The importance of CIPR incentives

As the second extension of the comprehensive income products for retirement (CIPRs), or MyRetirement, framework submission closed earlier this month, it is clear that these products are an important part of the future for retirement incomes.

The challenge for the Government is to get the framework right so that the incentives to use these products are enough for them to gain substantial traction.

Currently, the CIPR proposals leading product development are annuity-based solutions, collective/pooling solutions, and portfolio-based solutions. The idea is CIPRs will be made up of a minimum additional level of income and/or guaranteed level of income, a broadly constant real income for life, and flexibility.

The Government has indicated in successive budgets that retirement income products would be more tax attractive, and since 1 July 2017 the tax exemption on earnings in the retirement phase has been extended to products such as deferred lifetime annuities and group self-annuitisation products.

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The aim has been to enhance choice and flexibilities for retirees and enhance their standard of living throughout their retirement. 

Deloitte partner, Russell Mason, said CIPRs for many people would be a combination of a drawdown retirement product and an annuity or deferred annuity.

“You’ll be looking for a fund that offers a lot of flexibility where they’ll look at your age, dependency, situation and decide what sort of mixture you’ll need,” Mason said.

“The skill of financial planners is getting that balance right because our needs change a lot in retirement so at 65 or 70 you’re hopefully a very active retiree; at 85 or 90 there will be a different set of priorities.”

Mason noted that product providers that had started designing CIPRs had not allowed for change within the product if circumstances changed during retirement.

“It’s sort of what you buy is what you get, and if there is an exit or ‘get out of jail’ it can be quite expensive. One of the issues is if you retire at 65 and buy a product and you change your mind at 75 because of changed circumstances that’s going to cost you to change your mind,” he said.

“I think that’s why to some extent annuities haven’t proved popular in recent times. Also, a lot of people don’t like the idea of giving someone a big chunk of their money that they may or may not pay out in 20 or 25 years’ time. 

“Most people at this stage are going with drawdown products because most people haven’t accumulated a lot in superannuation.”

Social security treatment

One of the biggest concerns experts have had on the topic is the way the Government will decide on the social security treatment surrounding CIPRs.

According to Willis Towers Watson head of retirement solutions, Nick Callil, depending on the outcome of the social security laws, it could provide a positive incentive for the product and help get the CIPR regime off the ground.

Callil said for a deferred product, members would be looking for an exemption from an assets test in the deferral phase.

“There are products around where you pay a premium at age 65 but the insurance payment doesn’t commence until age 85. In that interim period, because you don’t have access to funds, you’d be looking for the rules to say that you’re not asset tested on the amount you’ve contributed towards that insurance payment in those 20 years that are deferred,” he said.

He noted that when the Government removed the full or partial assets test exemption for immediate annuities, “the sale and take up of those products fell off a cliff”.

“If you look around the world there are very few markets where longevity or pooled mortality products have been taken up in great numbers without there being strong incentives or compulsion,” Callil said.

“…If the social security settings aren’t right then that could severely inhibit the take up of CIPRs.”

The Association of Superannuation Funds of Australia (ASFA) director of policy, Fiona Galbraith, said it was concerning that the Department of Social Security had deferred its determinations about the social security treatment going forward.

Galbraith said given the target demographic of CIPRs would be part-pensioners or people who would eventually become part-pensioners, and the fact that CIPRs would be member opt-in, there was a need for the social security treatment to recognise the longevity component and not so much the account based pension (ABP).

“It’s a matter of looking at some kind of discount on the asset test or income test, and most people would be looking at the asset test,” she said.

“It’s a bit like what they’ve done historically with other super account based streams which is to build in a discount to the extent of a capital sum toward a longevity component of the CIPR, and maybe only a percentage of that counts towards the assets test rather than the full 100 per cent.”

The Financial Services Council’s (FSC’s) senior policy manager for superannuation, Blake Briggs, said the tax and social security settings were necessary “hygiene factors” that needed to be addressed before the products came to market.

“The FSC supports neutrality between product categories so that consumers are not deterred from choosing CIPRs, but whether any favourable treatment is necessary to overcome behavioural biases still requires further consideration and debate within the industry,” Briggs said. “This question will not be answered until the final design of the CIPR regime becomes clearer.”

