Building a default accumulation product to suit young superannuation savers is difficult but not impossible. Short-term market movements matter little as long stretches of time effectively wash away any differences between members. It’s an asset allocation puzzle.
Building a default income-focused product for retirement is far more challenging. Short-term investment decisions become critical as do the often opaque personal circumstances and needs of members. There’s now more pieces to the puzzle.
And yet this is the government’s solution–Comprehensive Income Products for Retirement (CIPRs) or MyRetirement products–to the sub-optimal retirement decisions that many members make on their own.
To make this vision a reality, trustees are faced with a huge task: create a default product that boosts retirement outcomes while maintaining choice and flexibility for millions of Australians by mid-2018.
More levers, harder decisions
Older investors become increasingly engaged with their super as they approach retirement, but with just 20% of 40% of Australians seeking financial advice, they still regularly make poor decisions.
Too many retirees opt for an account-based pension and draw income down at the minimum legislated rate in an attempt to make their money last as long as possible. It’s a choice that retains maximum flexibility, but often results in a frugal lifestyle.
In comparison, a CIPR should deliver more income (the Financial Services Inquiry suggests 15% to 30% more), manage longevity risk by sustaining income over a lifetime and retain some product flexibility (such as accessing a lump sum or leaving a bequest).
But greater certainty can only come at the expense of flexibility.
In the world of accumulation, this is typically seen as a portfolio construction decision. A portfolio can be constructed to achieve greater certainty of income (say with more bonds than shares), but at the expense of long-term growth.
In the world of retirement, trustees will soon also be able to add risk pooling to the mix from July 1, 2017. That’s when the government will extend the tax exemption to earnings in the retirement phase to products with variable income streams such as group self-annuitisation and deferred lifetime annuities.
CIPRs clearly have far more potential levers to pull, but given retirement is a one-stop destination, trustees will need to know their membership like never before if they are to actually deliver on the potential.
Getting to know members is crucial
Many fund members are placed in default accumulation options (including with default insurance) without their knowledge–this won’t be good enough with CIPRs.
While a “safe harbour” is proposed to protect trustees from claims that a CIPR was not in the best interest of an individual member, the reputational damage could be more extreme.
For example, what if a small number of members were placed into risk-pooled CIPRs without their knowledge and quickly died, forfeiting their entire super balance? What if a member with a terminal illness was placed into a risk-pooled CIPR?
Treasury’s CIPR discussion paper raises such prospects and suggests safe harbour provisions shouldn’t apply in all circumstances, such as terminal illness (or even a low super balance).
Funds may have a wealth of member information (such as average retirement age, gender, average account balance, occupation, life expectancy of individuals in each occupation and average income during working life), but they need far more.
There’s only one way a fund can learn it: by asking members. This should include information such as (non-super) average household income and assets, health status and risk preferences.
Super represents just one slice of household assets. Australian households’ financial assets are broadly evenly split across super, property (excluding owner-occupied homes) and other financial assets (including shares), according to the Australian Bureau of Statistics.
Funds that find out this type of information have an opportunity to become a central retirement hub for members.
New skills required to find new answers
While many MySuper products appear relatively similar, MyRetirement or CIPR products should look radically different if funds genuinely analyse and fulfil the retirement needs of their own members.
Some funds will find that one CIPR is not enough–the answer may well involve multiple CIPRs for different groups of members.
The path to making these decisions will place huge demands on super funds. They will need to consider not just member characteristics, but also the characteristics of their own fund, including scale, capability and existing skill sets.
While the industry is full of intermediaries, there is no widely acknowledged central role that brings together these disparate demands.
It will require a broad mix of skills including actuarial, big data, investment management, behavioural finance and communications. These skills will need to be backed by technology and platforms that enable cohort segmentation analysis and the delivery of general and personal advice.
Funds will then need to get creative if they are to solve such complex retirement problems with a default solution. As the Treasury paper makes clear, CIPRs are not an excuse to encourage sales of annuities or particular retirement income products.
It will take a blend of skills including analytic capability, actuarial firepower and capital market knowledge to produce new solutions. Milliman has refined these skills over decades working with insurers, pension funds, fund managers and advisers.
Solving the CIPR puzzle may not be easy, but it is a challenge that every fund will need to master.
Disclaimer
This document has been prepared by Milliman Pty Ltd ABN 51 093 828 418 AFSL 340679 (Milliman AU) for provision to Australian financial services (AFS) licensees and their representatives, [and for other persons who are wholesale clients under section 761G of the Corporations Act].
To the extent that this document may contain financial product advice, it is general advice only as it does not take into account the objectives, financial situation or needs of any particular person. Further, any such general advice does not relate to any particular financial product and is not intended to influence any person in making a decision in relation to a particular financial product. No remuneration (including a commission) or other benefit is received by Milliman AU or its associates in relation to any advice in this document apart from that which it would receive without giving such advice. No recommendation, opinion, offer, solicitation or advertisement to buy or sell any financial products or acquire any services of the type referred to or to adopt any particular investment strategy is made in this document to any person.
The information in relation to the types of financial products or services referred to in this document reflects the opinions of Milliman AU at the time the information is prepared and may not be representative of the views of Milliman, Inc., Milliman Financial Risk Management LLC, or any other company in the Milliman group (Milliman group). If AFS licensees or their representatives give any advice to their clients based on the information in this document they must take full responsibility for that advice having satisfied themselves as to the accuracy of the information and opinions expressed and must not expressly or impliedly attribute the advice or any part of it to Milliman AU or any other company in the Milliman group. Further, any person making an investment decision taking into account the information in this document must satisfy themselves as to the accuracy of the information and opinions expressed. Many of the types of products and services described or referred to in this document involve significant risks and may not be suitable for all investors. No advice in relation to products or services of the type referred to should be given or any decision made or transaction entered into based on the information in this document. Any disclosure document for particular financial products should be obtained from the provider of those products and read and all relevant risks must be fully understood and an independent determination made, after obtaining any required professional advice, that such financial products, services or transactions are appropriate having regard to the investor's objectives, financial situation or needs.
All investment involves risks. Any discussion of risks contained in this document with respect to any type of product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved.