A Retirement Income Renaissance?

A Retirement Income Renaissance?

The opinions and views expressed in this article are entirely my own and do not represent the views of my employer or any other third party.

The Retirement Income Review (now forever known as the Callaghan Report) was touted as an objective fact-based assessment of the state of Australia’s leading retirement system. At almost 650 pages long, it’s a behemoth and remains true-to-label with a series of findings and observations without making any explicit recommendations.

In many ways, this is bureaucrat and policy wonk cat-nip – they get to cherry-pick the facts to suit their political and policy-making reform agenda. Having said this, the report is a commendable and important effort to make sense of our highly complex but generally effective compulsory superannuation system. Exploring how it delivers, alongside other important private and public pillars, on the social “retirement” contract for all Australians.

Rather than attempt a chapter and verse summary of the report (by all means, have a crack), I’ve instead channeled my inner-Millennial to provide a “Top 5 list” of things that stood out to me from the report.

1. Half volleys dispatched to cover

Cover drive

While media commentary will undoubtedly focus on the Federal Government’s likely attempts to kill the SG rise off the back of the report, there’s a few no-brainer reforms that the report highlights again as having clear merit:

  • legislating a purpose for superannuation that is clearly oriented towards delivering retirement incomes – in the words of Nike “just do it” and stop worrying about the particular grammar and punctuation; and
  • the retirement covenant which has unfortunately been delayed to 2022 but will require superannuation trustees to specifically formulate a strategy to deliver their members positive outcomes in retirement.

If the report results in nothing else but ensuring these two things finally pass into law, then I would consider the whole exercise a resounding success!

2. Courage, Frydo

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As I read through the denser sections of the report that touch on the imperfect interactions between tax, social security, super and retirement rules – I started to feel a growing sense of excitement (stay with me, here) for true reform on the horizon.

My big bold idea for retirement has always been to means test the family home for Age Pension eligibility purposes. This continues to feel like the easiest and fairest way to address some invidious aspects of the current policy settings, namely:

  • the amount of unproductive capital locked in private property
  • the lack of incentives for retirees to downsize and free up stock for younger buyers
  • difficulties in accessing home equity as a source of retirement income
  • calibrating age pension eligibility to those most in need.

Rather than the Federal Government trying to double down on the Pension Home Loans Scheme (also explored in the report), it would be truly heartening to see Josh Frydenberg make the above a courageous centerpiece of their new retirement policy agenda. The report gives them sufficient ammunition for this and, they have a real live (and well-aligned) example of policy courage in action as the NSW State Government pursues their radical tax reform plan for stamp duty.

3. Biases and best interests

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The report does an excellent job of exploring some of the cognitive biases that effect how we, as humans, often make financial decisions that are against our best interests. In fact, page 159 (biases affecting saving) and 443-446 (biases affecting retirement decisions) are probably my two favourite sections of the report.

That biases affect our decisions shouldn’t come as a surprise to most of us and should be particularly familiar to super trustees who have fought against these biases (on behalf of members) in many recent situations, including:

  • supporting members to “stay the course” rather than switching into defensive assets at the bottom of the market and losing any future growth potential;
  • showing pre-retirees the benefits of maintaining an allocation to growth assets as they approach retirement (even as loss aversion starts to take hold); and
  • helping members understand that accessing their super under “early release” means they miss out on the 8th wonder of the world (compounding) in their retirement.

Where the report really hits the mark, is exploring how trustees have an obligation to support and guide members to overcome these biases. In fact, this is at the heart of their duty to “act in the best interests of members.”

If trustees can objectively prove that lifetime income and longevity protection propositions provide a benefit to some members (whether through a higher age pension entitlement or protecting against the risk they live longer than expected) then the report implies that trustees have an obligation to improve retirement outcomes by helping these members overcome the biases that have been historical barriers to purchasing.

In this regard, the work of the UK Government’s Nudge Unit is instructive. Perhaps if pooled longevity plans were framed as a decision to leave, rather than a decision to join at retirement – this would help address much of the apathy and “sense of loss” that surrounds pooled longevity products that protect against risks that feel too remote.

4. Advice by any other name…

Rose

Coming in as a close runner-up for my favourite section of the report is Box 5A-10 “What is financial advice?”. This lays out in clinical and confronting detail the complex terminology that currently surrounds the advice ecosystem in Australia.

Financial advice reform goes hand-in-hand with any system reform centered on the retirement phase. The reason for this is subtle, but profound. Consider the way super operates today is identical for the vast majority of Australians aged under 60 (and will continue to be due to the Government’s new stapling rules):

  • you start your career and are signed up to a MySuper product
  • you are placed in the default “Balanced” investment option
  • you have one goal: maximise your balance from now to retirement.

Which is to say, in accumulation every member is fairly homogeneous from a financial plan perspective. If trustees help you to maximise your net investment return, 90% of the job is done. But as you approach retirement, things start to get really hairy for members.

