Australia has probably the most admired accumulation system in the world, but our system of decumulation is a work in progress.
That superannuation funds, politicians and researchers are all talking about change is cause for hope. Indeed such is the level of agreement that the era of easy access to lump sums must end, several people we spoke to for this article referred to it in the past tense.
There is likely to be a 10-year warning on any radical changes to the law on lump sums, but in the meantime super funds have started taking baby steps towards a suite of retirement products.
The Actuaries Institute has estimated that 60 per cent of all fund assets will move from the accumulation phase and enter the retirement phase over the next 15 years. The vast majority of the $500 billion in self-managed superannuation funds is with those aged over 50.
That there is a moral imperative to act is evidenced by the familiar tale of the retirees who see their cash balance dwindle and seek to invest the remainder more aggressively over time. Or the retirees who jump out of equities at the bottom of the market and then miss out on their recovery – research carried out by HESTA found the highest amount of switching activity among its members took place at the bottom of the market crash in 2008/9 from equities to cash.
Staring at retirement
One answer is to allow funds to default members into an appropriate investment strategy. Sacha Vidler, chief economist at Industry Super Network, is putting together a research paper that seeks to reactivate Jeremy Cooper’s recommendation that MySuper continues into the retirement phase.
His paper is likely to be released after the election, with the hope off persuading a new government to allow super funds to default members into an appropriate income-bearing investment providing a pension. The process would work by negative consent as soon as a member starts retirement and ceases contributions.
This would not be an excuse to give up providing advice. “You would absolutely be trying to communicate with the member as much as possible to encourage them to express a preference.” Importantly, members would still be able to reverse their fund’s decision and draw a lump sum or even purchase an annuity, but the psychologically smart aspect of the exercise would be that members would be confronted with the stark reality of what their account balances could pay them in income and how lump sums would reduce this.
The logic fits in well with the culture of accumulation. Andrew Boal, managing director of Towers Watson, says intelligent default strategies have worked very well in the accumulation phase and should members should be similarly guided in retirement.
“However, at least for the moment, any default arrangement should be able to be unwound reasonably easily, to take into account the needs of members who may take a little while to seek out their own advice and make a decision,” he says. “For that reason, a suitably invested account-based pension should provide a reasonable starting point.”
The HESTA research found a lot of members simply staring at retirement. Debbie Blakey, deputy chief executive of the fund, says: “Many members need confidence to go into decumulation. Even that is a bit hard for them. They are frozen into that place of knowing they should do something but not knowing exactly what it is, so they do nothing.” Similar research at Care Super found that many members wrongly thought they were obliged to take their account balance as a lump sum and that there were no other options for them.
Numerous surveys of those aged over 55 show that they hate investment volatility. In theory, one sure way of achieving this is to purchase an annuity with part of their capital to assure a basic standard of living and then to invest the remainder in the market. The trouble is those in superannuation funds are generally loath to purchase an annuity. MTAA Super and QSuper have both launched annuities for just such a purpose, but both have received low take-up.
“It is expensive because there is a guarantee,” says Leeanne Turner, chief executive of MTAA Super. “That is what people have to understand if you want certainty. It does not come cheaply.”
She sees the launch of annuity as the start of a journey, rather than a destination. “It will not be the be all and end all. I expect further innovation. We have to start thinking outside the square for retirement income.”
Common objections to annuities are the lack of a tax advantage and the concern at the financial strength of insurers. Annuities in their fixed nature also take away the potential for growth that investments can bring – notably part of QSuper’s marketing for its annuity is that members have gained a discount from Challenger, which would help those who purchase them to feel they have gained some upside from the deal.
Richard Howes, chief executive of Challenger, the biggest provider of annuities in Australia, points out that Australians’ aversion to annuities is counter intuitive to research that shows their concern over feeling out of control in retirement. He believes that a greater focus on education, good financial advice and tax changes is the key to raising take-up.
“A lifetime annuity that takes care of basic living needs affords a feeling of safety that gives you greater control of the situation, which then liberates the member to seek more aspirational objectives with the growth part of the portfolio,” he says. “It is the only product which can protect against inflation, market and longevity risk.”
Challenger is well advanced in its preparations to launch a deferred annuity in 2014, which will offer retirees another means of gaining peace of mind.
“Without a deferred annuity, retirees are forced to under-consume because half of us will live past our life expectancy. Retirees do not need to be unnecessarily frugal in the early active years when they would otherwise be spending more,” says Melinda Howes, chief executive of the Actuaries Institute.
A deferred annuity starts paying out at the age retirees reach their natural life expectancy, as set by an actuary.
The product has caught the imagination of many super funds, not least because it keeps members invested with them for longer. QSuper has expressed an interest in offering them to members, while Danielle Press, chief executive of Equip Super, says she would even buy one for herself.
“If I was able to buy a deferred annuity today with tax treatment that was good, I would. For people in their early 40s, a deferred annuity is cheap. When I am 65, it becomes expensive and when I am 75, it is really expensive.”
As much as Press is a fan of deferred annuities, she expresses concern at the capacity of the insurance industry to provide enough for all Australians. Such concerns over capacity, added to the concern over cost and member distrust of annuities has led to the suggestion that the industry could provide an alternative.
“If we are smart enough, and I believe we can be, we can create a product that looks and feels like an annuity but does not have a guarantee,” she says.
Industry Super Network’s Vidler confirms that while it is not uppermost in the minds of super funds, some thought has been given to an industry fund venture.
“It is certainly conceivable but there are no plans. We are looking at ways that you could pool longevity risk in the future that is appealing to individuals and does not create overwhelming burdens for providers.”
There has also been some thought around the government providing a form of longevity insurance which could be purchased by retirees, confirms Howes. This could be compulsory to ensure that the public does not fall back on the Age Pension once their super balances are diminished.
“The problem with both these plans is that the poor (who generally don’t live as long) will subsidise the rich (who live longer), so it is not equitable,” she adds.
It is the belief of many that single product solutions should not be the main focus of reinventing the decumulation stage, but rather an advice process that leads to a personalised solution drawn from a toolkit of products and strategies.
Wade Matterson, leader of financial risk management at actuary and consultancy Milliman, believes that creating this toolkit will be essential for funds to differentiate themselves, but that the delivery and communication is where funds will do it well or not – a situation both QSuper and MTAA Super are already grappling with.
“As people get closer to retirement, they become more engaged and take control and they are going to look for advice through intra-fund advice or financial planners. The advice will have to be highly tailored for members’ personal circumstances. If you do not feel the advice coming from your fund is tailored or fits your circumstances, then you are going to look elsewhere.”
One example of this tailored advice is an implemented overlay of derivatives that Milliman has created to manage market risk for financial advisers’ clients.
If individuals like the investments they currently have but would like a mechanism to manage their risk to a major market correction in the four to five years before and after retirement, an overlay can pick up the slack. Other options within a personalised retirement plan include bequests, liquidity, health plans and downsizing property.
According to Grant Peters, insurance sector leader for Oceania at EY, such holistic personalised plans are the space the big banks are focusing on – although industry funds, corporate and public sector funds are known to be looking too. These will work across a number of products that banks already have in place such as home loans, reverse mortgages, insurance and advice. A key part of how they will work is through fund tools that interface with members and allow them to model life expectancy alongside potential income streams from different products.