Serving the pie

While the Government has focused on ‘growing the pie’ for retirement income savings, it has not yet figured out how to best serve it to retirees.

This has led to an industry filled with accumulation products, while the decumulation side – which will have the final say in how retirees live – has largely been overlooked in the market.

This was the view from the Retirement Income Review, which found little attention had been allocated by the industry to the retirement and aged care phase.

The review also found people viewed superannuation as means to accumulate wealth in retirement to live off via capital growth, rather than as an asset they could drawdown.

The industry and individuals saw the importance of accumulating income for retirement but had little understanding of what to do once they got there.
In other words, the industry has learnt how to make good pies, but is yet to master the best way to serve it over as many meals as possible.

Adrian Stewart, Allianz Retire Plus chief executive, said the reason most of the innovation in the industry had been focused on the accumulation phase was because that was where most of the money was held.

“All Australians that are working have access to superannuation in terms of participation but, as Australians are ageing, that weight of money is shifting from accumulation to decumulation. That weight of money is significant, it’s north of $60 billion that’s crossing the line from accumulation to decumulation,” Stewart said.

“That’s going to $200 billion over the next few years. Advisers are really forced to review client portfolios; retirement is always a catalyst for that reflection.

“If clients who are retiring don’t have an adviser, it’s usually at the point of retirement they will seek advice so that’s good.

“There’s all this stimulus that’s kind of forcing the discussion about what their retirement should look like.”

As a result of those discussions, Stewart said advisers and super funds had looked deeply into the risks that retirees faced and those risks were slightly different in retirement than in accumulation.

“When you reflect on product availability for accumulation it’s very broad – if you look at any platform there’s anywhere between 900 to 1,200 investment strategies available to advisers and investors on a platform,” Stewart said.

“But very few of them actually have been specifically designed for retirement and there’s this dearth of options available.”

Angela Murphy, Challenger Life chief executive, similarly said the reason the focus was on accumulation as opposed to decumulation was because of the weight of numbers.

“When you think about how many members a super fund has – they’ve got members right from those just starting work right up to those who near the end of their life,” Murphy said.

“But it would’ve been a smaller proportion of people who are actually in retirement, the vast majority are in the early phase.

“For the funds as well, it’s been a space that’s been changing quite a lot, they’ve been adapting to a lot of new regulations so we can see at the moment there’s consolidation, there is other government regulations… so they’ve just been distracted by other priorities.”

On the advice side, Murphy said a lot of advisers would have been seeing people who would have been primarily focused on building their wealth.

“There is more and more people moving into that retirement phase that is putting a push onto what the options are and how do we manage that,” Murphy said.

“It’s interesting to look at the risk profiling that’s done for advisers, so much of that will be focused on [for example] your tolerance for a year of negative returns, rather than perhaps your tolerance for running out of money before you die.”

HOW THE RIC WILL SHAPE THE INDUSTRY

Moving on from its focus on ‘growing the pie’, the Government launched the Retirement Income Covenant, which meant super funds trustees were now obligated to outline how they would help their members in retirement.

“In many ways the industry has been so focused on growing the pool of savings for retirees – the bulk of people have been in accumulation and it’s all been about growing that pot,” Murphy said.

“The Retirement Income Covenant in many ways is giving a kicker to something that perhaps over time is becoming more important.

“That is helping increase the number of retirees who are moving over into that actual retirement phase into the spending phase and they are retiring with bigger and bigger balances because they have been in the super system for longer.”

However, Murphy said there were a couple of key changes she saw happening around product innovation and the way super funds operated.

“The first is obviously going to be around product innovation to help advisers, help their clients manage the different challenges you face in retirement,” she said.

“The other thing is with superannuation funds – it would’ve been unusual five or 10 years ago to find someone with the word ‘retirement’ in their title – whereas most [super funds] now usually have someone responsible for retirement but typically a team of people working on what is the right retirement solution for their members.

“One of the things we will see with the onset of the Retirement Income Covenant is a lot of innovation in that space as well, the super funds will have specific retirement options and they’ll do that differently, but it will be a big shift from where we’ve been.”

INNOVATION DIFFICULTIES

Stewart said it was difficult to innovate in this sector because product manufacturers that could innovate in this area were limited to life companies.

“The traditional investment company isn’t structured to do this so they don’t typically hold capital,” Stewart said.

“They’re not a life company and they’re regulated by ASIC [the Australian Securities and Investments Commission], so there’s only a small cohort of life companies that will innovate in this space and the barrier to entry is high.

“You have these capital charges that are really quite onerous so that increases the intensity of manufacturing these products.”

Stewart said when trying to solve sequencing risk and longevity risk, the solutions essentially provided a guarantee for life. 

“In order to provide a guarantee, not only in Australia but most developed markets, you need to be a life company in order to make a promise – whether it’s a promise to protect capital or to protect income or guaranteed income for life,” Stewart said.

“Therefore, to be a life company – obviously life companies and banks are regulated by APRA [the Australian Prudential Regulation Authority] – there are strict capital requirements when you make a promise. 

“You cannot make a promise unless you can actually support that promise in terms of capital reserves.”

When it came to potential innovations, Murphy said she expected to see more options to tap into home equity, annuities, and income smoothing (products that help move income and avoid to crystallise losses at poor times in the market).

But ultimately, the big difference in retirement compared to accumulation was the known unknown – not knowing how long a person would live.

“The hard thing with life expectancy is if you’re [for example] a 65-year-old woman, your life expectancy is very much in the late 80s even approaching 90 now, but you still have a reasonable chance of living to 100,” Murphy said.

“One of those big risks is how long am I going to be alive which we refer to as longevity risk, but products that help manage that risk and help retirees think about how they will keep funding their lifestyle if they happen to be in that space.”

ANNUITIES

To understand annuities, there is a good example in recent history involving US President Donald Trump and the National Football League (NFL).

In the 1980s, a rival American Football league called the USFL drafted a quarterback named Steve Young. The league was competing against the better-established NFL, and Young was offered a $40 million contract by the USFL.

However, because the league was less financially sound than the NFL, it offered to pay the contract as an annuity over 40 years.

Later, an anti-trust lawsuit against the NFL by the USFL led by Trump, who was one of its team owners, resulted in the league’s demise and Young was only paid $3 million of the full contract, but he went onto have a Hall of Fame career in the NFL.

However, for anyone who held anxieties over taking out an annuity for a potentially similar scenario – former US Presidents and Hall of Fame quarterbacks aside – Murphy said regulations would prevent that scenario. 

“Within Australia, the regulatory environment that we’re in [requires us] to hold a capital buffer,” Murphy said.

“The money we get from the customer, Challenger then has to put in funding of our own to make sure that would never basically.

“APRA come and get us to do modelling that show what would happen basically for a one in 200-year market shock, what would our assets look like and our buffers sufficient.”

Murphy said in the changing retirement income landscape, annuities would continue to be a component but not the whole piece.

“Our experience with our customers has been that one of the real advantages of having something like an annuity is that allows retirees to feel more comfortable spending the money they have invested in other strategies,” Murphy said.

“It takes away the tendency we have to self-insure, not knowing how long we’ll live, we will put aside a big chunk of money in case we need it.

“What that means is we’re not spending it confidently, so it’s a really important component and, as we’re starting to innovate in the product sector, some of the feedback we have gotten from advisers is they loved the longevity risk protection – which is what the annuity provided – but they disliked being out of market exposure.

“Advisers were telling us ‘we really like that longevity protection but we would there to be an option for us to continue to have market exposure for our clients’.”