Facing up to the post-retirement product challenge

The focus of the Australian superannuation industry over the past two decades has been almost entirely on accumulation but, as Damon Taylor reports, it is now shifting its gaze towards post-retirement products.

As a savings vehicle aimed at providing for Australians in retirement, it seems almost redundant to say that superannuation’s growing focus is now not just retirement savings but retirement income.

Yet as Australia’s super industry matures, its focus must become exactly that.

With an increasing number of ‘baby boomers’ seeking retirement, longevity risk has become a very real concern – and for John Wilson, head of PIMCO Australia, the industry’s meaningful response relies heavily on the development of appropriate retirement income products.

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“Once upon a time, every super fund CIO and CEO thought that he or she was managing an asset pool for this mythical 25-year old with a 35-year investment horizon,” he said.

“And suddenly they woke up one morning and realised that 50 per cent of the entire assets in their fund were owned by people who were 50 years or older.

“So if you’re a business and your customer base changes, then you change your product mix to meet the demands of your customer base,” Wilson continued.

“And that’s what we’re seeing from a lot of super funds at the moment.

“They’ve realised that they’ve got this large group of people who are at or near retirement and that they now demand different things from their wealth management provider.”

Giving similar context to the industry’s post-retirement dilemma, Noel Lacey, general manager – product for AustralianSuper, said that there had been two main factors behind funds’ realisation that their focus must switch from accumulation to de-accumulation.

“The first is the fact that the baby boomers are now crossing the bridge, going from the accumulation stage to the de-accumulation phase and being drawers of the money,” he said.

“So that’s come into play far more prominently than it ever has previously.

“And equally, in the last few years in particular, returns have been pretty modest,” Lacey added.

“So if you start with the global financial crisis (GFC) years when things were poor, in that period through the last five years it’s been a period where members wouldn’t have seen much happening in their balances.

“So I think those two features have brought it to everybody’s attention; its brought about the question of what members are going to get out of superannuation and, more particularly, what they’re going to be able to draw down from it.”

But for Wilson, the challenge lies not only in the need for funds to change their mindset but also in the reality that post-retirement is now a feature of the superannuation landscape.

“This is a new feature of the landscape but it’s also going to be a continuing feature of the landscape,” he said.

“So what we’re seeing is the beginning of this requirement to produce well thought-out retirement income products.

“And this is going to be the key challenge for our system for as long as anyone in the industry can imagine.”

Yet while acknowledging the super industry’s lack in terms of retirement income products is an important first step, Russell Mason, partner – superannuation for Deloitte, pointed out that finding usable solutions within superannuation’s current framework was a far more complex task.

“And there are a couple of big dilemmas facing the industry here,” he said.

“One would be member engagement, but the other would be suitable post-retirement products.

“As it stands, while there have been some good attempts, there clearly hasn’t been one that’s ticked all the boxes,” Mason continued.

“If we start with annuities, you can go out and buy an annuity – but they’re expensive.

“And not surprisingly so, because a life office is issuing them; it’s the one taking onboard the longevity risk and the investment risk.”

Further detailing annuities, Ben Facer, principal, actuaries & consultants for Deloitte, said with the expense of taking on longevity risk, investment risk and the expense of running the business, the cost of annuities was probably not surprising.

“In fact, I would say that they’re not overly expensive or unduly expensive,” he said.

“There are simply those things that you’ve got to pay for in order to have an income stream that’s guaranteed for life.

“So it’s going to be expensive,” Facer noted.

“You are, however, getting benefits out of that in terms of longevity and investment protection.

“It’s simply a question of how much you value that protection relative to the expense that you pay.”

According to Mason, next on the list with regard to retirement income options were account-based pensions.

“The advantage here is that account-based pensions are a tax-free investment,” he said. “But the trouble is that all the risk, both the investment and the longevity risk, is back on the individual.

“If I take one out, am I going to live five years or 25 years or 35 years in retirement?” asked Mason.

“I have no idea."

“Chances are the average member is going to draw down way too little or way too much, and they’re not going to be able to sustain the standard of living that they’d like to.”

However, despite the inherent risk for the individual, it seems clear that with the Government’s current tax treatment of annuities, account-based pensions remain the super industry’s best bet.

And according to Lacey, that is also where AustralianSuper’s efforts are focused.

“In many ways, annuities for us are not on our immediate radar,” he said. “But certainly a greater variety of features and investment options within the account-based pension space is.

“So we’re certainly doing work at the moment to review those options and do two particular things,” Lacey continued.

“One, perhaps have a greater suite of options for retirees themselves and then equally, look at the options that we currently have and see whether they could be more suitable, whether they should be different.

“At the moment, we’ve got very similar options in the accumulation stage as we do in de-accumulation, and I think it’s clear that for a number of those options, there are reasons that they should be quite different.”

And while an approach comprised only of account-based pensions and more appropriate asset allocation may have its limitations, Lacey pointed out that it had the significant advantage of flexibility and simplicity.

“For us, the account-based pensions do have the advantage that they’re flexible, they’re low cost, they’re easy to understand and also there’s no counter party risk, which is a big issue for us and for our members,” he said.

“It’s the guarantee that there’s no capital loss in the event of death.

“The disadvantage of those, of course, is that there’s no longevity protection and the returns are variable in contrast to annuities, where the big advantage is certainty of benefit,” Lacey added.

“The problem in the current arrangement is that returns are low as we’re speaking, they’re quite expensive, which is a provider issue but also a capital issue, and they are difficult to understand generally.”

Of course, finding the most appropriate retirement income solution does not necessarily mean choosing between an annuity and an account-based pension.