Retirement is a personal journey. And for a journey, you need a map. For trustees to help you create this map (aka financial plan), they need to know your “personal goals” and “personal circumstances”.

Unfortunately, as the report makes clear, this is fraught with peril for trustees. Intra-fund advice doesn’t cut it. Personal financial advice is costly, complex and now has an extremely high compliance burden. Everything else isn’t really advice. In the immortal words of Star Wars, we need a “New Hope” for mass-market advice and guidance for retirees.

5. Long term care: back-to-the-future

Hoverboard

Buried in the report first at Box 4A-3 and then later at 5A-7 are some thought-provoking statements about the discordant interactions between the super, insurance, social security and aged care industries. Culminating in this piece of crystal ball gazing:

“If changes are made to encourage greater personal provision for aged care costs following the Aged Care Royal Commission, long-term care insurance may make aged care costs more affordable for people and give them the confidence to draw down their retirement savings.”

A comeback for “Long-Term Care Insurance” in the Australian market has been much speculated about but continues to be a Sisyphean task – beset by challenges on both the supply side and the demand side.

However, there is a scenario I can envisage where the intersection of reform may meet between the Aged Care Royal Commission and the Retirement Income Review – providing an impetus for industry participants to better serve our aging population. It is a risk factor and health burden that is poorly understood by the wider community and grotesquely under-served by both government and the private financial sector alike – the severe impact that increasing levels of cognitive decline and mental illness will have on the retirement well-being of our aging population.

Life insurers (including my own employer) have been highlighting the growing impact of mental illness on our wider community for some time. Alzheimer’s and Dementia will soon grow to be the leading cause of disability, decline and death for individuals over the age of 65. More than this, it is the unique impact that this category of illnesses has on well-being and retirement lifestyle. Among them being that it robs people of their financial literacy right at the time that they need it most – as they are faced with the most dizzying array of complex financial decisions whilst navigating the a bureaucratic range of government/private providers.

If there is a challenge our lucky country should seize upon with gusto to preserve the great Australian dream for all – surely it is this!

I hope you enjoyed this taste of the Retirement Income Report. If you don’t have time to read the report in full, I suggest you focus instead on the key observations and insights. This article was not intended to be a comprehensive summary of the report (or even an incomplete summary) – it is primarily a conversation starter.

I’d love to hear everyone’s thoughts and comments on the report below!

Tipping point

Tipping point
This article was originally published in ASFA Super Funds Magazine and is republished here.

Transitions to retirement will soon exceed the total amount of mandatory contributions. Speaking recently at the 2019 ASFA NSW Conference, ASHTON JONES explores what will happen when the retirement tipping point is reached, and retirement flows begin to outstrip mandatory contributions.

Almost 20 years ago, Malcolm Gladwell popularised the theory that rapid change is always preceded by seismic shifts in orthodoxy, in his book The Tipping Point: How Little Things Can Make a Big Difference. These tipping points can be identified throughout modern history – everything from the fall in New York crime rates, to the dominance of the iPhone, to the rise of political populism (think Trump and Brexit).

Many speculate that, in years to come, 2019 in Australian financial services will be most remembered for the release of the Royal Commission report. However, there is a tipping point that will change the superannuation industry even more profoundly.

Within the next few years, it is possible that transitions to retirement (assets flowing from accumulation into pension phase) will exceed the total amount of mandatory contributions into APRA-regulated funds. Once this retirement tipping point is reached, retirement flows will begin to outstrip mandatory contributions in an exponential fashion.

This trend will accelerate most funds moving into net outflow position (paying more money out than they are receiving in). Eventually, some funds will be pumping out as much money as banks’ daily payments processes. Superannuation funds will bear an even heavier societal burden once this retirement tipping point is reached. Millions of Australians will be reliant on them for their weekly paycheck, paying the rent, putting food on the table.

How can funds live up to this lofty position? Largely, it will come back to familiar fundamentals – risk, insurance and performance. But, it’s up to funds to confront the reality that their current retirement propositions are not fit-for-purpose to service retirees with a range of different needs and preferences. Funds will need to evolve their account-based pension retirement proposition to factor in more retiree-appropriate fundamentals.

Risk

Our traditional risk models have largely centred on the risk/return trade-off – managing unproductive volatility through diversification. In recent times, some funds have sought to use their muscle and scale to boost member returns by accessing asset classes that are largely unavailable to retail investors (private equity, infrastructure and unlisted alternatives). However, as funds move into net outflow they will need to be more conscious of sequencing and liquidity risk as more retirees draw down on their pension accounts. In particular, funds should not sacrifice appropriate access to liquidity (such as through cash and defensive allocations) in pursuit of a few extra basis points of expected returns.

