Mine Wealth + Wellbeing has shared with the industry a new tool, called MDUF v1, developed to improve how super funds design and assess comprehensive income products for retirement (CIPR).

The tool works by converting member retirement income preferences into a mathematical formula, known as a utility function. Hence the name Member’s Default Utility Function version 1, or MDUF v1 for short.

Mine Wealth + Wellbeing chief investment officer David Bell was lead research author on the project and unveiled MDUF v1 at the Conexus Financial Post-Retirement Conference in Sydney on March 14, 2017.

“[MDUF v1] considers the question: What is a sensible set of financial preferences for a trustee to assume on behalf of a default fund member?” Bell said.

UNSW associate professor Anthony Asher, a member of the project’s working group, added that the mathematical format allowed for trade-offs of the multiple wants and needs of members.

The research project took place over 18 months, with contributions from a panel of academics and industry professionals.

“This is a major step in terms of getting this onto the [super funds] agenda, because this is the way it is done universally in the academic literature,” Asher said.

Academics have used utility functions to solve retirement outcome problems for more than 50 years, Bell said.

Factors in preferences other methods leave out

“In most places, industry leads academia, primarily because money talks,” Bell said. “However, when it comes to retirement outcomes research, I believe the reverse applies. Academia leads and uses advanced techniques we rarely see in the industry.

“One important example of this is the utility function, which is simply a mathematical representation of an individual’s preferences.”

MDUF v1 captures preferences that other methods don’t consider but that industry participants know to be concerns for members.

In particular, MDUF v1 recognises preferences for:

  • Higher income
  • Smooth income
  • Not outliving savings
  • Value in residual benefit
  • Risk aversion.

“It can be used to measure the benefit of CIPR design,” Mine Wealth + Wellbeing quantitative analyst and project co-ordinator Estelle Liu said. “It is a credible, objective measure that captures a range of preferences of retirees and also catches the trade-off between them.

“Trustees can use it to compare potential CIPR solutions and can also try to design an optimal solution.”

A versatile tool

The 2014 Financial System Inquiry recommended the government require all MySuper licensed funds to offer a CIPR to retiring members by default, instead of a lump-sum payout. A Treasury consultation is underway to review the planned framework for CIPR, including whether or not it should be mandatory for funds to offer them.

In addition to assisting funds with the development of CIPR, the authors of MDUF v1 expect it also to be a useful tool for other purposes, such as helping regulators assess retirement income designs, or aiding policy groups in analysing welfare proposals.

Willis Towers Watson investment consultant Tim Unger, who also served on the working group, predicted the tool would help advance the broader retirement income adequacy debate.

“It has been put up there as a really good first attempt at creating utility function, but the expectation is that it can be improved upon over time,” he explained.

He added there had been a real attempt to make sure the formula, while complicated, was not so complex that it was intimidating, so the industry would engage with it and adopt it.

Industry peak bodies the Australian Institute of Superannuation Trustees and the Association of Superannuation funds of Australia have both agreed to be custodians of the work, making it available to the broader industry through the release of papers, presentations, models and Frequently Asked Questions sheets.

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