Longevity risk remains a continuing challenge for the superannuation industry, but as Damon Taylor reports, new approaches and new products are being assessed.
For some time now, longevity risk and the increasing need for suitable retirement income products have been known issues for the super industry.
Yet while such issues are now hotly debated, solutions are still in their infancy and for Nick Callil, head of retirement income solutions for Towers Watson, it is largely because changing member demographics have crept up on funds.
“If we look at life expectancies and therefore retirement life spans for someone who’s reached age 65, that’s been increasing by about a year every five or six years since the mid-1970s,” he said.
“So a 65-year-old in the mid-1970s was expected to live until say their late 70s.
“Now however, a 65-year-old is expected to live until around say the mid-80s and then, if the improvements we’ve seen over the past 20 years continue, it’s more likely to be late-80s coming up to almost age 90,” Calill continued.
“So that trend’s been there and that’s why I think it’s quite surprising that it has crept up on funds.
“Demographics, in one sense, are quite predictable. We know we’ve got large numbers approaching retirement and longevity risk has been apparent for some time – and yet funds and the superannuation industry more broadly have been slow to focus on that section of the whole savings and retirement life cycle.”
Also seeing a need for more urgency with respect to retirement income solutions, Melinda Howes, CEO of the Actuaries Institute, pointed out that the super industry had been understandably distracted in recent years.
“Obviously, everyone’s known its coming but super funds have had such a massive impost of regulatory change put on them that they’ve been in catch-up mode for a number of years now,” she said.
“They haven’t had the breathing space to stop and do that longer range planning that’s been necessary in terms of how do they retain their members as they move into retirement and what products do they need to have available.
“And I think the other contributing factor was that there was a sense of complacency that we had the right products in place with account-based pensions because while markets were strong, those products were going really well, retirees were happy and there were no problems,” Howes continued.
“I think where it’s all really come home is in the last five years when investment markets have been all over the place.
“It’s been apparent that having retirees fully exposed to market movements without any downside protection is not perhaps a sustainable strategy, but the other thing we’ve realised is that retirees need protection against longevity risk as well.”
But irrespective of what has taken place previously, Ross Clare, director of research for the Association of Superannuation Funds of Australia (ASFA), said that retirement income was without doubt an increasing industry focus.
“The demographic change is quite gradual and the majority of assets, certainly the majority of members, are still in accumulation mode,” he said. “But it’s always been an issue and it’s always been a challenge.
“In any country around the world, regardless of its demographics, when you have a defined contribution-based system, then there’s a question of what you do in retirement,” Clare continued.
“And no country has really dealt with it as well as it could be dealt with.”
Yet while retirement income solutions may not be as developed as industry pundits would like, retirees’ options are far from non-existent. Broadly speaking, such options are based around account-based pensions and lifetime annuities and according to Clare, all evidence points to them being well supported.
“Retirees are certainly taking them up at a great rate so on that basis, they are suitable to retiree needs,” he said. “The question of whether there should be more options available, however, is another issue.
“Account-based pensions suit many individuals quite well and there are various investment products available if they want to change the risk structure in terms of getting capital guarantees or investment return guarantees,” Clare continued.
“The problem is that all of those things come at a cost and that has to be considered.
“Does an individual think that the price is worth paying to get the outcome that the product offers?”
For Clare, the answer varies but he said that ASFA’s long-held position was that a greater variety of options, together with appropriate education and advice, were vital.
“People need to be able to make an informed choice,” he said.
“Defaulting or requiring a person to go into a life annuity when they have a poor life expectancy due to existing medical conditions would be bad policy.
“But having products which are competitively priced, because you’ve removed impediments and any unnecessary regulation, on offer to individuals to choose to purchase if they suit their circumstances, we would say is a good thing,” Clare added. “And then that transition is pretty important.
“Looking at better methods of transition in terms of education and advice is something that’s also an objective and that’s tied up with limited and scalable advice regulation.”
Echoing many of Clare’s sentiments, Callil said that current options were limited because super funds required a broader spectrum of products that fit appropriately within Australian regulation.
“What people need and what is the ideal product will vary among different types of members depending on how much they’ve had saved, what sort of lifestyle they’re expecting, what their sensitivity is or what their aversion is to running out of money,” he said.
“So those things are always going to be different but the key is to fill in the gap in between those account-based pensions and lifetime annuities.
“I think the account-based pension at one end is really where all the risk falls back on to the individual and then at the other end there are annuities, where both the investment and longevity risk are protected,” Callil continued.
“But what we need to do is colour in the middle of those two ends of the spectrum with a broader range of products where some, but not all, of those risks are protected but some also remain with the individual so that funds can match the products to what their members actually want and what they value.”