Insurance

Despite recent regulatory pressure and industry commentary, group insurance is still the most efficient method of delivering protection to Australians at scale. Group insurers, in the main, pay out the majority of premiums collected through claims (80 per cent to 85 per cent loss ratio). However, this won’t be enough in future as cross subsidies between young and old become more apparent and retirees start to wake up to the fact that Death, TPD and IP are less relevant forms of cover the older they get. The solution for insurers? Take the best parts of the insurance through super framework and apply it to managing the most important protection need for retirees—insuring against the risk of living longer than your savings. There’s a lesson here for government as well—mortality pooling benefits only arise at scale; we must leverage the scale of our existing group insurance framework in the development of the Comprehensive Income Product for Retirement (CIPR) legislation.

Performance

For an industry that should have a very long-term focus, we can be extraordinarily short-term in our thinking. Nothing illustrates this better than monthly performance league tables for investment returns. This short-termism fosters an unhelpful member mentality around the sustainability of returns and hinders a sensible philosophy of staying the course over the long term. Fund performance evaluations need to go back-to-basics and re-examine the very purpose of our industry – to provide sustainable and adequate retirement income. We need to find new long-term performance measures that allow members to compare which funds are most likely to maximise their retirement outcome and deliver the highest total income for life.

We need to find new long-term performance measures that allow members to compare which funds are most likely to maximise their retirement outcome and deliver the highest total income for life.

The development of CIPRs cannot just be another compliance exercise for the industry – there are sure to be more than enough of them in the years to come. Instead, funds should view this as an opportunity to invest in their most important emerging cohort and realise the overall retirement income objective of the system. If funds can do this, they will provide members with a purposeful and dignified retirement that will last long until the future.

The next evolution of retirement

The next evolution of retirement

How super can prepare for an ageing Australia

How super can prepare for an ageing Australia

This article was originally published in Super Review – Money Management Magazine and is republished here.

Today, Australia’s age pension system is comfortably supported by 4.5 workers per pensioner. But by the time a current 30 year old retires in 2050, the Department of Treasury forecasts that this rate will fall to just 2.7 workers per pensioner.

Needless to say, this has profound implications for future retirees.

The proportion of workers to pensioners (the “Dependency Ratio”) is a bellwether for the structural integrity of our retirement system. In its current state, we can expect three pillars of the Australian retirement system (the age pension, family home and super guarantee) to face major challenges, such as:

  1. The age pension becoming less sustainable for future Governments,
  2. Home ownership continuing to concentrate towards the older or wealthier,
  3. Many super funds’ net cash flow position moving towards negative.

We have shown immense foresight in developing a robust retirement system that is the envy of most comparable countries. To maintain this privileged position, the industry must acknowledge its challenges, and continue to innovate.

Opportunity knocks for super funds – however, supporting 21st century retirees will require new and creative services.

AN ERA OF CREATIVITY

For a start, super funds need to take stock and think deeply about the skills available across staff and partners. Different skills will be required to more closely match investment strategies to members’ retirement needs.

An emerging school of thought revolves around the idea that super funds need to broaden their value propositions beyond mere investment vehicles to full-service retirement concierges – but what does that mean in practice?

For a start, super funds can focus on the wellbeing and living standards of members rather than merely generating investment returns. This should lead to a better quality of life for retiree members, as super funds become a gateway to retirement planning, health and wellbeing services, or even aged care.

A number of super funds have begun to factor in the demographic shift through an investment lens, taking sizeable stakes in retirement villages around the country. As members age, this presents a natural synergy for funds to explore – subsidising retirement living arrangements for members could provide more value than the equivalent cash amount.

A similar shift in mindset will be required from insurance in super. People in their late 60s and over have less need for life insurance once mortgages are settled and children have moved out. However, retirees still face health risks and need a protection strategy.

Cover for illnesses such as dementia or stroke could be more valuable than the broad insurance cover typically available through super. And if benefits are provided through direct support – such as in-home care – this might be a better member outcome than an equivalent lump sum payment. This benefit model is particularly compelling in light of a North American study showing that 74 per cent of people over 65 suffer from at least one chronic disease, and for retirees facing cognitive decline and a diminishing capacity to make financial decisions.

A NEW RISK DIMENSION

Super funds must also recognise that members entering retirement face different risks to younger members and have different priorities as a result. Rather than being content to take on risk and watch balances accumulate over decades, older members will require investment strategies that manage sequencing risk (the risk of poor investment performance just prior to retirement) by factoring in their withdrawal behaviour whilst still allowing them to benefit from exposure to growth assets.

Super funds are also increasingly looking at lifetime income products, such as annuities, to provide security to older members with their increasing life expectancies.

This trickle will soon become a flood following the release of the Government’s Retirement Income Covenant Position paper. As currently proposed, all funds will be required to offer a Comprehensive Income Product for Retirement (CIPR) by 1 July 2020. This CIPR must include a component of longevity risk protection that provides a “broadly constant income for life.” Simple account-based pensions will not be sufficient.

