What happens when the retirement savings stop?

The focus of the Australian superannuation industry over the past two decades has been mostly on accumulation but, as Damon Taylor reports, super funds are increasingly examining their role in the retirement phase.

Though Australia may have had the superannuation guarantee in some form since 1992, the acknowledged reality is that it is only now seeing the first wave of retirees to have benefited from that savings regime.

Within what is yet an immature system, the superannuation industry’s focus has been accumulation, but according to Tony Hildyard, country head, New Zealand for PIMCO, that focus must take the next step and turn to supporting superannuants during retirement.

“As things stand we’ve had 20 years of compulsory savings, and over that period you really saw corporate and other superannuation funds really not want to deal with the retiree,” he said.

“They moved everything to member choice and I think they were quite happy to see people take their money when they retired so that they could just focus on the accumulation role.

“What’s happening now, of course, is that you’re getting this big demographic bubble that’s getting close to retirement and there’s been a realisation that the focus has, to this point, been just on accumulation,” Hildyard continued.

“That same realisation’s occurring for retirees as well and they’re seeing that staying in a superannuation fund with the current offerings is not ideal.

“Retirees are risk averse, they want some income certainty, they want control of their assets and they’re very frightened of running out of money and therein lies the challenge.”

Commenting on the current offerings alluded to by Hildyard and what makes them less than ideal, Andrew Boal, convenor of the Superannuation and Employee Benefits Practice Committee at the Institute of Actuaries of Australia, says there are approximately 5.5 million Australians aged between 45 and 64 who will be reaching 65 in the next 20 years.

“So that’s a massive tidal wave of baby boomers about to reach that critical point in their life,” he says.

“Now as to what’s happening out there at the moment, we had a look at 60 funds not long ago and the average asset allocation for their accumulation assets, was about 73 per cent in growth assets but of those, only 43 funds had a default option for post-retirement.

“The rest either didn’t offer anything or at least required the members to make an active decision to do something,” Boal continued.

“And of those 43 that had a default post-retirement option, two of them defaulted to cash and four of them defaulted to something more conservative but the rest basically didn’t make any change.

“Predominantly, most funds that have a default option in retirement are still using the same default asset allocation as prior to retirement, and while that may or may not be the right thing, it’s a statement of where things are at the moment.”

Looking at not just the superannuation industry but also at what is being offered by a number of large financial services institutions, Dr David Knox, senior partner at Mercer, said that the most popular product out there was probably the account-based or allocated pension.

“So that’s a very flexible product for the retiree. It has a lot of advantages to it but the major disadvantage is that it leaves all the risk with the retired person or household, both longevity risk and investment risk,” he said.

“So we’re starting to see the development of some other products where the provider picks up some of those risks.

“The most obvious one is the term annuity type product, which Challenger is selling quite a lot of,” Dr Knox continued.

“And that’s really a fixed interest product where you offer an income for a period of three years, five years, 10 years or whatever but there’s no longevity protection.

“It’s an annuity but it’s only for a fixed term and what Challenger and the other providers would be doing is trying to match that liability by investing in bonds and other types of fixed interest products, thereby reducing their risk.”

Dr Knox said that the third type of product available, and one which was gradually developing, was the variable annuity.

“Again, it can be a flexible product where the provider offers some investment protection but also some longevity risk protection to the investor,” he said.

“By and large, these products haven’t yet been very successful in the Australian market but I think there are a couple of reasons for that.

“One, they’re fairly complicated. Most retirees don’t understand how these risks are protected and that’s understandable because realistically, I can’t protect your investments without a fairly complex set of hedges and other assets in the background,” Dr Knox continued.

“And the other reason is that longevity protection is not yet well understood in the Australian market.

“So when you put those two things together in the one product, for reasons that are understandable it appears expensive and individuals are saying as much.”

Yet according to Pauline Vamos, CEO of the Association of Superannuation Funds of Australia (ASFA), the retirement income options currently available have issues that go well beyond price.

For Vamos, the Superannuation Industry Supervision (SIS) Act and the Taxation Act, in their current forms, are the most significant hurdles — and hurdles that must be overcome before any retirement income products are likely to gain traction.

“At the moment, because of restrictions in SIS, you can only really have allocated pensions or annuities,” she said.

“And then you’ve got issues with capital requirements and you’ve got issues with the taxation treatment of annuities.

