Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 242

Five challenges for post-retirement products

The concept of a post-retirement investment product was flagged in the Super System (‘Cooper’) Review in 2009-2010, but accumulation was the main area of focus for superannuation at that time. The concept, and associated CIPR acronym (‘Comprehensive Income Product for Retirement’) was an important recommendation in the Financial System (‘Murray’) Inquiry in 2014. It was noted that a 15% - 30% uplift in retirement income was possible, based on modelling by the Australian Government Actuary.

CIPR is a good idea in concept. However, taking an idea from concept to in-practice in a big complex system is difficult. That is the challenge currently faced by the policymakers at Treasury. Where they land will have a significant industry and system impact one way or the other. The stakes are high.

There is a strong commitment to continue down the CIPR path (or MyRetirement, as the Government plans to name it). An important next step announced last week by Kelly O’Dwyer is the proposed development of a retirement covenant which would require superannuation fund trustees to design and offer appropriate retirement income solutions to their members. An advisory group of industry professionals has been created to provide feedback to the Government.

CIPR and the desire to pool risk

The motivation for CIPR is that there is little pooling of longevity risk in post-retirement. Many people are frugal with their superannuation savings, a result of a combination of conservatism and an element of bequest motive. These savings were tax advantaged and remain tax advantaged while in an account-based pension. The outcome is a below potential post-retirement lifestyle and a tax advantaged bequest, neither of which meet the objectives of Government policy.

The concept of a CIPR is a default (i.e. unless otherwise selected by an individual) solution designed broadly to provide constant income for life, regardless of lifespan. This sounds intuitive, but as responses to the consultation paper identified, is difficult in practice.

What are the main immediate challenges?

I would summarise the main challenges, in order of priority as:

1. Reconciling the difference in objectives between policymakers and super fund trustees who act on behalf of their members

The preferences of the Government implied by the consultation paper and the design of the proposed Actuarial Certification Tests (required to be passed for a post-retirement product to be certified as a CIPR) suggest a focus on expected retirement income with little concern for variability of outcomes, the value of residual benefits or access to capital.

In practice, a trustee of a super fund needs to respect these other preferences (variability, residual benefits and access to capital). Consider two examples:

First, a male primary income earner, who unfortunately dies in the first year of retirement (around a 1% chance) and the trustee’s CIPR has no reversionary benefit for the surviving partner.

Second, a non-home owning member requires access to capital for one of many possible lifetime events, but unfortunately the trustee’s CIPR provides no access to capital.

Surely, a trustee is obliged to consider these issues in the design of their post-retirement default solution. There has been case law in the UK which has confirmed as much.

Do these differences mean much? Resoundingly yes! I was part of an industry project to establish a sensible set of preferences for trustees to assume on behalf of their members. These preferences were then developed into a metric known as the Member’s Default Utility Function (affectionately ‘MDUF’, see ‘Utility function’ research wins Retirement Innovation Award for more). At Mine Super, we then used MDUF to calculate the benefits of CIPR and we found that the proposed CIPR framework actually subtracted from retirement outcomes (Mine’s submissions are here and here).

A possible solution is that the trustee of a super fund must codify their own set of preferences that they assume on behalf of their members.

2. Incorporating the age pension into CIPR design

The original CIPR consultation paper framed a post-retirement solution which focused on consistent income for life in absence of the age pension. In practice, this guarantees an inconsistent retirement income profile for households.

Perhaps policymakers are frustrated at the current status quo of using an account-based pension and relying on the age pension for longevity insurance. However, ignoring the existence of the age pension risks over-insuring against longevity risk especially for members with lower retirement savings and experiencing lower income as a result. I believe that the age pension should be incorporated into CIPR design.

3. Interaction with the means testing for social security

Concurrently, the Department of Social Security (DSS) is developing means-testing rules for lifetime income stream products such as life annuities, deferred life annuities, and group pooling equivalents. The proposed rules appear fair in isolation but deeper analysis at Mine Super suggests that the treatment of account-based pension solutions is much more generous.