Suitability

Briggs noted that flexibility would also be important for the CIPR regime as there was significant variation in the needs of consumers in retirement.

“There’s a responsibility on trustees to proactively identify those kinds of people and steer them away from a CIPR.”
– Paul Murphy

“The risk is that the actuarial requirements, or the regulatory regime, are too restrictive. This would discourage trustees from entering the retirement market as they would struggle to justify offering a particular product to their consumers,” he said.

However, he noted that CIPRs would not necessarily be appropriate for all cohorts of members, such as those with health issues or very low balances as they might not receive the same benefits from a CIPR that other consumers would have.

“It would be appropriate for trustees to take into account this information when choosing to offer – or not offer – a CIPR to a consumer,” Briggs said.

“There is a clear public policy reason for all trustees to consider offering a CIPR, however it should not be mandatory for a trustee to offer a CIPR, especially for sub scale funds, and at least in the early stages of the CIPR regime. 

“Some trustees may not have the necessary skills or experience to design a suitable CIPR for their members and there may be unintended consequences if the CIPR regime is mandatory.”

For Vanguard Investments’ senior manager for superannuation policy, Paul Murphy, trustees offering CIPRs would need to identify closely which members would be suitable for the products.

“If someone who is about to retire and had a terminal illness or something, if you had that information then it would be wrong to promote the CIPR to them as they’d lose out,” Murphy said. 

“A lot of the discussion is around targeting the average member so that would be like a ‘soft default’, but trustees offering them in a collective big industry fund would have to have enough warnings if you’re this kind of person, or that kind of person, and if it was not the right product for you. 

“There’s a responsibility on trustees to proactively identify those kinds of people and steer them away from a CIPR.”

However, Murphy noted that from a strictly rational financial point of view, funds would want more people in the pool to have more assets.

“That’s part of the problem with annuity type products generally: you kind of ‘win’ if you last longer. In a sense you’re getting subsidised by people that don’t survive as long and that sounds very grim and dog eat dog in that sense but it has a collective purpose behind it,” Murphy said.

Callil noted that there would also be a larger take up of CIPRs if there was a wider range of products as at the moment CIPRs were limited to immediate annuities and deferred annuities.

He said there needed to be a wider range of other products from life companies and financial institutions to allow funds to blend longevity protection and other desirable features like liquidity and investment choice.

“I’m in favour of allowing trustees to tailor the CIPR up to the point based on the profile of the member being offered. My view is funds should be able to offer three or four different CIPRs based on known information on the members,” he said.

Callil said the funds should be able to tailor a CPIR from that known information for a retiring member without it being regarded as an advised product and part of that was that funds should be able to form a view of whether longevity protection was appropriate for the member.

On the other hand, as CIPRs are opt-in for both the member and the fund, Galbraith said ASFA had recommended that the Government could look at an alternative solution where trustees had to form their own retirement income framework to look at whether they should offer CIPRs or not.

“And potentially to disclose to APRA [the Australian Prudential Regulation Authority], if they have decided not to offer CIPR, why not. That may well be that they’re offering an alternative income stream product that isn’t a CIPR or may be that they think that for their demographic that an account based pension is sufficient,” she said.

“So basically just having trustees engage with whether or not to offer a CIPR on a more proactive basis.

“There is also an increasing role of the need for advice for members coupled with appropriate disclosure and the role trustees have in educating members so that the member can make an informed decision.”

Other considerations

Galbraith also said that it was important for the framework to get the period right in which members could withdraw capital.

“We’re suggesting a two-year period. As this is a long-term proposition, this would allow members the opportunity to receive advice and review before their capital is irretrievably locked away, so there are some elements that need some consideration so that they are designed properly,” Galbraith said.

For Mason, it would be important for there to be a full government guarantee behind annuities so that there was capital certainty, greater certainty about the integration with social security so that there might be deemed interest rates to give people greater certainty in their

entitlements in retirement, and more flexibility with the minimum drawdown.

“As you get older you have to draw more and more of your balance but as we live longer and longer in retirement maybe you don’t want to do that, maybe you’re working part-time and maybe you want to slow up the drawdown and then there will be more when you really need it,” he said.