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A defining year for super requires your input

This is a defining year for the superannuation industry. This year, Australia’s retirement system could begin to step up to a higher level and deliver better retirement outcomes. This opportunity comes through the Government’s continued support for the development of post-retirement solutions which focus on income, risk management and flexibility, known as CIPR (Comprehensive Income Product for Retirement – see CIPRs are coming and that’s exciting for more background).

Treasury has just released a wide-ranging consultation paper on CIPRs. One of the more pragmatic suggestions is to use the name 'MyRetirement' rather than 'CIPR'.

This is your chance to contribute to an important development. If Australia gets it right, then we can really advance our retirement system from being accumulation-focused to one that effectively delivers good retirement incomes. If we don’t, we could end up with a clunky retirement system providing highly variable outcomes to individuals dependent on which fund they are in, a system full of legacy issues which prove extremely difficult to unwind, effectively fastening our system into a lacklustre gridlock.

If we get it right, our retirement system can be one of the best in the world, not permanently middle-of-the-field.

If you, your firm, your industry body or your research department at university have insights or views to share, then you should make a submission. Put aside any feelings of change-fatigue or submission-fatigue and rise to the occasion, as there is a lot at stake.

From my initial read these are some important areas:

1. Should MyRetirement be integrated effectively with the Age Pension?

The proposed objective of superannuation set in the Superannuation (Objective) Bill 2016 is 'to provide income in retirement to substitute or supplement the Age Pension'. In contrast much of the modelling set out in the CIPR Consultation Paper does not seem to account for the Age Pension. Perhaps this is for simplification purposes given the means testing that accompanies the Age Pension. The ‘supplement’ component of the objective suggests ignoring the Age pension will be inefficient and result in a large welfare cost. Put simply, a CIPR designed to provide a consistent income ignoring the interaction with the Age Pension would provide an inconsistent net income in practice.

2. Do people place a value on their residual account benefit?

One of the motivations of CIPR has been the observation that people deny themselves an appropriately high level of retirement income because they do not use mortality pooling products (such as life annuities) and, because they are risk averse, they spend down their savings too conservatively. There have been suggestions that retirement income levels could be 15% - 30% higher if retirement income products were better designed. This type of outcome analysis doesn’t place any value on the residual benefit at death. I understand that people do not want to outlive their savings but I challenge the view that any residual benefit has no value. This is a critical issue which requires considered debate.

There is a lot of research which identifies that people do place a value on a bequest. Further, our system is built around the individual, not the household (something which itself creates large inefficiencies hence welfare cost – a previous submission we made to Treasury suggested the objective of super should be household, not individual focused).

Consider the case of a couple household with one primary income earner. If this person were to pass away first (half the time would be a sensible initial guess) then the residual benefit would fund the retirement outcome for the surviving partner. This issue comes through clearly when we talk to our fund members. Finally the residual benefit acts as reserve funds to meet unexpected expenses such as aged care, health care and family related expenses. To put no value on the residual benefit in the design of a CIPR, in sports parlance, is a huge call.

3. How will annuity pricing work in a CIPR environment?

Annuities have historically been a direct transaction between an individual and a life company, typically facilitated by a financial planner. Historically there has existed a bias whereby people who elect to purchase annuities on average live longer than the broader population. To protect themselves against this 'self-selection' risk, life companies may apply some loadings when pricing annuity contracts.

If super funds chose to direct members into life annuities through their CIPRs, then much of this self-selection issue will disappear. Maybe annuities embedded in CIPRs could be priced cheaper than life annuities purchased directly. If this were the case then it puts financial planners in a tricky situation – should they just recommend their clients to a well-designed CIPR?

There are many interesting issues around how life companies, super funds and financial advisors would interact in a CIPR world.

4. CIPR portability - will we be left with a collection of retirees left stranded?

Treasury’s consultation paper rightfully raises discussion around CIPR portability. This is potentially a big issue as a simple example will illustrate. Consider a person, who at retirement, moves into their super fund’s CIPR (CIPR1). CIPR1 contains 50% exposure to a life annuity and 50% to an account-based pension. For some reason the retiree is not happy with their CIPR provider and would like to switch to the CIPR of another fund (CIPR2), which we assume has the same product mix, but perhaps a different annuity provider. If the life annuity cannot be exited (at a good price) then what does the retiree do? They could transfer their remaining 50% exit proceeds into CIPR2 but their effective exposure is now 75% to life annuities and 25% to an account-based pension, a mix of products that neither super fund thought best when they designed their CIPRs. There is the possibility of CIPR exiles who can’t really transfer to another CIPR.

These are just some of many issues which require careful consideration. A concern, opinion or a critique counts for next to nought if you didn’t share it at the time when submissions were requested. Written submissions are due by 28 April 2017.

 

David Bell is Chief Investment Officer at Mine Wealth + Wellbeing. He is working towards a PhD at University of New South Wales. 

