Paul McCartney was only 16 years old when he wrote “when I’m 64” in 1958, so can be excused for taking a pessimistic view of what we now regard as an active phase of life during which many of us will still be working by choice. Still, median life expectancy from birth was not quite 70 back then, so maybe McCartney had perfectly valid expectations around the timing of his sunset years.
But 70 is a long way short of 92 and 94, which are today’s median life expectancies from birth for men and women, according to the 2015 Intergenerational Report. The relentless upward march of life expectancies is set to continue, the implications of which are increasingly occupying the minds of super fund trustees and CIOs tasked with guiding members on the conversion of their superannuation to lifetime retirement income.
While in recent years we’ve seen the likes of VicSuper, QSuper, Media Super and Equip introduce targeted longevity solutions for members, overall industry progress has been more subdued, most likely due to the large number of pressing regulatory and reform issues on the table.
But the call for widespread adoption by funds of specific longevity solutions remains as topical as ever. The current Financial System Inquiry (FSI) has provided the latest and more forceful reminder that longevity “is a major weakness of Australia’s retirement income system”, pointing out that the most popular retirement product, the account-based pension, provides flexibility and liquidity but leaves individuals with longevity, inflation and investment risks.
The FSI recommends that fund trustees pre-select a comprehensive income product for retirement, which should include a specific longevity solution, which would be a significant improvement on the implied pre-GFC approach to ‘managing’ longevity risk in account-based pensions. This essentially consisted of an unabated high allocation to equities on the basis that ‘members will be retired a long time so still need mostly growth assets.
While a review of this approach was inspired by a 54 per cent plunge in the All Ords and only a partial recovery some five years later, there’s every indication that the super industry’s demand for specific longevity insurance solutions is a permanent feature rather than passing fad – though it must be noted that high equity allocations continue to be regarded by some as a universal panacea for longevity and market risks, courtesy of the exuberant use of optimistic equity risk premia.
For those funds looking beyond the status quo, the bigger question has become whether, and how much, members are prepared to pay for additional longevity risk insurance or risk management beyond the $338 per week Age Pension, and what would they actually be getting for their money?
Courtesy of the FSI’s Final Report, an experimental new concept has emerged at the other end of the certainty spectrum to the AAA rated Age Pension. Group self-annuitisation (GSA) does as the name suggests – it transfers longevity risk from individual to a collective of members whose assets are pooled for the purpose of managing idiosyncratic longevity risk. The actual level of income provided will depend entirely on actual mortality and market experience.
Because there are no guarantees in a GSA, there is no need for shareholder capital to protect investors’ interests, and theoretically, this partial risk management service can be provided for a lower cost than guaranteed full longevity insurance such as that offered through modern lifetime annuities.
Which is as it should be, given that a GSA provider deducts its management fee before and irrespective of investors receiving any returns. Life offices, on the other hand, only get paid after they’ve met their promises to investors, and instead of a fixed percentage of assets under management, they receive whatever positive spread they can make on invested assets. But what exactly are these fees buying, in terms of longevity risk protection for the member?
In the case of a GSA, it’s difficult to say, because it will depend on the mortality experience of the invested pool. The only thing that’s certain is that some members will die before others, so bonus income will be paid – but the quantum and timing of receipt is unknown and unpredictable.
By way of contrast, life companies issuing annuities guarantee a fixed earning rate, or fixed payment schedule in the case of lifetime annuities, and are subject to APRA regulation under a regime similar to that imposed on the banking sector. In addition to prudential reporting and oversight APRA imposes stringent regulatory capital requirements intended to permit annuity providers to withstand a 1:200 year adverse economic event, materially worse than the GFC, which has been described as a 1:75 year event.
So, when it comes to longevity insurance, as with all forms of insurance, you will ultimately get what you pay for. Or rather, what the member pays for, or will pay for when they’re 85 years old and at their most vulnerable.
Richard Howes is chief executive of Challenger Life