Cuffelinks has been home to some articles (and lively discussion forums) on the need to develop tools which can accurately forecast and communicate the range of retirement financial outcomes that people may experience. I label such tools ‘outcome engines’. Without doubt the information produced would be valuable for people saving for retirement. In fact, it could be the most important financial information they could be provided with. Furthermore, the engines would deliver exciting opportunities for financial service providers to better assist their members and clients, from which they can build longer term value-adding relationships. So why has the industry been so slow to react?
An ‘outcome engine’ is simply a computer programme which, as its core function, can project expected retirement financial outcomes for an individual or a couple. The information is richer if it further explains the range of possible outcomes. It sounds simple but the calculations quickly become complex. For instance, it might take as little as one hour to build a simple model that compounds expected contributions through time and then determines the optimal drawdown rate assuming death at a certain age. But the world is far more complex and it could take years to develop a fully detailed model which considers factors such as wage outcomes, taxes, age pension, asset returns, inflation, savings rates, house prices, mortality rates… the list goes on.
In the Australian financial services industry there are only a small number of outcome engines developed by well-respected firms, and the projections from each model do not always match. This is because there is subjectivity involved in the assumptions that populate such models.
With a quality outcome engine, a financial service provider could better go about its business. Consider the following examples:
- Provide fund members and financial planning clients with projections of the range of possible outcomes they may experience in retirement (for a good article on this see “Super funds fail clients by not reporting retirement income” by Bev Durston, Cuffelinks 2 May, 2014)
- The outcome engine could form the basis of an interactive tool which enables someone to understand how their savings and investment decisions impact upon their retirement outcomes
- It could be at the heart of default option design for superannuation funds. For instance, is a balanced or a lifecycle strategy the best approach from a return / risk trade-off? This could be extended to more advanced fund designs such as a cohort-based strategy (grouping fund members by different characteristics). Who knows where the future may take us? A powerful outcome engine combined with personal information from members through successful engagement strategies may lead to personal superannuation strategies (I call this mass personalisation)
- An engine could similarly form the basis for generic financial plan design, or depending on its flexibility, could be used to develop tailored financial plans
- It could assist in the design of new products such as post-retirement account based funds, life policies, hybrid products such as variable annuities, as well as mortgage equity release products and aged care solutions.
When one considers all these possible uses, it seems such an obvious leadership opportunity for major super funds and wealth managers. For major wealth managers the opportunity is most compelling – they pretty much undertake every activity listed above, and they desire to communicate with their clients better.
And yet, beyond consultants and specialist financial software firms, there are hardly any groups in Australia who have their own outcome engine at the heart of their business. Even the bigger wealth management groups tend to fall back on consultants to produce case by case project information. Why would this be so? It is hard to understand but I suggest a few reasons: the development spend would be large and shared by many cost centres (which can create headaches for large firms in terms of ownership); the internal design skills may be low, having been whittled down through years of internal cost cutting; finally outsourcing provides a degree of assurance (but this may not guarantee accuracy which one major financial firm unfortunately discovered recently with their retirement calculator).
It requires a heavy investment in technology, including a decision whether to buy or build. But designed well so it can be used across all of a company’s relevant business, it can be a transformational process – the language of the firm would shift to being retirement outcomes focused.
All this could well contribute to the renaissance of the actuary (and note I have refrained from making any more actuary jokes following received threats of a left skewed outcome!). The educational grounding of actuaries in Australia is highly suited to this task. An actuary is versed in the statistics and modelling of finance, mortality and risk. They have programming skills and a strong focus on communication. With defined benefit funds in decline we have seen the role of actuaries diminish in the superannuation industry; the next 10 years will see increased demand as their skills become highly valued and relevant.
The most important point is a question for all financial services firms: what resides at the heart of your business?
David Bell’s independent advisory business is St Davids Rd Advisory. In July 2014, David will cease consulting and become the Chief Investment Officer at AUSCOAL Super. He is also working towards a PhD at University of NSW.