Of course, longevity in product design requires a deep understanding of mortality trends and their influential factors – this is why it is the natural domain of insurers. Understanding these trends could offer ancillary benefits for super funds, including being able to provide more tailored member experiences and bespoke retirement solutions from a menu of different propositions.

Super funds can’t allow their members to face these risks alone, and should look to leverage the trust held in them through goals-based advice that helps members to mitigate risks and retire in comfort. Meanwhile, new savings products – outside the super balance with its many access restrictions and contribution limits – could support one-off costs, whether health-related expenses or a well-deserved holiday. If recent investment data is any indication, historically-maligned insurance bonds are beginning a resurgence.

While some of these ideas will undoubtedly fall by the wayside, now is the time for debate – while we still have the luxury! Whatever happens, it seems likely that super funds will naturally move to become the key pillar in Australian retirement over coming decades – particularly as structural changes in our economy challenge the age pension and the very concept of home ownership for many young Australians. While there are many clear challenges for super, I look forward to seeing it evolve to a bold new dynamic.

Ashton Jones is Head of Investments, Retirements and New Propositions at TAL.

What can we learn from retirement overseas?

What can we learn from retirement overseas?

Our perception of retirement is uniquely Australian:

“She’ll be right mate, my employer takes care of my super and the government will give me a pension when I run out.”

Because of this laid-back attitude, retirement is an afterthought for most Australians:

 

All that rushing doesn’t leave much time to pause and reflect on how we can make superannuation and retirement work best for ourselves, let alone everyone else.

Take me for example. For a person who only recently exited his twenties, I spend an (un)healthy amount of time thinking about retirement. This isn’t so much a reflection of my Millennial eagerness to race through the different stages of my life but borne out of a fascination of how the human experience evolves over time.

It’s clear that we have a world class retirement savings system – Australia has the 4th largest in the world by assets and consistently ranks among the top 3 for AdequacySustainability and Integrity (Melbourne Mercer Global Pension Index 2017). We punch above our weight. But why aren’t we the best and how can we get to the top?

Mercer raised four areas that need more focus in Australia’s superannuation system:

  1. Part time workers, contractors and gig employees
  2. Working women and stay-at-home mums
  3. Ensuring retirees have an adequate income
  4. Stability in legislative and regulatory reform.

Addressing these areas would make a real difference. But how can we continue to evolve our retirement system? Maybe should can start by reflecting on how others around the world culturally view and experience retirement.

UK and USA – one step back, two steps forward

Our closest cultural cousins, the UK and USA, can teach us a few things from opposite ends of the retirement spectrum. The UK is still feeling the effects of a tumultuous transition from compulsory annuitisation in 2015. Where previously Brits were obliged to take out an annuity at age 75, the UK has now adopted a model that looks a lot like where Australia is heading (although they have arrived at it from the opposite direction). The challenge for the UK, like Australia, is to provide the right mix of tax and social security incentives to ensure a balance of private retirement savings, public pension welfare and longevity risk protection.

At the other end, the USA has a comparatively miserly retirement system (the 401K) that relies largely on voluntary opt-in savings. Without a compulsory retirement savings framework, the USA continues to struggle with incentivising working Americans to adequately self-fund their retirement. Amidst this landscape, innovations in public policy are arising as bureaucrats turn to behavioural finance or “nudge theory” to incentivise employers and their employees to save for retirement.

As explained in the Planet Money Podcast “Nudge, Nudge, Nobel”, Richard Thaler (the father of modern behavioural finance) and some of his academic protégés proposed changes to how employers enrol their employees in 401(k) retirement savings programs with profound results:

  • implementing default enrolment into 401(k) programs where the employee must specifically elect not to contribute has now been adopted by 68% of companies
  • a Save for Tomorrow scheme where employers automatically increase the 401(k) contribution rate each time an employee receives a payrise has also been adopted by 3/4 of the companies above.

Continental Europe – a house is not a home

There are diverse retirement models throughout continental Europe but three examples I will touch upon provide an insight into the important role that progressive housing arrangements can play in a high quality retirement system:

  • Scandinavia, the world champions of retirement systems (MMGPI 2017), where both the “Neighbourhood aged care” and “Co-housing” models originate.
  • France, the home of Viager, a quasi-gambling style system of property exchange where the buyer wins or loses depending upon how long the seller lives.
  • Germany, which has protection for rental tenants practically written into its Constitution: “Property comes bound with duty. It must be used to serve the public good.”

Neighbourhood aged care (also known as Buurtzorg) and Cohousing has experienced a meaningful surge of public policy interest around the globe. Buurtzorg was first pioneered in the Netherlands with nurses self-organising to provide in-home care services. Enabled by technology with little administrative overhead it has been shown to reduce costs per patient by approximately 40% (compared to comparable care models). Cohousing involves retirees pooling their resources to establish sustainable living environments and sharing the cost of in-home care. This provides them with greater control over their retirement housing as they age and also tackles the most insidious and underappreciated risk associated with aging – social isolation.

