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CIPRs are coming and that’s exciting

It appears that CIPRs (Comprehensive Income Products for Retirement) will soon eventuate. The Government has finally released its response to the Financial System Inquiry (FSI). Among many recommendations across different segments of the finance industry, the Government supported the FSI’s recommendation for CIPRs to be created by all institutional super funds for their non-defined benefit default members. This is a really good thing – a sound recommendation, sensibly endorsed by the Government. If the regulators (in terms of developing policy) and industry (in terms of design and implementation) get this right, then the vast majority of Australians should experience a better financial retirement outcome.

Bring it on!

I can’t remember ever being so excited about a new piece of policy! Any super industry professional who is begrudging this change should self-reflect and consider a career change. Compared to other changes of the last decade or two, this one will have the greatest positive impact on the retirement outcomes of average Australians. The Wallis Inquiry (also a financial system inquiry) focused on regulation, competition and disclosure, and the outcome was arguably a collection of disclosure documents and a multitude of products that the average Australian doesn’t understand, especially given our low national levels of financial literacy (see Do clients understand what advisers are saying?). The Cooper (Super System) Review created MySuper products which generated some efficiency gains but also, in my view, sowed the seeds of an unhelpful focus on fees to the possible detriment of net returns to members.

While much of the emphasis has been on efficiency during accumulation, the post-retirement solution has been left unaddressed. Here it is important to acknowledge history: Cooper’s vision for MySuper was as a whole-of-life product: “MySuper products must include one type of income stream product, either through the fund or in conjunction with another provider, so that members can remain in the fund and regard MySuper as a whole of life product”. However this was not supported by the Labor Government at the time, potentially because MySuper already represented significant change. Murray’s vision for CIPR is broader than Cooper’s. It is a clean sheet of paper to research, innovate and create a default retirement solution for default members. At a minimum it focuses the industry on retirement outcomes in the presence of investment risk and uncertain lifetimes, and super funds will now be required to consider mortality outcomes.

The design of future retirement solutions

Currently the industry relies predominantly on account-based pensions and an age pension system which guarantees a level of income close to ASFA’s definition of Modest Retirement Outcome. Who knows what future retirement solutions will look like? While not writing off the account-based pension, we may see greater use of both life products and mortality-pooling solutions. A post-retirement solution could incorporate basic financial advice. The best CIPRs will include multiple components blended together.

I have concerns that the concept of CIPR and even Murray’s proposed (and endorsed by Government) objective of superannuation (“To provide income in retirement to substitute or supplement the Age Pension”) are not fully formed. Perhaps it has been deliberately left this way as a concept which is then thrown to the industry and regulators to work through and devise the best solution.

It is the process which will drive numerous beneficial outcomes. I believe that at the heart it needs a retirement outcome engine (see ‘Outcome engines’ should be the heart of your business). This could be mandated and reviewed by APRA: for instance, it could be a requirement that every super fund must have an internal engine capable of modelling the distribution of retirement outcomes of their default members. The development of such an engine will ensure appropriately designed products, form the basis for trustee education, and could be used as the framework for member education and engagement.

Implications across the finance industry

The implementation of CIPR will have many flow-on effects across the industry. Those who think this is an issue solely for institutional super funds risk missing opportunities and facing threats. Consider the following possibilities:

  • Actuaries will be in much greater demand across the industry, particularly within super funds. It is surprising how few actuaries are employed by super funds. We could now be entering ‘the age of the actuary’ as their skills in risk, mortality and modelling become more highly valued.

  • Fund managers have the opportunity to design products and services that assist super funds implement successful CIPRs. Meanwhile some of their products and services may prove less relevant in a CIPR environment.

  • Annuity products are likely to be more actively assessed and used by super funds as a component of their CIPR. Is the current market structure of the annuity industry in Australia in appropriate shape to support the potential demand? Effectively we have one dominant player, Challenger Life, and a couple of other large groups playing a small part. Is this deep enough to ensure price competition and the opportunity to diversify exposure? Perhaps we will see other new entrants or super funds negotiating solutions directly with offshore life companies.

  • Asset consultants could play a pivotal role or could lose out, depending on how they have shaped their business. Some asset consultants, those with an actuarial practice (especially if the practice has a strong interaction with the investment practice) are well-placed to perform an integral role in assisting super funds to design their CIPRs. Those whose retirement practices are embryonic and based on simple solutions which do not account for mortality risk are at risk of losing business.

  • Financial advice may be more heavily scrutinised. Most financial planning software fails to consider the range of mortality outcomes; financial plans are developed for a certain age (albeit some buffer can be built in). It would feel like a strange system if default funds have the systems and explicitly manage for mortality risk while financial planners do not.

Exciting change is upon us! Grasp the opportunity to develop better retirement outcomes for the average Australian. It is the biggest change the industry has experienced, and if we do it well, we will improve one of the best pension systems in the world.

 

David Bell is Chief Investment Officer at superannuation fund, Mine Wealth + Wellbeing. He is also working towards a PhD at University of NSW.

 

13 Comments
Ross Johnstone
November 04, 2015

All CIPRs (Challenger included) depend on the ability of the vendor, at some future unknowable time, to pay money. This will largely depend on the capabilities of the vendor and its actuary either or both of which could prove inadequate and both of which must make assumptions about distant future conditions. At best the vendor or perhaps the guarantor must be a government which could use the up front payment for infrastructure.

Boyd
October 30, 2015

David,

Are you talking, to some degree, about the long-awaited introduction of deferred annuities? If so, what type of premium/price do you think would be payable for a deferred annuity starting at age 65 and payable at say, 85 years of age if a person wanted a $20,000 pa income? If I remember correctly, the Cooper Report suggested a $20,000 once-off premium payable at age 65 would provide a $20,000 pa income at 85. Is this figure still an reasonable approximation?

