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As the superannuation industry continues to reach maturity, average retirement balances continue to grow. This, combined with an ageing population, in particular baby boomers entering retirement, is causing significant growth in the size of assets held within the retirement phase across the industry.
Figure 1: Projected cashflows into retirement
It appears as though the Retirement Income Covenant will require superannuation funds to provide a retirement income strategy specifically for these members who are retired or approaching retirement helping them to both achieve and balance the following objectives:
The offer of innovative retirement income products is expected to form an integral part of an effective retirement income strategy for a number of member cohorts. This is good for members, but there are complexities associated with retirement income solutions that potentially present challenges for trustees seeking to fulfil their obligations under the covenant. In particular, the design and operation of retirement income products are sufficiently more complex than those of accumulation products to warrant a different approach. For many funds, this will require a transformation from their traditional retirement income product offerings because current offers typically do not implement structures to effectively mitigate sequencing and longevity risk for a number of member cohorts, and simply rely on an account-based pension for all members in generality.
Increased balances, more complex retirement income products, and the interaction between superannuation, the tax system and the Age Pension, suggest that members will require increased guidance from trustees to navigate their personal situation. The cost of obtaining full comprehensive advice is too high for most members under the current regime, not to mention the lack of trust currently plaguing the industry since the Hayne Royal Commission. All these factors have prompted moves to reform the delivery of affordable and accessible financial advice. The Financial Services Council (FSC) and others have been undertaking further analysis and review of operating models, but future changes remain unknown at this stage.
It is clear from these developments, however, that because many retiring members require increased guidance whilst being unable to afford full comprehensive advice, scaled advice in some form will be needed. The retirement income system is complex, but much can be done to simplify the choices for the bulk of members. Where a certain level of complexity is inevitably involved, the intelligent use of technology can support many members to understand and navigate the system with the aid of data analytics and intuitive visualisations.
Achieving scale and digital advice
Mass-customisation is an attractive potential model for both retirement income solutions and the associated delivery of scaled advice, and this was in fact the model posited by Treasury in their first consultation paper on Comprehensive Income Products for Retirement (CIPRs). Mass-customisation provides the cost savings benefits associated with mass-production, while simultaneously allowing for tailoring at the member level. The operation of a single advice solution which can service most members of a fund can significantly reduce costs for trustees, reduce manual errors in delivering financial advice and provide a digital audit trail.
The delivery of quality financial advice requires the consideration of multiple factors. One example is market risk. Unfortunately, though there have been tools developed to show members what their retirement outcomes may look like based on “best estimate” assumptions, they are generally static and one-dimensional. Members are typically only shown what an “average” scenario looks like and are provided with little information about the possible range of retirement outcomes they may experience.
This presents a significant barrier to communicating the value of retirement income products that include longevity protection – which we expect to see more of in a future “Retirement Income Covenant” world. For instance, including some form of annuity within a retirement solution provides a minimum income bound that may be valuable in a poor market scenario when compared to the best estimate assumptions. With tools that do not communicate a range of scenarios to the member, this information is not immediately available to them as they engage in retirement planning.
While there is the ability to explore different scenarios through altering the underlying assumptions, the default provided to members has a powerful impact on the decision-making process. It cannot be assumed that most members will be able to explore each option themselves or even know how to do so, and the baseline scenario provided will often be viewed as an anchor. We have seen this already with many retirees drawing down income from their account-based pensions at the legislated minimum drawdown levels.
Further, by properly utilising modern web and mobile technologies, it is possible to develop tools that move projections from the realm of the static to the interactive. They can do this by introducing the dimension of time; members should be able to flip between alternate retirement solutions quickly under various market scenarios and make an informed decision about which suits their circumstances the best. As a specific example, elevating member statements from the static to the interactive may be a goal worth pursuing, legislation permitting.
The Retirement Income Covenant position paper proposes that it is at the trustee’s discretion whether they construct their retirement income strategy for all members of the fund or by segmenting members into cohorts. However, it is clear that no single default scenario or product design will be suitable for all members. This is where the power of mass-customisation comes to the fore. Figure 2 shows the number of members retiring each year divided into three cohorts by superannuation balance at retirement. Let’s consider each cohort in terms of a simplified retirement income strategy for a fund offering only an account-based pension and an immediate lifetime annuity.
These members are unlikely to benefit from annuitisation, instead relying on the Age Pension for longevity protection. They are defaulted to an allocation of 100% account-based pension (with an appropriate default asset allocation).
Between $200k and $1 million
These members would likely benefit from some form of annuity for longevity projection in retirement to supplement the Age Pension to insure against longevity risk and poor market returns on their account-based pension. They are defaulted to an allocation of 75% account-based pension and 25% immediate lifetime annuity.
Greater than $1 million
Members with balances this high are unlikely to benefit as much from annuitisation, as they can self-insure a significant part of the risk and will be considering bequests. They will also likely have access to full comprehensive advice. They are therefore defaulted to an allocation of 100% account-based pension.
Even though the retirement income strategies for each cohort are different, the products required to facilitate the implementation of the strategies are the same. Likewise, the scaled advice or digital guidance provides to all three cohorts can be the same, with the ability to vary the annuitisation amounts (ands types), but using the default allocation as an anchor.
Figure 2: Projected members retiring each year by retirement balance
Of course, there are further factors that should be considered in the customisation of retirement income products. The Retirement Income Covenant position paper identifies the following as potential factors to consider when defining cohorts:
If these factors were added to the previous example, the default annuity allocation for the middle cohort could be set algorithmically by the fund. The algorithm may be complex, but the product mix remains simple. Additionally, the increasing capability of modern technology readily supports the development of interactive tools that can provide these extra dimensions to online advice. The advice can also be easily delivered via all modern platforms to improve engagement with existing members and potentially win new ones.
In our example, we considered only two simple product “building blocks”, an account-based pension and an immediate lifetime annuity. However, there are already a range of other features being developed including annuities and pooled longevity products that are investment linked and that incorporate payment deferral periods. These features can be readily incorporated into a digital advice solution.
By offering digital advice solutions that incorporate simple product "building blocks", providers can efficiently cater to multiple niche cohorts of their membership. At an industry level, this approach can also bring down the marginal costs for funds associated with the development and maintenance of retirement income solutions and associated guidance. It will also help with the migration of retirement income products to acquiring funds in a merger transaction, and reduce the incidence of legacy products, which is a very real risk in such an innovation-charged environment.
Andrew is a partner in Deloitte’s Melbourne office in the Actuarial Consulting practice. Andrew has spent more than 30 years advising clients on superannuation, life insurance, employee benefits, risk management, investments and talent management. During his career, Andrew has also driven research and public policy in various areas of interest, including retirement income products and solutions, retirement adequacy, member disclosure and advice, member engagement and digital solutions, governance and managing conflicts.
Anthony is a Director in Deloitte’s Sydney office in the Actuarial Consulting practice. Anthony is a qualified actuary (FIAA) and software developer with over 12 years’ experience in the financial services industry. Anthony possesses a unique skill set and a passion for solving complex problems in the retirement income, banking and wealth management spaces and communicating results in innovative ways. He has a track record of delivering quality results to clients and has an in-depth knowledge of Australia’s retirement income landscape.