The viager system in France is a little more complex to understand but shares some things in common with equity release products. Viager involves a private contract between two parties whereby:

  • the seller remains within the property and receives a lump sum amount (known as the bouquet) and a fixed monthly payment from the buyer for the rest of their lives
  • the buyer receives a discounted purchase price for the property (determined by the sellers calculated life expectancy) but is exposed to the risk that they are required to continue paying the seller if they live longer than their calculated life expectancy.

Germany has a relatively simpler approach to guaranteeing housing security for retirees through an extremely strong legislative framework designed to protect renters. Germany has one of the lowest home ownership rates in the developed world precisely because of how heavily stacked the decks are in favour of renters:

  • tenancy laws strongly favour tenant rights over landlord rights
  • rental increases are legally capped to 15% over a 3 year period
  • mortgage-interest payments are not tax deductible by home owners
  • long-term leases are common and may be transferred across generations.

Japan – why retire at all?

Japan has one of the highest average life expectancies in the world. If anyone could be considered the masters of a long and healthy retirement, it’s Japan. So where in Japan should we look for the secret sauce? The region where women live longer than anywhere else in the world – Okinawa.

In the local Okinawan dialect, they have no word for retirement. Instead, the concept of “Ikigai” remains supreme. Translated literally it means “a reason to wake up in the morning.” Ikigai imbues Okinawan’s entire adult life and extends beyond just pursuing hobbies in retirement. Okinawans take responsibility for what they are taking from and contributing back into the world until their final days.

Hear Dan Buettner explain this better than I ever could in his TED talk:

To culturally shift our mindset from retirement to purpose, we must ask ourselves:

  1. What do I like doing?
  2. What am I good at?
  3. What allows me to live my values?
  4. What can I give back?

Our Ikigai lies at the centre of these 4 questions.

Returning to Australia

The flip side to all of this is that many economies around the world don’t enjoy the freedoms and benefits of a strong social safety net (let alone a generous lifetime age pension). As a result, many cultures do not yet enjoy the expectation of a long and relaxing retirement. Instead, the combination of shortened life expectancies and the need to work to maintain an adequate income mean that most reach the end of their life still employed.

Even with emerging economies that are more matured, such as in Latin America, retirement products are so homogenous that the only competition occurs on price. This provides little incentive to innovate and consumer engagement in their retirement savings all but impossible.

Australia should be grateful for our world class retirement system but acknowledge that it has largely been built on the back of 3 long-standing pillars:

  1. pioneering compulsory superannuation contributions
  2. our cultural obsession with home ownership
  3. a generous age pension safety net.

“So what can we do to keep Australia at the forefront of global retirement trends?”

Mercer had a few ideas which they shared in their 2017 MMGPI survey:

  • apply a mandatory Superannuation Guarantee (SG) Contribution requirement at all wage and salary levels (currently applies above $450 per week)
  • review superannuation arrangements for part-time workers, contractors and the gig economy (where employers are no legislatively required to contribute)
  • focus on reform to improve retirement savings outcomes for women through increased mandatory contributions and greater protections for stay-at-home mothers who are dependent upon their spouse’s superannuation savings
  • separate superannuation regulatory reform from the political cycle by placing ongoing legislative responsibility in the hands of independent bodies.

One thing is for certain, Australian consumer expectations about superannuation will change dramatically as technology, demographics and regulatory forces ripple through the system. Personalisation will be demanded by a Millennial-dominated workforce. Speed and control will be expected as on-demand real-time services (such as Amazon, Uber and the New Payments Platform) become ubiquitous.

Trustees and service providers can either ride the wave of innovation and reform that will sweep across the Australian superannuation landscape or be swept away in the tide. Regulators, employers and trustees will need to work together to make this innovation work for end consumers, but the ideas below should be possible:

  • employers to offer salary packages which include automatic increases to the super contribution rate at each pay rise (particularly whilst the government drags its heels on increasing the mandatory SG contribution rate).
  • jointly held retail superannuation and pension accounts that provide consolidated retirement outcome projections for couples and families
  • unique superannuation accounts that can be easily switched between funds allowing the “pot to follow the person” wherever they go in their career
  • legislation to make renting a stable and compelling alternative to home ownership and reduce the tax incentives associated with property investment.
  • flexible workplace arrangements that enable a slow disengagement from full-time work and encourage retirement gap years before returning to the workforce
  • retirement counselling and transition services provided by super funds to support involuntary retirees who exit the workforce in a sudden manner
  • including the family home in the assets test to determine age pension eligibility to encourage downsizing and retirement funding through home equity release.
  • progressively lifting the eligible age to access superannuation and the age pension to align automatically with increasing life expectancy assumptions.

But perhaps, more than anything else, we all would benefit from adopting a more nuanced perspective on retirement (akin to the Ikagai concept I described earlier).

