Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 76

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.

 

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Strategy

$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Strategy

Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.