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Rethinking the superannuation fund mission

Many Australian superannuation funds have developed a broad mission or goal. Often, this statement will include an objective of delivering strong returns to members, together with engaging and providing valuable additional services to them.

While no one would dispute these are worthwhile objectives, we contend that funds can go further. As the superannuation system in Australia matures, the fund mission can evolve to articulate a goal for the retirement standards of its members.

Specifically, we argue that:

  • trustees should take on greater responsibility for ensuring that members are aware of their potential outcomes at retirement, and – within limits – take steps to control the range of those outcomes
  • the fund mission should be defined as the delivery of reasonable retirement expectations in a reliable fashion, in such a way that member retirement plans will not need to change materially as retirement approaches, and
  • retirement expectations should be expressed in terms of the level of income in retirement, rather than the accumulated lump sum value. The planned retirement date is also a key aspect of retirement expectations.

It is pleasing to see a growing number of superannuation funds presenting projected incomes in retirement to members with their annual statements. While this suggests an increased focus on delivering income in retirement, we believe the thinking behind the fund mission we outline here has not yet become entrenched among funds. Account balance remains the primary benefit indicator for most funds, and fund objectives remain expressed in terms of a target real return and likelihood of a negative return, rather than retirement outcomes.

We have produced a comprehensive article on our proposed approach, which can be found on our website. Here is a summary of the main issues.

Challenges in defining a fund’s mission

Given a fixed level of contribution, a static investment strategy, and the wide range of individual circumstances, retirement outcomes are highly uncertain and can vary significantly across members. Factors such as division of member benefits between multiple arrangements and a shift away from the traditional ‘work, then retire’ model make measuring an ‘adequate’ income difficult. Finally, there is a range of risks – in particular, large drawdowns in markets occurring near retirement – which make planning member outcomes a challenge.

However, if the ultimate aim of superannuation savings is to deliver retirement income to members, clarity of mission is an important first step in managing the risks in the fund.

Developing a fund’s mission is complex. There is no single form of mission which will satisfy all funds, or even satisfy all stakeholders within a fund in terms of the level or certainty of outcome. However, we believe fund-specific factors may be incorporated into each fund’s mission, and that the challenges posed by the changing external environment can also be addressed.

Fund versus individual targets

If a ‘good outcome’ target is set using only a single measure of adequate income in retirement (e.g. a replacement ratio), we risk setting funds an impractical and undesirable target. When members choose to retire, they will have accepted that the retirement income generated from many sources is at least sufficient for them to stop or reduce their working week.

Every member will accept a different trade-off and have varied emotions depending on their expectations of retirement timing and anticipation of their standard of living. Here, ‘adequate’ might be defined as a neutral emotional state, neither disappointed nor surprised with the outcome.

Setting a target retirement income – and financing it – is also highly complex, requiring current and future income requirements to be compared and valued based on potential future returns. This is a self-referencing problem: lower ability to contribute or lower future expected returns imply a worse retirement outcome. As such, we believe members may redefine ‘adequate’ a number of times during their working life.

This suggests a need to recognise risk in defining the superannuation fund mission. We must discuss risk in terms of the range of outcomes to plan for, rather than the degree of certainty with which a single outcome may be achieved. We argue that material adjustments to member expectations of retirement income or date are risk events that the fund should be managing. A ‘good outcome’ would then be that a fund enables members to form reasonable expectations of retirement income and a retirement date and then deliver an outcome not materially worse.

Articulating member expectations

Investment choices are disengaging to most individuals and beyond their understanding and experience. Members don’t generally form expectations of their ultimate retirement benefit based on their investment strategy. A member’s expectations are more likely to link the amount paid in contributions (the input) with the amount they receive in benefit (the output). Together, these can be seen to form a plan which allocates to future consumption from current consumption.

Within such a plan, a level of risk and uncertainty in both the inputs and outputs is inherent. Investment strategy can then be seen in two ways: it attempts to translate the member’s plan into reality and also implies a likely range of adjustments to the plan that should be expected. These adjustments may be in terms of the inputs or outputs – to achieve a given level of benefit, members have the choice between making higher contributions with low potential volatility in their contribution level or making lower contributions with a high potential volatility. We believe communicating risk in this way provides a more engaging approach to retirement planning for members.

Journey planning

Under the mission framework proposed here, we have accepted the inevitability that a member’s plans will alter over time, but it is important to distinguish between the scale, and potentially the direction, of alteration. We define this as material alteration to the plan and treat it as a risk event for the fund.

A material alteration could be the result of one of the following:

  • the member was too optimistic (or pessimistic) in setting their retirement income expectations previously
  • events were within the expected ranges of likelihood, but the trustee took a higher (or lower) level of risk than that communicated to the members
  • events were outside the expected ranges of likelihood.

In this framework, trustees have a wider role to ensure that members understand not only the expected level of retirement income but also the reasonable revised range of possible outcomes from the fund based on the chosen investment strategy (or the default strategy if no choice is made). Through this process, a member will, over time, see how their journey is developing relative to this range, and the impact on the expected outcome. For members who are sufficiently engaged, access to the necessary tools will allow them to understand the impact of utilising the ‘levers’ available to shape their potential retirement incomes.

Engagement with the member in this way builds an understanding of the changes they can expect, making it more likely they will react appropriately to events as they occur.

Actions for trustees

Trustees seeking to develop a member-focused mission can begin with the following steps:

  • Understand your membership in more detail – this could in the first instance involve analysis of the projected retirement incomes your members are on course for.
  • Decide where along the spectrum your fund should sit in terms of designing a default investment strategy – this could range from a generic default strategy at one end, to a highly customised, member-focused strategy at the other.
  • Improve the information provided to members about their expected outcomes and the range of potential retirement incomes, with the width of this range being driven by decisions regarding the default strategy design.
  • Provide members who choose to be engaged with the tools to help them understand the impact of using the different levers at their disposal and thereby design a better journey plan.

 

Nick Callil and Jeff Chee are senior consultants at Towers Watson.

 

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