform and tentative innovation

As part of the Stronger Super agenda, the Government considered mandating that MySuper products provide a post-retirement solution for members.

It was decided as part of the consultation process that it would not be in the interests of members due to low balances, the imposition of significant costs, and increasing complexity for those funds that currently did not have an offering.

However, the MySuper consultation working group issues paper released in May stated that mandating that MySuper products offer post-retirement solutions “at some time in the future” may encourage the development of products when the superannuation system matures and post-retirement assets become substantial.

The ASFA Spotlight on Super Policy Issues paper revealed that there is some appetite among super members for compulsion. Some 39.3 per cent agreed with the proposition that upon retirement people should be required to purchase an income stream that lasts until death. One-third of respondents did not have an opinion, and the remaining 28.6 per cent disagreed.

Graeme Mather, Mercer’s head of superannuation investments Australia & New Zealand, does not believe a compulsory approach is the right way to go, although he supports some sort of soft compulsion where members can opt out of going into a default post-retirement product.

“If we don’t have some sort of compulsion, taxpayers 20 years from now will be funding the age pension, and the cost of that age pension could be significant,” he says. “It’s up to the industry to create better solutions and choices for members.”

Wade Matterson, senior consultant and leader of Milliman’s Australian Financial Risk Management practice, says that innovation is happening, but it is being driven in spite of the Government’s agenda at this point.

“Obviously the retail sector sees the opportunity to satisfy the needs of their client base as well as retain that client base, while the industry fund market is faced with the massive challenge of retaining their members, who will become more active in their decision making. So they’re looking at post retirement solutions,” he says.

“But there have been so many reviews that organisations haven’t been comfortable to innovate; when you don’t know what the legislative framework is going to look like going forward, you carry massive risk.”

A lack of innovation in the superannuation sector has more to do with the relatively small size of account balances than with the number of Government reviews over the last few years, says AIST chief executive Fiona Reynolds. She says need drives innovation, and yet the average account balance is currently $19,000 across industry as well as retail funds. 

“People with those modest amounts will tend to take a lump sum,” she says. 

Nonetheless, post-retirement solutions are high on super funds’ agendas as the first lot of baby boomers start entering retirement, Reynolds says. She adds that their approach to product will depend on the demographic of their membership.

The innovators

Wade Matterson believes that as the reform picture becomes clearer, product developers have felt more confident in developing solutions. Organisations are already taking different approaches to the post-retirement problem and a real mix of products will emerge, he says. 

“I think it’s a fascinating time. There won’t necessarily be one single solution that really dominates, and we’ll see through the evolution of the market what works and what doesn’t.”

Investor attitudes to risk clearly changed following the global financial crisis (GFC), resulting in the introduction of products to address investment market risk and provide some capital security. Product providers have attempted to utilise the benefits of both account-based pensions and annuities to develop variable annuity-like products.

The current leaders in that area are arguably AXA (North), Macquarie (Lifetime Income Guarantee) and OnePath (Money for Life). Another innovator is Challenger, which sought to address Australia’s traditional aversion to annuities by providing some access to capital through its Liquid Lifetime product.

The fascinating thing about product innovation at the moment is that two distinct universes – funds management and insurance – are starting to merge, says Matterson.

“There’s a lot of work going on at this stage to start to redesign the traditional structures around variable annuities, guaranteed products or protected products,” he says. 

Innovation was also happening in the background in terms of dynamic asset allocation approaches, which may not seek to provide a guarantee but attempt to better insulate investors’ returns from market downside, Matterson adds.

Innovation will only speed up as a number of groups build up their internal expertise. MLC and NAB Wealth is one that formed a dedicated retirement solutions team earlier in the year. That team is still growing and has attracted much of its talent from AXA.

Yet innovation is not just about product. The need to change advice pricing models in light of the proposed Future of Financial Advice reforms will also drive innovation in how advice is given.

