When thinking about the accumulation phase and post-retirement, David Bell uses the analogy of car design. “If you are trying to design a new model of car and put two designers in separate rooms and told one to design the front and the other to design the back, there’s a risk you’d end up with an ugly car if you then stuck the two pictures together,” said Bell, the director of St David’s Road Advisory.
“We have that potential if we focus too much on accumulation without thinking about how that can be integrated with post-retirement.”
A whole-of-life approach
Bell’s message is that Australia needs to take a holistic approach to the post-retirement issue, “where accumulation and post-retirement are talking to each other to deliver the best solution.” For various reasons, from demographics to the structure of the financial advice and product industry, this is not happening at the moment in Australia.
“A whole-of-life approach can lead to far better solutions for individuals, because if we have separate approaches, we have one arm tied behind our backs,” said Bell.
In the current environment, there are two main options for people once they receive lump sums, one being annuities and the other high-yield strategies – for people with large balances – where funds were re-invested to deliver an income stream while preserving, as much as possible, the capital base.
The Australian annuity market, however, has yet to develop to the point where the product could be considered a real solution to post-retirement incomes. “Australia is a very difficult marketplace for annuities,” said Bell. “The products have a lot of inflexibility. They have low liquidity, there are tax issues and, without healthy competition between providers, there must be question marks over the health of the industry to deliver.”
“We have to consider the possibility that the life annuity market won’t develop to a point where it forms part of the solution, so perhaps in Australia the solution will come from other sources.”
Home is where the annuity is
One solution, according to Bell, could be the family home. Many people were taking their lump-sum payments and using them to pay off their mortgages.
“The reality is that for many people the family home will be a large portion of their asset base, and it is very important that asset is worked hard,” said Bell.
“So, as well as providing accommodation, it is also a source of retirement income via a mortgage release or reverse-mortgage market. Because if annuity markets don’t develop sufficiently then reverse mortgages may become a much larger feature of post-retirement plan, and there are some opportunities there for further product development.”
While high net-worth individuals would continue to invest in high-dividend yield products, not many people would have sufficient capital to drive those level of incomes, Bell said. In that context, he forecast a “much greater focus on low volatility products.”
“High income is a fad at the moment, but that is largely irrelevant because it is particular for high net-worth people, so I would also advocate a switch to develop products of low volatility,” said Bell.
Longevity products for everyone
Hazel Bateman, the associate professor of actuarial studies at the University of New South Wales, agrees with Bell that annuities were problematic in Australia, and that other solutions needed to be found. “We have a very small demand for life annuities. Last year in Australia only 109 were sold from two providers,” Bateman told the session. “A lot of people retire with very small accumulations so there’s no point in buying a life annuity.
“The challenge is that we have to create retirement income and longevity products for the whole of the income distribution, not just the top end, because at the lower end people seem to spend their retirement savings and then go on to the old-age pension.”
Optimal form is good advice
Earlier in the session, John Ameriks, the principal of investment counseling and research at Vanguard in the United States, presented research from his home market on why people were reluctant to use annuities. “The first one is around precautionary motives – the saving for a raining day – and the other one is issues around leaving a bequest for their children, which is very important for some people,” Ameriks said. “They say that if they don’t need it, they want it to go to their kids.”
Ameriks said Vanguard had done some theoretical modeling which showed that, in the US, annuity products are pitched at too-expensive a price against what the target market is prepared to pay.
Vanguard had also looked at products around longevity insurance, which was not an immediate annuity “but a smaller lump sum now, almost a deferred annuity that doesn’t demand a lot of immediate capital outlay”.
“People were able to tolerate higher prices for these products, which would suggest they have a greater chance of adoption post-retirement,” said Ameriks. “But there is no magic bullet to retirement income. The optimal form is good advice, which uses basic building blocks to give people the right outcome.”
In association with AIST, Conexus Financial is holding a Post-Retirement Conference on March 5, 2013 in Melbourne. Click here to find out more.