According to Howes, it is exactly that middle space, a hybrid approach to account-based pension and annuities, that was likely to be most popular for Australians.
“It’s interesting because if you look overseas, there’s a big market in the US for variable annuities, which is essentially an account-based pension that turns into a guaranteed pension as people get older,” she said.
“It’s an account-based pension with a floor under it, I guess you could say, a guarantee that underpins it.
“So those products are very very popular but they have quite a different tax treatment to here and so the popularity is largely driven by that tax advantage,” Howes explained. “But I think that’s the sort of thing that we’ll see here.
“It will be that sort of combination product and approach.”
But the problem, according to Howes, was the stalemate that had developed in terms of product development, cost and take-up.
“We’re in a bit of a chicken and egg situation at the moment because you need weight of numbers before this kind of thing will be successful,” she said.
“With anything that’s got a guarantee in it, you need a large pool of lives to make that product efficient as far as the pricing goes and as far as the risk goes.
“And that’s difficult because whilst there’s not many people in them, you’ve got to price the risk higher,” Howes continued.
“They become expensive because you’ve got to spread the costs over fewer people and then because they’re expensive, no one buys them.
“So the only markets where these things have really gained traction is where there’s some level of compulsion and maybe that’s the answer but it’s a pretty big policy call to make.”
Yet while the super industry may be crying out for more in the way of retirement income product options, there are some well-lamented impediments that must first be removed.
Deferred annuities, in particular, remain handicapped by their tax treatment, by aspects of the Superannuation Industry Supervision (SiS) Act and by issues around social security, but according to Clare, change is already in the wind.
“The SiS stuff’s already starting to change,” he said. “And I think the tax treatment of deferred annuities is in the Coalition Government’s superannuation policy document as one of the key areas they intend to address.
“So I think politicians have realised there are impediments and on the tax side, they’re seeking to address them,” Clare added.
“And at ASFA, we’ll be working with the incoming government and looking at possible changes to FOFA (the Future of Financial Advice reforms), which we certainly see as important, seeking to ensure that arrangements around advice don’t inhibit the provision of advice on various retirement options.
“As to the other stuff, the Centrelink income and asset arrangements and age pension, there’s no indication at the moment that the Government will be going there but it’s certainly something we’ll be raising with the incoming Minister.”
Of course, it is those issues around Centrelink arrangements and social security treatment that Calill sees as the biggest barrier to making annuities and other similar products more attractive.
“I think having a product where your money’s tied up and deferred in terms of you actually receiving income from it for a period, having that counted as an asset in the assets test is a big disincentive,” he said.
“And I think that’s a challenge for the industry to convince the Government that it makes sense for that not to be included as an asset.
“There needs to be an incentive for these longevity-type products to be taken up because its clear that incentives, if not compulsion, are needed in order to make them more attractive,” Callil continued.
“It’s unfortunate but it’s all too clear that the history and the attitude of most retiring Australians is still very much focused on lump sum.”
However the more telling impediment, according to Howes, is the fact that while issues persist in taxation, in social security and in the SiS Act itself, product providers’ options are limited.
“We talked to a lot of pension providers when we were putting our paper together last year on longevity and we asked them what they were doing in this space as far as innovation and new product development was concerned,” she said.
“And at that stage, they all said that they weren’t even really getting to go, mainly because of that tax impediment.
“Obviously, there are many road blocks in place but the tax one was the big one and now that it’s been announced that it’s going, I think that will encourage people to really start doing something in this space,” Howes continued.
“But it’s still not easy – a product provider has to deal with something like 4 or 5 different agencies to get one of these products approved and their rules are often conflicting.
“It’s just a real mission at the moment so one of the things we’re calling for, and also ASFA are calling for, is to have a bit of a one-stop shop where there’s one body that you can go to to get these things approved.”
Indeed for Howes, the issue is not just the handicaps that are in place for creating new products but the time it can take to bring those products to market.
“Look, this is something that was on the Labor Government’s agenda and it’s clearly on the new Government’s agenda as well,” she said.
“It’s a matter of getting it to the top of their priority list because at the moment, they see it as a longer range issue, not a pressing urgent issue.
“So one of the reasons we wrote our ‘Longevity Tsunami’ paper last year was to try and create that sense of urgency in policy-makers’ minds that people are retiring now, that they need these products now,” Howes continued.
“Because even if you removed all these road blocks today, it would be a year to two years before new products are on the market because that’s the product development timeline.
“We really need to be doing something about this like yesterday, not in a year’s time.”