Matterson says increasing complexity in the post-retirement area will require advice businesses to rethink the way they give guidance and make sure that risk profiling is more specific to the individual. Ultimately, advice has to come first, says Matterson, as that is where one will get a better sense of what people can and can’t accept. From there advisers can look to newer products to tailor the types of outcomes clients expect, he adds.

There is also a greater need for more sophisticated post-retirement advice tools, says James Hickey, a partner at Deloitte Actuaries and Consultants. He says holistic post-retirement planning software and systems will have to take more into account than super assets.

“They will need to incorporate the home and various other things, like social security, tax and all those other issues important to retirees,” he says.

Product revival

Product innovation is good for ensuring greater choice, but some claim older products that can be used as part of a retirement income strategy are experiencing a revival of interest.

The former chair of the review of the superannuation system and current chairman of Challenger Retirement Income, Jeremy Cooper, says having more choice is good and asserts that Challenger does not advocate a 100 per cent allocation to annuities. However, more options add to the complexity of decision-making in a population where only one-fifth seeks out financial advice, he says.

“Retirement is not a good time to be making choices between very complicated products. A lifetime annuity puts forward a very clear and simple promise,” Cooper says, adding that investors want simplicity and transparency.

Deferred annuities often come up in discussions around longevity risk, although in Australia they are currently buried under a pile of conflicting regulations.

“That makes us a real outlier globally,” says Cooper. “If you look at all the comparable retirement systems, deferred annuities interestingly play a role in them because they are actually a very powerful product with a powerful financial proposition at the end for a relatively modest amount.”

Even if those regulatory hurdles are removed, Matterson questions whether deferred annuities will ever be popular.

“It comes down to investor psychology – people are very good at making decisions around short-term outcomes, but they struggle with making decisions that affect them over a longer term horizon,” he explains. 

Mather says that while he likes the concept of annuities, he worries about the lack of consumer protections in Australia.

“I think for the annuity market to be successful in Australia we need some sort of consumer protection,” he says, referring to compensation schemes like those available in the UK.

Equity release products are another area some in the industry claim is seeing a revival of interest. The reverse mortgage market saw 11 per cent growth in 2010, according to a study commissioned by the Senior Australians Equity Release Association (SEQUAL) and conducted by Deloitte. 

James Hickey says that in the past advisers have not considered property to be part of their discussions with their clients. This is changing as they look to downsizing or other forms of early equity release, like reverse mortgages and reversion products, he says.

Government is certainly not ignoring the high rates of homeownership in Australia. Following the Intergenerational Report, the Productivity Commission recommended a government-backed aged care equity release scheme. Hickey says the reverse mortgage sector experienced funding constraints through the GFC and, while banks have stayed active in the area, non-bank lenders have been lobbying the Government to find a way of promoting greater availability of funding.

“From a public policy perspective, that may be beneficial to the Government because it may reduce the strain on the future financial system,” he says.

Industry super funds slow on the uptake

Most industry super funds have not been quick to innovate, sticking to account-based pensions if they offer a post-retirement option at all. Yet account-based pensions reveal their true weakness in a downturn.

Cooper says it is bizarre that some super funds still do not have a post-retirement solution. But, for those that do he feels it is fair that Government require specific duties around inflation, longevity and market risk, proposed as part of MySuper.

“The industry is waiting to see what that actually means,” he says. “There’s a fork in the road there. I think a lot may just fiddle around with the allocated pension to address those risks, but there are others that may feel that real annuity style income in retirement deals with those risks. So that’s a bit of a question at the moment.”

Regardless of what Government mandates, the whole-of-life approach to retirement savings is out there. On the retail side, BT Super for Life is perhaps an early innovator as members gradually move from a savings account, to a transition to retirement account, and finally into a retirement account. 

Matterson says the industry fund sector faces the greatest change as it was built out of a wholesale model where members are pooled together to enable low cost investment solutions.

“But as people retire it is no longer a wholesale discussion,” he explains. “You need to talk to each member individually because retirement is a very personal thing. The model has to change to a more retail-like model and the funds that wake up to that are the ones who will be in the best position.”