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8 Comments

David Bell

February 03, 2017

Hi Douglas,

Your points on the value of personalisation are highly relevant. The key to an effective submission to Treasury will be to enumerate the opportunity cost to society (so some sort of a welfare cost measure) of a homogeneous versus a heterogenous solution.

Best, David

Douglas Bucknell

February 01, 2017

A crucial point alluded to above and pointed out in many of the Productivity Commission submissions (into MySuper Efficiency) is that members are not a homogeneous group. Heterogeneity matters. Some with a lower starting retirement balance should have CIPR influenced by the Age Pension factors and perhaps less so by bequests considerations. Others that have managed to save more, with higher starting retirement balances as cohort may rightly place greater value on bequests and flexibility.
Furthermore these cohort elements are discernible during the MySuper accumulation phase. They could and should for efficiency reasons be linked to a thru or ‘to’ automated MySuper investment option selection during the accumulation phase. In other words the Smart Defaults that have already been commented upon by the PC and others. The discussion paper touches on this on this aspect through ‘‘segment-customised CIPRs’

Dennis Barton

February 01, 2017

Note that the paper is only suggesting “MyRetirement” replace the acronym “CIPR”, but it is an improvement.

Mutual Pensions Pty Ltd (MPPL) is finalising its submission now.

An important point to be made in the submission is that the Government needs to ensure that it quickly enumerates the specific obstacles to Group Self Annuitisation that it will remove, not just make a generic removal statement, which would perpetuate the chicken and egg cycle we have endured for more than a decade.

MPPL is pleased that its general product meets the CIPR requirements and need only be tweaked to meet Trustees’ decisions on the details of their CIPR.

Dealing with the specific questions in the article……

1 Integration with Old Age Pensions Means test must stay. Careful of too much precision in projections given possibility of inflation change and legislative change again to OAP.

2 Value of Residual Yes and no. Depends on family situation and preferences. ~30% in the subject time of life groups are single. Failure to address residual will make MyRetirement a white elephant.

3 Annuity pricing Under the soft default arrangements, super funds power to “direct” will be limited. There is a lot of difference between going with the default flow when one has no money in super at career start and doing the same when the super is worth half as much as the house. Be assured, there will be self selection into MyRetirement.

4 Portability Portability out of lifetime annuities will be difficult but not impossible. Portability out of Group Self Annuitisation will be possible as long as the funds go to a similarly structured GSA.

David Bell

February 03, 2017

Thanks Dennis,

Agree that it is important to consider the range of possible outcomes a member may experience rather than just the expected outcome. This is where the main retirement outcome statistics let you down. For example a statistic like shortfall risk is ignorant to the size of the shortfall, and focuses simply on the probability of a shortfall.

GSA's are an interesting potential solution. What will be intriguing is not just the product design but the treatment of these from a means testing perspective (versus how life annuities are tested).

Cheers, David

David Bell

January 30, 2017

Hi Bruce,

Glad you are making a submission - I'm sure your insights will add value.

You make a number of good points. My concern with your comment on couples / one breadwinner is that your solution, while effective, potentially works better in an advice environment, not one where we are trying to develop mass solutions for members we know little about.

Cheers, David

Bruce Gregor

January 30, 2017

You raise a lot of good considerations with CIPR. I share a number these concerns and will be making a submission. However in my advance discussions with Treasury it appears they will not consider submissions on associated age pension issues - they advised these issues need to be separately directed to Human Services. This makes no sense.

To take your issue re "residual account balance". I would argue that if someone makes an advance commitment to a deferred lifetime annuity payable from (say age 67 - age pension age) and that deferred annuity makes no payment of residual on death, then that deferred annuity (when in payment) should not be counted under Asset Test for age pension - just Income Test. Also the most efficient way to deal with the one breadwinner issue is for the couple to asset split and have two separate deferred annuities plus extra personal assets for last survivor issues.

Bruce

David Bell

January 27, 2017

Thanks for your comment Scott and your point is well taken. Interestingly it seems like CIPR in its proposed outline will be a homogenous solution (i.e. cannot be tailored). Beyond the inefficiencies and welfare cost of such an approach, this creates real ethical challenges for product designers - as a product design (once we account for real world effects like Age Pension) will favour some members at the expense of others.

David

Scott Tully

January 27, 2017

Thanks David for highlighting some key areas to be considered in the development of MyRetirement. As you note it is important that there is strong engagement with government to ensure that the system has the best chance to be effective.

A key point you make is around the incorporation of the aged pension in the assumptions and analysis. The MySuper modelling CFS has undertaken with Mercer has highlighted how important the aged pension is in developing an accumulation strategy so will obviously be even more critical in developing retirement solutions.

The other factor often ignored in modelling is savings (or the lack of) outside the superannuation/pension system. Perhaps too hard for a 'default' system but important to an individual.


 

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