“So the first step is to remove some of these and then you’ll start to get some innovation in the area,” continued Vamos. “That’s number one.”

Giving specific examples of those hurdles, Boal said that current SIS regulations really only took into account two types of income products in retirement.

“One is an account-based pension, like an allocated pension, and the other is an annuity or an immediate life income stream that starts paying tomorrow,” he said.

“But if you’ve got a product that doesn’t actually pay anything for maybe 20 years, like a deferred annuity, that doesn’t really fit any of the current definitions.

“And the other thing is that in the Tax Act, because [the product] is not drawing an income immediately, it’s treated as though it’s still in accumulation mode, and as a result the investment income on the investments supporting the annuity are taxed at 15 per cent, rather than tax-free like any other post-retirement product,” Boal added.

According to Boal, there is definite room for the Government to provide both the superannuation industry and wider financial services industry with impetus for developing more attractive retirement income products.

“But the SIS and Tax Acts are just the start,” he said.

“On top of that, when product providers are trying to develop new products, and we’ve seen new products being developed by companies like OnePath and Macquarie and Challenger, they’ve all had a go at innovating product design in this area.

“But in coming up with new products, you actually have to deal with the Tax Office, you’ve got to deal with APRA (the Australian Prudential Regulation Authority), you’ve got to deal with ASIC (the Australian Securities and Investments Commission), you’ve got to deal with Centrelink because different products in retirement are treated in different ways for aged care and social security rules,” Boal continued.

“So you’ve got to work out the design of your product and negotiate with each of those four regulators about how the product will be treated and what the tax implications will be.

“It’s a very complex and difficult area for product innovation, so if we could simplify the process for new product development in this space, it will only be to the benefit of the industry as a whole.”

Alternatively, Hildyard said that while government intervention and legislative change would certainly assist the development of retirement income products, there was a tendency for people to look to the government and simply hope for something.

“I know some of the insurance companies, for instance, are sitting there saying ‘should we or shouldn’t we get into this?’” he said.

“They’re asking themselves whether there’s a real demand there and saying that if the government makes it compulsory, then they’ll jump into it.

“And that sort of mentality comes back to cost — but it’s all a bit chicken and egg,” Hildyard added.

“At the end of the day, its incredibly important for Australia to continue its prosperity and to look after these retirees because otherwise people aren’t going to have the money that they needed in retirement and they’re going to be falling back on the pension and various other things.

“We do need a solution though, so while the industry might welcome leadership from the Government, in the interim I don’t think we can sit here and wait for it.”

Clearly, whether the impetus is to be provided by government or the wider superannuation marketplace, the development of retirement income products will be interesting to watch.

And according to Vamos, all necessary stakeholders are on board and initial development is underway, so from here it should just be a matter of time.

“I think the conversations have been had and we’re all pretty much of the same view,” she said.

“When you look at the tax forum, when you look at some of the Henry submissions, when you look at our pre-budget and other submissions, we know what to do.

“The bottom line is that there’s been so much on the legislative agenda that the government hasn’t turned its mind to this because it just hasn’t been pressing,” Vamos continued.

“But now that they’ve done Stronger Super and the Future of Financial Advice Reforms, now they’re starting to turn their minds to it and that’s why we’ve seen it being a topic of discussion on the superannuation advisory council and a topic of discussion on the tax forum.”

Also looking to the future and to what products would be brought to the table, Hildyard predicted that different funds and providers would come up with different solutions.

“So the funds with very high average age are going to have a lot more focus on this than the funds with much more broadly spread demographics,” he said.

“And the solutions for funds with savers with very high balances are likely to be different too.

“So if you’ve got a fairly old demographic in your fund with high balances, you’re probably going to lean towards some income solutions and not worry too much about a guarantee,” Hildyard continued.

“On the other hand, if you’ve got a very broad membership with a lot of young ones and lower balances, you’re probably going to continue what you’re doing at the moment.”

Hildyard added that he expected the Australian market would evolve to the same sort of solutions that were already in evidence overseas.

“We are, however, in a unique position where we’ve got these big superannuation funds and they’re not individual savings schemes like you see in the United States with the 401(k)s and such, and as a consequence you’re in a position where you can build some of these products,” he said.

“And I think long term we will evolve to some kind of income product with an option to guarantee your income via some kind of life policy or longevity policy. “We just need someone to make that first move.”