The needs of the individual

Product providers need to understand the dynamics of the pre-retiree and retiree market when innovating, says Matterson.

“We need to consider the composition of the market where certain solutions are applicable – for people with low account balances, for example, it may be more about trying to inflate their income over a five, 10 or 15 year period before they move on to the age pension.”

Mather agrees that innovation should be driven by what investors are looking for, which Mercer has termed the ‘trilemma’ – good returns, protection from risks and access to capital. Although it is impossible to develop products that address all three issues entirely, he says, the important thing is that the approach would seek to address investor needs. 

Mather says the problem with MySuper’s approach is that it has unintentionally focused on costs.

“A lot of super funds are looking to minimise costs. That’s wrong – they should be focusing on value,” he says, adding that the whole reform agenda could be counterproductive when it comes to product and service innovation.

Those super funds focused on adding real value for members will look to better risk profiling, says Mather.

“One of the biggest innovations we’ll see in the future is individual dynamic de-risking strategies for members, where there is some sort of financial engine that will automatically change the risk of members to help them achieve the ultimate objective, which is defined at the outset,” he says. 

“I get annoyed when people in the market say that balanced funds are alright for everybody, when clearly they are not.”

Mather conceded that a lifecycle approach is too late for those with low balances now nearing retirement. He says Mercer is currently collating data to discover the impact on low account balances should investors stick to higher allocations of growth assets.

The crux of the matter is that solutions will have to address the myriad needs of a varied group of individuals.

Hickey says the advice and distribution networks are the key to product developers gaining a better understanding of pre-retiree and retiree needs.

“Far too often they design a great product that makes imminent sense to the financial literate people in the organisation. But unless they tap into the needs of their customer base, it’s not successful,” he explains. “I think innovation will be more driven by members’ and advisers’ needs, and the product providers will adapt their offerings to suit.”

Deloitte partner, Stephen Huppert, says while variable annuities, for example, have not been the sales success that some providers had hoped for, they could be a viable option in the future.

“Sometimes it just takes time for advisers and consumers to understand the product, and for the product providers to understand the needs of consumers and tailor the product better,” he explains.

The advice sector was also a key to success from a distribution perspective, according to Matterson.

“As people get to retirement, the problems are so sophisticated that they are generally going to seek out advice. Organisations can be a bit slower bringing product to market as long as they have a strong distribution network.”

Matterson says it will be very interesting from the perspective of industry funds. They traditionally haven’t had distribution or advice capabilities, yet they are starting to tap into the independent adviser network.

“I think that will be a key to funds being able to retain their members and get the right services to them,” he says.

A shift of thinking required

Cooper says the shift of mindset from an accumulation to decumulation mindset is happening across sectors. 

“There’s a fair degree of acceptance that we’ve built a fairly good accumulation system but perhaps the retirement piece has still got quite a lot of work to be done,” he says.

Mather says the industry needs to step back and challenge the status quo now and again.

“We’re here to help members to achieve better outcomes, save for retirement and, more specifically, to help retirees replace their working income with an income stream in retirement,” he explains. “We’re not here to maximise return, create funds that are compatible with each other, and increase funds under management. I think the industry sometimes forgets that.”

A change of attitude is also required among investors, Cooper says.

“We do appear to be culturally wired up towards taking equity risk in retirement. If you look at a scale of risk in retirement around the planet, we would be at the extreme risky end,” he says.

Looking at the years since 2000, Australian retirees have had an unhappy four years out of 10, he says.

“Retirement is not about averages but about actuals. It points to the number one defect of using just one style of product in retirement.”

Again, Reynolds points to demand as the real drivers of change. She feels that the shift in mindset from accumulation to decumulation thinking will follow naturally as people have more money accumulated to warrant a decumulation strategy.

“That’s why the funds with older members with larger balances are doing a lot more in this space than those that have young members with low account balances,” Reynolds says.