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‘Outcome engines’ should be the heart of your business

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 incomeby 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.

 

7 Comments
Tortoise
June 03, 2014

I have been using the various online calculators available to effectively plan for my retirement and wealth building. As stated above, the calculators have varying assumptions so it can be difficult to line up the different answers you get as a result of your input.

I use these tools in my business to explain to clients the importance of ongoing advice; they may need to change course depending on the inputs we put in. Changing legislation like the recent retirement date changes can create a major shift in thinking.

I also use the basics such as a hand calculator or spreadsheets to supplement the online calculators. All up, each advisor needs to do more than use 1 tool to keep the garden in top shape!

Brent Bevan
June 03, 2014

You're on the money David!

I penned a small piece recently for Money Management along the same lines, basically appealing to the average planner as to how important these tools could be to quality advice and to question why they don't already have access to them?

This stuff is not rocket science (well it doesn't have to be for most applications). For any industry that has pushed to systematise the sales, advice and compliance aspects of wealth management, it makes little sense that none of the big players seem to show even a remote interest in this area? Risk profiling, modelling, systematised advice documentation and reviews, client education, compliance risk mitigation..... A well functioning process, hell even simple changes to existing frameworks could have profound affects here, for client outcomes and the professionalism of the planning industry.

Even when given the chance, certain groups preferred to spend hundreds of thousands of dollars on adding a few charts or extra questions to a traditional risk profile questionnaire, rather than investing or even modifying an off the shelf investment risk model. Those models that do exist were created to back product sales (and in my experience, the assumptions and models encompass all the flaws that proper models seek to mitigate and avoid).

For me it seems that improving or systematising the quality of retirement advice is very low on the priority list for the majority of industry players. Each to their own conclusions as to why that's the case.

Jolyon Parslow
May 31, 2014

This proposal is absolutely core to any real analysis of an individual's actual situation, and the complexity of possible future events, but could go much, much further in vision, as there is a huge opportunity far beyond a better calculator on a super fund website.

As Jeremy Cooper broaches in this same edition of Cuffelinks, the tyranny of averages has to end. Elsewhere on Cuffelinks, David Bell has discussed the psychological and human barriers to rational decision making. As someone who falls well outside the first standard deviation when it comes to many measures, I am sick of generic approaches and average solutions by average advisors, and by the Government's average based policies and retirement systems.

This proposal is something the superannuation and advisory industry should do, but won't because as the incumbents in the industry they can't or won't want to make changes or be capable of seeing the breadth of the opportunity. I recommend instead David and Peter go outside the system and attack from there with an entrepreneurial industry wide and (eventually) world wide product which vacuums up a wider market and links them to the switched on, better players in the industry.

Marc Andreessen, the very experienced US software venture capitalist wrote in the WSJ on 20/8/11 'Why Software is Eating the World', and pointed out the huge transformations in all industries being caused by software. For a more accessible and very thought provoking recent interview, see http://www.econtalk.org/archives/2014/05/marc_andreessen.html.

There are armies of bright young mathematically literate software entrepreneurs around the world right now, attacking every traditional industry from health to education and more. As Zero software is currently showing in small business world wide, against the country-based incumbents who have failed to penetrate the whole market, the opportunity lies in greatly expanding the market, being the world wide leader, and providing integrated add-on services. While tax codes and regulation vary world wide, accounting is accounting and investing is investing, and people are people. Australia desperately needs ventures which use our brains, and since we supposedly have a leading super system, why is it not producing leading software products?

As someone who is a well educated investor but has had 3 out of 3 bad experiences with planners, with very poor 'boiler plate' plans drawn up, I've opted out and gone DIY. There have to be hundreds of thousands in Australia who are under serviced, and billions around the world. It is well documented that we have a very expensive and sometimes ineffective or biased current system. That makes it ripe for disruption.

A software-based outcomes and education venture in the hands of investors could provide everything from sophisticated outcome projections to graduated education of investors, plus all sorts of add ons through API's, and links to proven products and services. By expanding the market, this need not necessarily threaten Peter Hecht as people often need human advice, and would not make the best high end financial planners obsolete. However, it would, more than any watered down government legislation, weed out the lesser planners and let the stars shine, just as Zero lets accountants deal with otherwise uneconomic shoe-box small businesses, and moves them up the value chain as they grow.

Peter Hecht
May 30, 2014

At my age I can say how ridiculous projections and statistics are. Projections are nearly always wrong and statistics hardly ever prove anything.

As investment planners or advisers we should know this. If we can interpret what is happening now and corelate this to the more likely certainties, we should be able to come up with some reasonable investment plans.

"Muddling through" means to upgrade, change. talk to clients as often as is necessary, at least every six months, to ensure that the previously recommended paths are still the right way to go and in the best interests of the clients.

A long term relationship with a good financial adviser is more likely to produce a good outcome than any computer program.

David Bell
May 31, 2014

Peter, I politely disagree. I agree that common sense, communication and experience are all important. But I believe better decisions are made and advice provided when those qualities are supported by high quality quantitative tools. This is not a one approach versus the other debate; it is about developing the best approach to improve the overall outcome.

Regards, David

Peter Vann
May 30, 2014

Bravo David!

I can concur with some of your comments about the lack of development of quality outcome engines. One can relatively “easily” implement a Monte Carlo system to include uncertainty, but they are generally quite slow and most likely impractical, particularly for reporting to a large member base or for real-time calculations, particularly optimisations.

However, when Chris and I developed Version 1 of our stochastic model, we realised that this is probably not going to be done by many institutions for various reasons. But we are simply two guys who spent a little bit of thinking time, with some scepticism, to work out a closed form calculation incorporating some of the complexities of stochastic age pensions, investment volatility, minimum withdrawals etc etc (with no long winded simulations), check and test it, and then write some production code. Maybe the combination of a qualified actuary and maths PhD helped, maybe it was our combined experience, who knows!

In any event we strongly believe that this is a necessary tool to incorporate in any retirement planning system. Without it one is running in the dark when answering many questions relating to analysis of the impact of many options in accumulation and retirement on the retirement outcome.

Looking forward to your next article. BTW, I hope you can attend my talk next week and contribute to the discussion; as you have probably already guessed, I will get to the heart of the issue in your final paragraph with respect to super funds.

Peter

David Bell
May 30, 2014

Further to Peter's comments above, if anyone would like to hear Peter speak on this and related topics (he is clearly a leading thinker in this area) there is a free lunch event next Thursday (5th) at Macquarie University's Applied Finance Centre (in the city). Details are below:

"Five Retirement Myths"
Peter Vann BSc MSc PhD

"Brown Paper Bag Lunch"
Thursday, 5 June 2014
12.30 - 1.30pm

Macquarie Applied Finance Centre
Level 3, 10 Spring Street, Sydney CBD

 

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