In fact, for Mason, one possibility is blending the two according to the cycles an individual might go through in retirement. 

“So typically a retiree will start off in a very active phase,” he said. “They’ll do the grey nomad or the overseas trip, they’ll spend more money because of their physical fitness.

“They’ll then move to what is traditionally a little quieter phase, still active but perhaps without the big overseas trips,” Mason continued.

“You’ll then have the frail phase which is potentially quite expensive towards the end of their life when medical expenses start to increase dramatically.

“And while they may be covered in part by the Government or health care, often they’re not fully covered and you can have out-of-pockets there that can be quite substantial.”

In light of such a retirement cycle, Facer and Mason recommended a transition between annuity and account-based pension type products.

“Now, a couple of organisations have put this idea forward so it’s not new, but I think what has a lot of merit is a three-phase retirement,” Mason said.

“You buy an annuity which gives you a guaranteed income, part of your money for the rest of your life, then you also put some money aside in an account-based pension.

“But you’re not expecting that to last your entire life, it’s just for all the earlier and active years,” Mason continued.

“So you might put a 10-year time horizon on that account-based pension and then, at the same point in your retirement, you buy a deferred annuity that kicks in at age 85, 90, where your costs of living may go up dramatically.

“Now, that deferred annuity falls outside the super system so it isn’t tax free – if it was within super, this would be a far more attractive and far more practical option.”

Asset allocation strategy

While the product side of superannuation-based retirement income may be a work in progress, the one area already gaining traction with super fund executives is asset allocation.

Talk of life-cycle investment is becoming more commonplace, and according to Mason, such options are already taking shape.

“I’ve actually seen two or three funds that I’m involved with look at their default option, and it could be their MySuper option, as having been balanced,” he said.

“So they’ve realised that might not really be suitable for the retirement phase, and they’re looking to change that. 

“They’re looking to have a default option so that if people roll over into an account-based pension, they’ll automatically default into something that’s lower risk and has more income-producing investments.

“They’ll move away from capital-increasing investments and look at income investments.”

Similarly, Wilson said that for better or worse, asset allocation had been where the majority of super funds’ retirement income efforts had been focused.

“Our experience has been that most people are still taking what we’d call an asset allocation approach to this,” he said.

“So that’s essentially saying that to the extent that we have a group of older members who have relatively high balances, sufficiently large lump sums such that they’re objective is capital preservation and income, then we’ll de-risk that portfolio.

“So where it may have had very significant exposure to growth assets, we’ll reduce that exposure and have more income assets – as I say, an asset allocation approach.”

However, for Lacey, regardless of what choices are being made, the important point is that funds are, in fact, changing their approach to post-retirement investment.

“We’re in a position now where people are moving their focus from what is an account- balance building regime to a drawdown regime versus superannuation now being there to generate an income stream,” he said.

“And traditionally, that hasn’t been there in the Australian thinking.

“I mean, we’ve generally talked about lump sums and people building a balance to withdraw for retirement, and then allowing people to manage that lump sum themselves,” Lacey continued.

“But there certainly needs to be much more focus and much more attention paid to assisting members in managing that money by actually providing options that generate an income stream and deliver that for them.

“People are used to getting pay cycles and managing that money on that basis, so we need to have income streams that allow people to continue in that vein as they’re used to.”

In terms of what that means for retirement income product development, Lacey admits that he does not have the answers.

“But it clearly means options to deliver income streams are far more important,” he said. “So we’re looking at those things and I suspect others are doing much the same.”

“And I’m certain this is the key area where there is likely to be change into the future.”

Indeed, it seems clear that the future alluded to by Lacey has already begun to take shape.

The industry has realised that if accumulation is important for the role it plays in establishing a superannuation balance, de-accumulation and the role it plays in realising that benefit is equally so.

And for Wilson, the dialogue generated from that realisation has been enormous.

“It really has been staggering,” he said.

“Business preservation drives a lot of behaviour, so if you’re a fund and you suddenly realise you’ve got a large mass of members who are at or near retirement, you need to have a solution for that membership because if you don’t, then your business is at risk.

“So everyone’s worked out that that’s the problem they’ve got but, more than that, they’re pretty anxious to get the right sort of solution.”

Yet in finding that solution, Mason said that member education was vital.

“It’s about making people aware of what they need in retirement, how much they need,” he said.

“And that’s why I like the ASFA (the Association of Superannuation Funds of Australia) approach of working backwards and saying, ‘what do I need to have a modest or a comfortable or a more than comfortable lifestyle?’

“So the question then becomes how that lump sum can be divvied up between an annuity, a deferred annuity and an account-based pension,” Mason continued.

“Because if I said to the average person, ‘you need $1 million in retirement,’ they’d say ‘no way, I’m only earning $60,000 or $$70,000 or $80,000 a year, I don’t need that much, that’s just a millionaire’s figure.’

“So I think there needs to be some reality checks as to what is really needed in retirement, firstly to help people target that amount and secondly, to educate them on longevity risk and what it may mean for them.”

For Mason, while longevity risk concepts are simple, the repercussions and a solution to the problem are not.

“At first blush, it’s just a simple thing; you talk to people and they say, ‘well, life expectancy for me as a male is 80 years of age,’” he said.

“Well, of course that’s going to be from date of birth. Once I get to 65, its closer to 90 years of age.

“So it’s some of the very simple concepts like life expectancy, the fact that 90 isn’t necessarily when you’re going to die,” Mason continued.

“Yes, by then half the population will have passed away, but half again are going to exceed that.

“So whether they’re within the super industry, or members themselves, people need to understand that longevity risk and then look to package different products to meet that need.”