If we did, maybe we would all segment our lives a little bit differently:

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If you enjoyed this article, please like or comment below. You can read my previous articles on topics as diverse as artificial intelligence, blockchain and Milennials at my website Fintech Freak.

Disclaimer: The views and opinions expressed in this article are solely those of the author in his personal capacity. The information contained in this article is general advice only and does not take into account your individual needs, objectives or financial situation. 

4 shockwaves shaking up the superannuation sector

4 shockwaves shaking up the superannuation sector

This article has been syndicated by Financial Standard and is available in the Expert Feed section of FS Super’s Journal of Superannuation Management

The super system is big. Much bigger than you realise. It’s so big that most numbers describing super are incomprehensible:

  • $2.3 trillion of assets invested in 2017
  • $10 trillion of assets estimated by 2040
  • wellbeing of 15 million working Australians
  • the 4th largest pension system in the world.

 

For a system so big, it’s no surprise that shifting it in a new direction takes time. Right now it’s being pushed and prodded by external forces harder than ever.

In this article, I delve into how these forces are creating four big shockwaves that are rippling through superannuation and reshaping it for future generations.

1. Big isn’t better (but it helps)

APRA has had enough. For years it has taken an influencing rather than instructing approach to the perceived problem of too many underperforming funds. The prevailing wisdom has been that consolidation or outsourcing within the sector was inevitable:

The merger option for small super funds

It’s clear now that APRA sees the scale=success equation as more nuanced. To prove it, they have gotten very specific on their criteria for success and will be naming and shaming funds that don’t measure up or have a long-term plan for sustainably improving member outcomes:

Why is APRA becoming so interventionist? In my view, it’s a product of many superannuation funds losing focus on core values (more on this later). The first and foremost responsibility of a fund is to ensure members receive an adequate return for the fees they pay. For some struggling funds, their only way forward will be to merge with others or outsource core activities.

I am hopeful though, that many funds can refocus on their core purpose and provide a more compelling, cost-effective and tailored proposition to their members. One big barrier for smaller funds to do this is the complexity associated with legacy product rationalisation. A myriad of regulations still operate to make it complex for trustees and providers to consolidate or transfer members to more contemporary products. The successor fund transfer regime is good but more can be done by regulators to assist funds in this regard.

Choice and competition is always good for consumers, particularly when funds differentiate their proposition by focusing on areas where they can truly add value to their specific member base. What use is retirement advice when the bulk of members are under 50? What benefit is there for life insurance if the member is under 25 with no mortgage or dependents? Funds need to know what their members are paying for but more importantly what they value. The best way to find this out? Ask them.

2. How to live safely in a net outflow world

“Do not fear death so much, but rather the inadequate life.” Bertolt Brecht

Like many members, I fear death less than I fear not making the most of the years that I have left. Superannuation theoretically plays an extraordinary role in protecting and preserving the lifestyle of hardworking Australians in their retirement years. The problem is, the system was built to make it easy for workers to get money into super (while taxing them on the way in) with little thought as to how they would get money out 40 years later (hence no tax on the way out).

A big shift is coming. Australia’s population is ageing rapidly. The number of people above retirement age grew from 1 million to 3.5 million in about half a century. Within our lifetimes, 1/4 of Australians will be aged over 65 and 1 in 14 will be aged over 85. Source: Ageing in Australia

What’s worse? People don’t even realise that they’re living longer and continue to underestimate their future life expectancy. A National Seniors Australia (NSA) surveyof 2,000 of its members found that, on average, seniors over the age of 50 underestimated their life expectancy by seven years. This generational change will result in many, if not most, funds moving into a net outflow position and the Federal Government’s fiscal deficit position growing rapidly:

Few funds are well equipped to service members in such an environment, let alone help them to make the transition to a comfortable retirement. The funds that proactively focus members’ attention on a retirement outcome rather than an account balance or annual return will be the ones best placed to win. In this future, funds will only succeed by boldly partnering with specialist providers to:

  • individually tailor retirement solutions for members
  • provide calculators and tools to demistify projected retirement income
  • cost-effectively protect against longevity and sequencing risk
  • offer savings and retirement alternatives to superannuation
  • equip members to overcome their behavioural biases that lead them to be overly conservative and apathetic about their future self.

Regulation may force their hand anyway but funds can’t rely on a Comprehensive Income Product for Retirement (CIPR) or an Alternative Default Model regime alone to deliver quality retirement outcomes. Regulators may even go further in fulfilling their promise that superannuation policy setting will be reoriented around a retirement income focused purpose. The unspoken threat on the regulatory horizon is future governments dipping into the superannuation honeypot by taxing retirees on pension withdrawals. Then we would really see a new retirement paradigm emerge, one that may no longer be so dependent on superannuation.

3. If you build it, Millennials will come

“If I have seen this far, it is by standing on the shoulders of giants.” – Sir Isaac Newton

In many ways, this could be the mantra of the super “disrupters” gaining a lot of press attention. There are new ones popping up every day, super designed for:

  • the lads (Grow Super)
  • techies (Spaceship)
  • women (Human Super)
  • mobile addicts (MobiSuper)
  • first grade spellers (Zuperannuation) – kidding!