Matt
October 30, 2015

Nothing to get excited about here. In 2018 (or 2017 at the current rate) Prime Minister Morrison will announce a "root and branch"review of the retirement incomes system to be headed by some industry luminary (I'm tipping it will be someone like Cameron Cline or Ahmed Fahour), and the whole process will start over. Sure there will be some private sector innovation at the margins, but CIPRS and retirement income products in general are in the too hard basket for Australian politicians. That's unlikely to change.

David Bell
November 01, 2015

Matt,

Usually I put comments like these in the negative / cynical bucket and let them slide. However the crux of this article is that this is good change and it is something all in the industry should be positive about. I think it is important to make a case for being positive about change and CIPR's. I make a few points.

First, a CIPR, well designed and implemented, will deliver a better expected retirement outcome than a generic account-based pension. This is great for the millions of Australian's in default funds.

Secondly the superannuation industry is still immature and there are areas that need to be improved. This is a problem with DC systems the world over. One gaping hole is post-retirement. The recommendation of a CIPR will improve our system.

Finally, I guess we could all claim regulatory review fatigue and down tools. However why do that when the recommendation of a CIPR actually improves retirement outcomes? Given the ten's of billions of dollars spent annually on the age pension and super tax subsidies, and given the social importance of a good pension system I can understand why there have been a number of reviews. It would not surprise me at all to see another review announced in three years time. However I wouldn't expect a reversal of CIPR. It is a logical and good idea on which Murray built on Cooper's original recommendations (so there has been consistency).

I guess the choice is whether to be positive or not about the challenge, work and opportunities posed by CIPR's. I am very positive.

Regards, David

Anthony
November 01, 2015

Matt, I respectfully disagree. We can no longer afford to dismiss retirement income products as being "too hard".

What makes this Government support of CIPRs so exciting (and definitely not something that will be a throw-away policy) is the fact that these products will consider not only market risk (the current accumulation paradigm) but also longevity risk. Existing research (both local and international) would tell you quite clearly that this is the best approach for retirees.

I also think that David's idea of compulsory retirement outcome generators is a brilliant one which will assist with the financial literacy problem that we have at the moment. This will, in turn, make the retirement income problem "not so hard".

David Bell
October 30, 2015

Chris,

I can't speak for the retail funds because Mine Wealth + Wellbeing is a profit-for-member business model.

I choose the positive view on this situation: nearly all super funds don't consider mortality risk in their post-retirement solution and soon they will. Longevity risk is one of the largest risks to individuals in retirement; now it will be better managed. Retirees in default funds should have a more secure retirement outcome.

Perhaps if we see super funds of any kind mis-use the intention of CIPR to profit then they should be called out. Of course we have APRA regulating the industry and there are research ratings groups who assess the funds.

Overall I am positive.

David

Chris Shelling
October 29, 2015

You're drooling over CIPRs because retail super funds will make a mozza off them. Not because they are in the best interests of superannuants.

Bruce
October 29, 2015

For what will for many years be small balances in Default funds at retirement, I cannot see why there is a priority now on CIPRS - a nebulous concept that has the risk of offering ATAP (all thinks to all people) but a contract which offers indecernable difference to an allocated pension when calibrated against the investment risk outcome of both options.

Lifetime annuities bought voluntarily, need careful consideration of family circumstance before money is locked up. The members life annuity amount from a default fund might be trivial in the context of offsetting age pension but on later death an uninformed surviving spouse may have found the cash alternative very important in a non-home owning low assets existence. Cash guarantees on life annuities in old age remove the redistribute purpose of life annuities.

Lifetime annuities in super should be the preserve of very significant balances where they can have a meaningful impact on offsetting age pension cost and giving security of total income in retirement. If made compulsory for say 30% of all super (not just Default) above say $50,000, the community rating of CPI indexed nonprofit life annuities would be a valuable completion of Australia's retirement income objectives for super and would offer clearly superior projected outcome to any other approaches to secure real retirement income..

David Bell
October 30, 2015

Bruce,

You make some interesting comments on small balance members but I think that CIPR is much more than simply transferring members compulsorily into a lifetime annuity at retirement. If that is what the regulations end up requiring then that would be disappointing. But surely a trustee would be obligated to consider many facets of a retirement product design including bequests and accessibility. It would also make sense to consider what role the age pension plays in the outcomes of members with different balances. The range of considerations is so broad it could be daunting, but that is what in my view makes this such an exciting challenge.

David

Dave
October 29, 2015

Hmmm...aren't these CIPR things just annuities under a different name? And who gets to wear all the risks?

David Bell
October 30, 2015

I view that comment as a little uninformed. Yes there have already been announcements that some funds will go down the life annuity path for their CIPR. But there are other solutions and the best solutions may be a combination of products. For example there is an interesting product out there that pools members to hedge the bulk of an individual's mortality risk but does not provide a guarantee and so potentially offers a higher return.

David

Alex
October 29, 2015

Why would super funds have to be told by government to offer decent retirement income products? I must be missing the whole point of super?

David Bell
October 30, 2015

Unfortunately super is a big complex industry which in my view isn't as mature as you might expect. Much of the attention has been placed on the accumulation stage and not the post-retirement stage, partly because balances were not that large at the point of retirement. Now they are becoming more sizable and the regulatory reviews and the government have prompted the industry to have a better look at their post-retirement solutions. It's not like there weren't funds trying to innovate but now you will see far greater innovation.

The key difference is that super funds will now be mandated to account for mortality risk in the design of their CIPR. This is an area that nearly all super funds have ignored - the focus has largely been on account-based structures hence investment risk. I predict this will prompt a lot of innovation across many parts of the industry.

David

 

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