Managing the decumulation phase to adequately fund retirement is a challenge that is yet to be resolved, the 5th Asset Owner Forum hosted by Fund Business has heard.
The challenge is acute. Not only are a growing portion of members reaching retirement age, their life expectancy is significantly longer than that originally envisioned when the majority of superannuation schemes were designed; and it continues to increase. To illustrate the extent of the problem: Australia’s population currently includes around one million people that are aged over 80, a segment that has grown much faster than the rest of the population over the course of the past 20 years. By 2050, the over-80s are expected to account for more than eight percent of the population, compared to less than three percent at present, the conference heard.
At the same time, productivity gains are likely to be significantly below those achieved in the post-World War II period, putting further pressure on the returns that can expected from investments.
“Gone are the days where you could assume an eight per cent return from your defined benefit. The reality today is that for return forecasts, when you crunch the numbers, it is much harder to get anywhere near that […] If you compound a lifetime saver at six [percent] versus eight [percent] the numbers are very different and that is a very significant issue right across the industry. There is a danger of failing to meet member expectations in terms of generating a reasonable long-term return from today’s starting point of low rates and high valuations combined with the potential for structurally lower economic growth, lower productivity and demographics,” Matthew Griffith, senior consultant at JANA told the audience.
Cary Helenius, director at Lifetime Income, told the Summit that despite Australia’s mandatory superannuation system, today’s funds are not sufficient to last the retirees’ lifetime. He said a change in thinking is required to deal with the challenges at hand.
“Decumulation is not about wealth creation, it is about wealth management and that is a paradigm shift in thinking for all participants, for governments, for funds, for planners and for the retirees themselves,” Helenius said.
He said that the products currently available are not sufficient to address the shortfall, and the focus on comprehensive income products for retirement, coupled with new regulations to cater for innovation, is essential.
“The traditional longevity solutions of guaranteed annuities haven’t provided the answer for numerous reasons, including the capital requirements required to maintain the guarantees in the products, the lack of suitable investments to support these products, and […] the lack of perceived flexibility for retirees which has not made them very attractive from a retiree perspective in the past,” Helenius said.
He said that allocated pensions are also not sufficient in providing a longevity solution. “They don’t secure income for life and so they aren’t by themselves a sustainable solution either. New products will need to emerge and hence the government discussion and focus on comprehensive income products for retirement and the introduction of new regulations to cater for innovation [is welcome] in this area,” Helenius said.
Meanwhile the age-based default, though inherently logical, was also questioned on the grounds that it is too mechanical and insufficient to cater for a long life. “The principle for age-based defaults is sound in that members would logically expect to reduce risk as they are closer to retirement or as they’ve achieved savings levels closer to their objectives, but the problem lies in the implementation. There are challenges with mechanically rebalancing and shifting member cohorts at times when it might not make sense to do so from an investment perspective. Secondly, where should one aim? What is that point? You want at 65 to have a certain balance, but at 65 you have got an average life expectancy still of another 15-20 years […] so you don’t want to de-risk too aggressively,” Griffith said.
While industry criticism that the accumulation style products that have been rolled out so far for retirement have been inadequate is “probably a justifiable criticism”, Griffith said trustees are dealing with a complex set of challenges, making it harder to provide an effective ‘single’ solution.
“The trustee I think has got a slightly different problem. They are faced with a dilemma: members are very different. So am I building a suite of products like a retail platform and am I arming my business with a bunch of financial planners or advisers to help members select that product […] or is my job to build a product which does the job in some way that a planner was trying to do, which is creating a product that has a path dependency to it, managing the sequencing and longevity risks etc?”
Griffith said the cost of providing innovative product solutions can outweigh the cost of simply hiring a group of financial planners that can provide targeted advice. “If you’re an executive of a fund you are going to say ‘do I want to spend X million dollars on developing this [product] or do I want to spend it on building a group of financial planners that can solve the problems at the member level?’. The expectation management here is very complex and that is a challenge we see right across the industry. It goes right to the heart of how Trustees define their role and their definition of success for their members,” Griffith said.
The challenges of developing suitable products are such that conference participants were asked whether it was time to stop focusing just on products and focus on service delivery instead.
Helenius said that to deal with these challenges, a complete shift in mindset is required. “You have got to take the problem totally differently. You have got to look at who are you catering for, look at the retiree and look at what their needs and requirements are, not just build a product, so it is coming at the problem from the opposite way to what we traditionally do, which is moving forward. Here you have got to look at it […] backwards,” he said.
Griffith also said the focus on product is “a real danger of the tail wagging the dog.” He said the proliferation of product in post-retirement is “enormous” but questioned whether the proliferance of CPI plus products is really suitable. “If you ask an actuary that question for defined benefit they will be able to say ‘the target return is this because the average salary is this, mortality is this’ and it seems to me that thinking more constructively in those dimensions is a better starting place than just saying here is a product it is CPI plus three,” Griffith said.
David Bell, chief investment officer at Mine Super highlighted the journey for super funds looking to develop retirement solutions for members: “As the work is highly complex, the need for specialist modelling teams and the education requirements across all levels of the firm, are big foundational work pieces. We have progressed from there to being highly active during the regulatory and policy reviews in the retirement income space.”
Bell also said looking beyond product returns towards understanding the individual needs of members is an important objective.
“What are we trying to achieve for our members, what do retirement outcomes look like for our members or what should a trustee be trying to achieve on their behalf? You can’t just have a CPI plus, that is just a return outcome, [you need to understand] what retirement looks like, what are we trying to achieve, how can you quantify that, how can you to work towards a greater retirement outcome.”
Bell said the challenge is a complex one. “Among our 60,000 members no two members will have the exact same retirement requirements, it is all going to be something different and that gets back to the value of advice. In our fund, 55000 members default and 5000 get some sort of advice. So what should a trustee assume for those members that we don’t actually know that much about, who aren’t engaged?”
Bell said these questions led Mine Super to develop the Member’s Default Utility Function, which – as the name suggests – converts member retirement income preferences into mathematical formula that considers the sensible financial preferences to assume on behalf of a default fund member.
“We worked on it for 18 months with 14 people from industry and academia. We came up with a sensible set of preferences for what we think trustees should assume on behalf of members that they don’t know that much about. We think people want higher income in retirement, that is not rocket science, we think they want smoother income, we think they are risk averse [and] all things being equal we would say that it is bad to run out of money in retirement. Finally, we think people place some value on a residual benefit at death. We finished that work last year and it is freely available through the websites of AIST and ASFA.” Bell said.
Finally, Bell commented on the opportunity for greater collaboration amongst asset owners, “Our research identifies that a pooled mortality solution is the best longevity solution, and the larger the pool size the better. The complexity of the challenge is immense, with a shortage of talented human resources. There is a fantastic opportunity for collaboration amongst asset owners, particularly profit-for-member funds,” he said.