I’m an inherent skeptic about whether these new entrants are in it for the long haul. But really, that doesn’t matter. What matters is that they represent an important customer acquisition trend. You can make prospective members care about the fund they select by tailoring the experience down to the lowest possible level (or the lowest common denominator in the case of Grow Super’s hilarious ad below):

But what’s behind their sudden rise? A mix of technological and market trends:

  • the rise of outsourced administration / trustees for hire
  • a rapid improvement in out-of-the-box superannuation software solutions
  • the advent of seamless electronic contributions/rollovers (aka Superstream)
  • savvy entrepreneurs and VC investors seeing big captive margins in the super industry and sniffing a quick juicy pump and dump.

Incumbuents can learn from this. Millennials will gravitate towards those companies and people who share their values or have similar core characteristics. You shouldn’t have to start a whole new super fund to provide a great experience to female members. In fact, Spaceship’s entire proposition could be encompassed by making available a single tech-focused investment option within an existing fund and marketing the hell out of it.

So why aren’t more funds doing this? Corporate inertia and high barriers to entry surely play a part. The bright side is, if there’s an easy answer, there’s an easy solution…

4. Forget FinTech, focus on the fundamentals

Blockchain, bitcoin, artificial intelligence, insurtech, supertech. They’re all just spokes on a wheel. This one’s on top, then that ones on top, on and on it spins – crushing the innovation ambitions of super fund board after super fund board.

Unlike Daenerys Targaryen though, I’m not advocating that funds break or reinvent the innovation wheel. Rather, funds need to return to their core principles and reflect upon how they add value to members. At a recent presentation by Bravura’s Darren Stevens, I got profound insight into the areas where Australia’s largest superannuation fund (Australian Super) believes it can add value to members long term:

  1. net returns (gross returns less fees)
  2. insurance
  3. education / advice
  4. retirement planning.

If most funds reflect deeply enough on their strategic ambitions, they would all boil down to a version of these four things. If a super fund’s value proposition is so ubiquitous, what is the purpose of having so many different funds? I think it comes back to my earlier point that choice and competition are good for consumers only if funds are adding value to the specific member base they serve.

For funds to have a differentiated purpose which reflect the members they service, they must understand the member preferences and characteristics that demand a unique and tailored service model. For example, one sector of the economy grossly under served by the superannuation system are contractors including those working in the “gig economy”. Where is Share Super – a fund designed for members in the sharing economy? *cue series A funding round* As ASFA points out, “It is crucial that superannuation settings are adjusted to ensure the superannuation system remains fit-for-purpose, and can best meet the needs of all Australians.” –Superannuation and the Changing Nature of Work

I’d argue that to better service members, most funds don’t need more or different regulation, but they do need to adjust their service proposition and provide more tailored solutions to members. Innovate but do it with purpose. This may sound odd coming from a “Fintech Freak” but innovation to me has never been about experimenting with the coolest new technology or chasing the latest upswing on the Gartner Hype Cycle.

Innovation must always be purpose-driven and customer-centric. Superannuation funds should look to the experience of sports drink giant Gatorade for inspiration. Gatorade invented new products by reinventing old ones in a “Third Way” approach to innovation. When Sarah Robb-O’Hagan took over Gatorade she eschewed the typical approaches to innovation (incremental improvement or a radical rethink) to focus on a Third Way of innovating around the current product to make it more valuable. Superannuation funds fighting for relevance amidst powerful regulatory, technological and demographic forces would do well to learn from this experience.

What other #shockwaves would you suggest are shaking up the #superannuation system? Please comment below with your thoughts to start a conversation.

The information contained in this article is general advice only and does not take into account your individual needs, objectives or financial situation.

 

How will Millennials live in retirement?

How will Millennials live in retirement?

By the time I’m 70, my retirement will hopefully begin. I’ve wanted to retire earlier but my $1.6 million (if I’m lucky) won’t be accessible tax-free until then. There was controversy in 2037 when the New Democrats indexed preservation age to our life expectancy but most people agreed it was time to tweak the system. After all, it had been many years since the now defunct Labor and Liberal parties had agreed not to touch the super system for two decades to provide some retirement planning certainty… 

This is, of course, a fantasy and given the Government-of-the-day’s proclivities to tinker with the super system, unlikely to ever become a reality. In the context of the major changes announced in the Turnbull Government’s inaugural Federal Budget, it is worth reflecting on the landmark years of the super system:

  • 1992: mandatory super contributions are introduced
  • 2006: taxation is simplified and super choice is enabled
  • 2016: the objective of super is enshrined.

Milennialls will look back on the most recent changes as a defining moment that reframed the super system around this objective:

“To provide income in retirement to substitute or supplement the Age Pension.”

