The provision of more innovative retirement-income products will become a major strategic battleground in coming years as manufacturers and baby boomer retirees grapple with the increasing longevity risks of retirement, with more pooling flagged by many as a solution.
Innovation beyond the account-based pension would be required to provide lasting income but also allow retirees more flexible access to their money, Andrew Robertson, the founder of Ingevity, which has developed a pooled retirement-income product, said.
Speaking at the 2008 IFSA conference last month, Robertson said the development of better retirement-income products would be “one of the key strategic battlegrounds for the industry in the next five years”. Also speaking at the conference, David Knox, worldwide partner with Mercer, said “the impending retirement of the baby boomers has sped up interest in this space”.
Robertson held that account-based pensions were effective in the early years of retirement but could not manage the longevity risks involved in people living to 90 years and beyond. Knox said the crucial problems emanating from longevity risk were retirees’ lack of understanding in this area and the limited range of retirement-income products available to them.
Major stakeholders, such as superannuation funds, financial planning groups and life insurance companies should help retirees develop accurate expectations for retirement that take into account the spectrum of risks involved in longevity.
These risks are: longevity itself, and whether retirees have realistic expectations of how much money they will require; their exposure to markets while in retirement; the effects of inflation and costs of health care; the future viability of the financial institutions they are with; and legislative change.
“The key question is: when will their money run out? This depends on the individual’s health and ambitions in retirement,” Knox said. “We have seen a lot of education on superannuation and choice of fund but not all that much on longevity risk.” While many people expected that living to age 80 with $250,000 in savings would be quite easy, this sum “isn’t much if you live to 95”. Knox said that today’s 60 year-old male was expected to live an average of 19.9 years, and women 23.6 years, after 65 years of age. But for today’s 30 year-olds, however, men were expected to live 24.5 years after age 65, and women 27.5 years beyond.
Given these statistics, it was reasonable that retirees invest with a 20 to 30-year time horizon. Knox added that financial planners could better prepare their clients for longevity risk, by conveying that the life expectancy statistics currently used were not appropriate for clients approaching retirement since they did not account for recent reductions in mortality rates due to medical advancements. “These numbers are based on the mortality rates of people living today.”
Although actuarial or statistical data reflecting the perceived drop in mortality rates was not readily available, “financial planners need to factor in some improvement in life expectancy,” he said. This was particularly important since the retirees living longer were generally middle and higher-income earners that could more easily afford advanced health treatments, and were more likely to purchase financial advice, than low-income earners. “Life expectancy is usually less for people in lower socio-economic groups,” Knox said.
Knox added that manufacturers should provide more choice to retirees beyond account-based pensions which, while effective, are “very individualistic”. A product that pooled a designated sum from retiree accounts, such as 15 per cent, into a reserve fund to provide additional income for members living beyond a designated age, such as 90, was appropriate. “If we get to 90, we draw on that pool. If we don’t get there it’s like we’ve paid an insurance premium but have not made a claim. “If we are going to treat longevity risk in a reasonable way there will be some pooling. If we operate on individual islands we won’t solve the problem.”
Robertson said the core of a future pension could be a pension account, but with a long-term equity exposure, a seamless tax structure across super and other investments, capital protection, more flexible access through the internet and ATMs and a pooled ‘longevity fund’ enabling “those who live longer to be funded by those that don’t”.
But Knox said there would unlikely be any single product or investment that could comprehensively manage longevity risk. “We need to separate the risks and diversify solutions, and not rely on a single product or investment.” This could involve parcelling a retirement income and distributing it across several products or investments. “There is no silver bullet,” the actuary concluded.