When we account for the new rules, incorporate the age pension, and assume the sensible preferences of MDUF, we find no rational demand for lifetime income stream products. In fact, the optimal solution would be not too dissimilar to the status quo (use the account-based pension in conjunction with the age pension).

Hopefully DSS and Treasury will together find a solution so that this issue does not become a sizable disruptor to the intentions of CIPR.

4. A reassessment of the realistic gains from CIPR

When the Murray Inquiry suggested that a CIPR could deliver a 15% - 30% uplift in retirement outcomes, I was perplexed. Eventually we got to the bottom of this claim: it was based on a hypothetical product design and only assessed retirement income with no value placed on residual benefits or access to capital. I feel the hypothetical product would not be acceptable to the public and could create risk for any trustee who used it.

A realistic improvement in retirement outcomes (using a more holistic measure, such as MDUF) would be in the order of 5% - 10%, still a large number at a system level.

5. Industry cost and ability to opt out

The cost and effort of developing a CIPR could be large, much larger than that associated with MySuper. But would this ‘retirement covenant’ allow for some funds to opt out and not offer a CIPR? What would happen to members of those funds at retirement? Would these funds be allowed to be specialist accumulation-only funds? Could the covenant be used to drive further consolidation of the super fund industry?

CIPR could provide a high-quality safety net but it could prove under-utilised as members leave for reasons such as becoming more engaged or after receiving financial advice. It could be a lot of industry expenses if many people opt out, and getting the system-level cost/benefit analysis correct is a difficult challenge.

 

Overall

These are exciting times for retirement planning. While some people may feel regulatory fatigue, I find the opportunity to be part of a system delivering good retirement outcomes a great motivator.

There are complex issues to be resolved. Broadly, everyone is pushing in the same direction but there remains a large dispersion amongst stakeholders. With such a complex area, there is the chance of a policy mistake. The welfare cost and industry cost of a policy mistake could be large. This risk is partly reduced by the quality of the advisory group which has been assembled.

 

David Bell is Chief Investment Officer at Mine Super. Estelle Liu is a Quantitative Analyst in Mine’s Investment team. Together, they led the working group which generated the Member’s Default Utility Function, an award-winning, freely available, advanced framework for assessing retirement outcome design. The views expressed in this article are their own and may differ from those at Mine Super, a sponsor of Cuffelinks.

RELATED ARTICLES

A defining year for super requires your input

CIPRs are coming and that’s exciting

Retirement income products - what's ideal?

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Shares

Exploiting Warren Buffett

Growth investors are using Buffett to justify buying blue chip stocks at almost any price. It’s a recipe for potential disaster, as investors in market darlings like CBA and Cochlear may be about to find out.

Property

Population density trends and what they mean for housing

With Australia’s population moving through the fastest rate of growth since the 1950s, our cities and towns are naturally densifying. This is a look at the latest trends and how they will impact the property market.

SMSF strategies

The ultimate superannuation EOFY checklist 2024

We're nearing the end of the financial year and it's time for SMSFs and other super funds to make the most of the strategies available to them. Here's a 24-point checklist of the most important issues to address.

Shares

The outlook for Nvidia, from a long-time investor

Nvidia has taken the world by storm and is now the third largest stock on the planet - larger than Meta, Amazon, and Alphabet. Here is the latest take on Nvidia from a fund manager who first invested in the company in 2016.

Economy

Gross National Happiness?

Despite being richer, surveyed measures of happiness have been flat to falling in Australia. Some suggest we should focus less on GDP and more on broader measures of wellbeing, though there are pros and cons to that approach.

Shares

The power of dividends

In an era where growth companies dominate and the likes of Nvidia grab all of the attention, dividend paying stocks are flying under the radar. Some of these stocks offer compelling prospective returns.

Fixed interest

The best opportunities in fixed income right now

After more than a decade of pitiful yields, bonds are back offering better prospects for income investors. What are the best ways to take advantage of the market inefficiencies in Australian fixed income?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.