The six biggest changes

Underpinning this objective, a number of changes to the taxation and access rules of super were flagged. However, there were six in particular that have the potential to significantly redefine the retirement of future generations:

  1. A lifetime cap on tax-free pensions: is $1.6 million enough to live comfortably in retirement? The Liberal Government is betting that it is by restricting tax-free pension account balances to this amount. This will have an enormous industry-wide impact, making administration more complex for superannuation providers and requiring advisers to rethink their wealth accumulation plans for clients.
  2. Restricting voluntary contributions: it just got even more difficult for workers to make contributions above the mandated employer contribution level. For the young who are salary sacrificing into super, the limit on pre-tax contributions (i.e. concessional) will be reduced to $25,000 p.a. For those closer to retirement or who have received a one-off windfall, your ability to make after-tax contributions (i.e. non-concessional) has now been reduced to a lifetime limit of $500,000. Importantly, this lifetime limit applies to non-concessional contributions made since 2007.
  3. Taxing transition to retirement earnings: the Government will remove the tax exempt status of earnings supporting a transition to retirement (TTR) pension. TTR pensions have been particularly popular with those that have been reducing their working hours whilst still earning a relatively high income. They have been even more popular with advisers recommending a re-contribution strategy. That will all end and TTR pensions will be treated more like accumulation accounts.
  4. Removing the work test: this has been a long time coming and will allow individuals to contribute to their super, regardless of their employment status. This will open up a range of contribution options to older Australians, including downsizing the family home and increasing the prevalence of spouse contributions.
  5. The untimely demise of anti-detriment payments: this was an unfamiliar benefit to most average Australians making super contributions but a well-known value-add by advisers that could find the right super fund. Essentially, a super fund could elect to provide a refund of a member’s lifetime contributions tax payments upon their death. This has been used heavily in estate planning but was inconsistently applied throughout the industry and won’t be available anymore.
  6. Resurrecting (tax-free) deferred annuities: deferred annuities have been seen by a number of insurance and superannuation providers as the silver bullet in the retirement income debate. Given the advantageous nature of these tax changes, expect to see a lot of innovation in this space and increasing focus on product-centric retirement income solutions.

Predicting the impact on Millennial retirements

These changes should be read in the context of the newly defined objective of the super system. Simon Swanson (Managing Director, Clearview) summed this up well in arecent interview:

“Superannuation is no longer a wealth accumulation game, it is a retirement income game.”

I see a number of long-term super industry trends emerging during my (and other Millennials’) working life as a result of these changes. Some will emerge rapidly, whereas others will be so imperceptible they will only be apparent in generational hindsight. In order of speed and likelihood of change:

  1. increasing system complexity: this one is a no-brainer and perhaps not the boldest prediction ever made. These changes add to the complexity of the system for both providers, advisers and most importantly members. Expect to see the consolidation of superannuation funds accelerate as the costs of administration become too much for sub-scale providers. Quality advisers will continue to be worth their weight in gold to members trying to navigate the murky retirement waters.
  2. diversifying retirement product mix: expect to see a comeback in insurance-based products including deferred annuities and insurance bonds. A mix of these products, along with an account-based pensions may become a more affordable and compelling proposition. Automated decision support tools will proliferate assisting members to determine their optimal product mix to achieve their desired retirement income and lifestyle.
  3. encouraging self-employment and entrepreneurship: a subtle aspect of the changes is how they benefit the self-employed by making it easier for them to contribute to super. At the same time, as the company tax rate falls to 25%, there may be incentives for the self-employed to restructure more income through their companies. Furthermore, high income earners will have to find other investment opportunities outside of superannuation such as equity crowdfunding and investing in small businesses. This prediction is slightly more far-fetched but I wonder if it will be an unintended consequence of Malcolm’s much-touted innovation economy.
  4. inter-generational poverty: in many ways, the wealth of current pre-retirees has been built on the twin pillars of home ownership and superannuation. This may be slightly controversial, but what if these super changes merely add to the growing body of thought that younger Australians are being affected by one of the worst examples of inter-generational poverty visited in history? As house prices continue to rise (perpetuated by negative gearing tax concessions that continue to be preserved by the latest budget), the likelihood of Millennials owning their own home decreases by the year. Combine this with the new objective of super and there is the potential for Millennials to have less tax-effective wealth accumulation opportunities than their predecessors. We could even see the emergence of a new advice specialty – overseas retirement planning – as Millennials with limited retirement incomes, but freed from the shackles of home ownership, set sail for fairer (and cheaper) shores.

You can read my series on ideas transforming Australia’s wealth in 2016 below:

Idea #1 – Goals-based investing

Idea #2 – Blockchain (Part 1, Part 2, Part 3)

Idea #3 – Roboadvice

Please note: this article is for general information and illustrative purposes only and should not be relied upon for any purpose. The accuracy of the information contained within cannot be guaranteed.  You should consult a financial adviser before making any personal financial decisions.