Yet the question remains. If impediments are removed and a greater range of retirement income products become available, will Australians actually look to an income stream? Or will the attraction of a lump sum benefit be too great?
For Clare, much depends on account balance.
“The notion that people take lump sums and blow it and go on the age pension is, to me, pretty much an urban myth,” he said.
“People with medium to high balances invest them quite sensibly and a great deal of research proves that.
“Tax-free investment earnings in super is a good incentive for people with medium to high balances to keep their money in super,” Clare continued.
“And at the lower end, they’re not going to pay much or any tax at all on investment or other earnings so it may be quite a sensible financial decision for them to have money outside super because there isn’t a tax incentive for them.
“But the evidence of people dissipating money and then going on the age pension just isn’t there.”
Seeing similar trends according to the level of retirement savings a member had accumulated, Callil said that there was still no doubt that Australians valued the lump sum benefit mentality.
“I think for the lower account balance groups, it’s reality, that what they’ve saved, if it’s $50,000 to $100,000, then stretching that over a retirement lifetime is always going to be a hard sell,” he said.
“There’s no product that can magically turn that into a material income for them.
“But I think in the middle and higher account balance members, I think converting their thinking to income is important and it’s great to see the industry already doing a number of things in that space,” Callil continued.
“At Towers Watson, for instance, we’ve certainly been talking with some of our clients about the concept of actually setting a retirement income goal as their fund’s mission statement.
“In other words, embedding an income culture within a fund and translating that out into everything they do and the ways in which they communicate with their members.”
According to Callil, it could be a big cultural change for many funds but if the industry was to encourage a bias towards income streams in retirement, it was one that was necessary.
“At a more nuts and bolts level, I think we’ve also got the initiative of putting retirement forecasts on members’ statements,” he said.
“So every year, members could be receiving not just what their account balance is now but a forecast of what their balance at retirement will deliver in income terms, including the age pension allowance.
“ASIC (the Australian Securities and Investments Commission) has given some protection in terms of funds who are prepared to go and do that, but I think we can do more in that space,” Callil added.
“I think there’s perhaps even a goal we should have of actually making that mandatory just as we have account balances being mandatory at the moment, actually having every fund in the land pushing out statements with an income forecast on it.
“It’s only a small piece of the puzzle but these are steps that the industry has to take.”
Indeed if there is one aspect of retirement income products that all seem to agree on, it is that the super industry cannot afford to be idle.
The hurdles presented by taxation, by the SiS Act and by social security may yet be in place but for Howes, such hurdles need not hinder progress.
“So while changes to the tax legislation have been announced if not legislated, my suspicion is, and I haven’t talked to product providers recently, but my suspicion is that activity is already underway,” she said.
“I know there’s a lot of activity in terms of how you take people through the decision process side of things but I think we, as an industry and a profession, need to keep talking to the new Government about the importance of removing the rest of these road blocks.
“That’s important, to keep that pressure up, but I would also say that the time for sitting on our hands is well past,” Howes added.
“We’ve just got to go in the environment we’ve got, we’ve got to get out there because super funds are at the point now where they’ve got populations of members ageing and for them, if they don’t nail this and get good, flexible, cost-effective products out there for their retirees, they’ll lose them.
“What’s clear to me is that as the weight of money over the next five to 10 years flips over from accumulation phase to retirement phase, the winners will be those who’ve got these products available within their super fund already.”
According to Clare, ASFA’s focus would remain on removing impediments.
“The point I make and the point ASFA makes is about removing impediments, opening up opportunities, having a regulatory, tax, and social security framework that’s product neutral, having advice readily available at reasonable cost,” he said.
“All those factors are important when it comes to people making informed decisions to choose the best product available.
“And it could be a mix of products – people might not want to put all their money into an annuity or a deferred annuity, they may not necessarily want to put all their money into just a balanced portfolio supporting an account-based income stream,” Clare continued. “So it could be a mix of things for many people and then for others, it’s one or the other.”
Callil’s advice to funds was to move forward with both product development and political pressure.
“There will always be a regulatory landscape to deal with and it may never be ideal,” he said. “So my advice to the industry would be not to wait but, at the same time, we need to keep the pressure up to remove those obvious barriers.
“In the product development space, I would say funds already are [active], but they need to continue to look at what’s available overseas, at what’s available in other marketplaces, but most importantly they need to look at what their members actually need,” Callil continued.
“I say that because I don’t think the solution is the same for each type of member and I don’t think the suite of solutions that should be developed is the same for each fund, because they each have quite different demographics.
“So it’s incumbent on funds to look at their members, to look at what the risks are that their members are seeking protection from, and what features their members really need – and then to deliver.”