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Searching for the post retirement silver bullet

I confess to being a non-believer in silver bullets in the context of post retirement products. The silver bullet is probably not a product, but good financial advice. However, I also admit that my view on the product silver bullet has changed over the last two years, and I am now more of a believer than I was.

What does our post retirement look like?

Contrary to some commentary this year, our post retirement system is in reasonable shape. According to Rice Warner, 85% of client assets are invested in income streams. Those taking lump sums generally have small balances and appear to be doing sensible things with them, like paying off debt. We have a reasonable array of post retirement products in the retail market (account based pensions, annuities, variable annuities) and the recent Melbourne Mercer Global Pension Index 2014 ranked Australia second in the world.

However, there’s a bit that’s not great. There are mounting longevity challenges. Mercer’s data shows there’s a 35% chance that a white collar fund member retiring now will live to 91 if they are a man and 93 if they are a woman.

With 93% of retail money in account based pensions, it’s clear that most members have little longevity protection (apart from the age pension). Our exposure to annuities is significantly lower than many other major countries, some of which have more than 50% of their retirement assets in annuities.

Burnt by the GFC, many investors remain risk averse with lower exposure to growth assets, with comments like this being the norm: “More than anything, I want to ensure that my husband and I have financial security and safety for our money … nothing too risky.” This thinking is showing through in spades in both quantitative and qualitative research at Colonial First State.

Even though our system ranked well in the Mercer study, the Global Age Watch Index 2014 ranked Australia behind France, Canada, UK and the US for income security. This measure took into account pension coverage, levels of poverty in retirement (defined as half average earnings) and income replacement for the population over age 65.

It’s not surprising that the Financial System Inquiry Interim Report commented, “the retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees”.

For a while, many believed variable annuities were the silver bullet. In some ways they can seem to offer the upside of equity markets with the downside protection of a lifetime annuity. With around $2 trillion of assets invested in them, they have certainly been popular in the US. However, their success has come under a cloud since the GFC, with a number of providers exiting the market due to problems with hedging their exposures. In addition, it is apparent that the factors that have driven their growth in the US are not translatable to the Australian market. Commissions of around 7% are reportedly common and there are tax advantages that are specific to the US. With about $2.6 billion invested in variable annuities in Australia, there has been some interest, but it’s clear they are probably not the silver bullet.

Global changes provide pointers

Three global changes might provide an idea about the worldwide view on the silver bullet.

In 2012, the OECD Working Party on Private Pensions developed a series of 10 recommendations for the “good design of defined contribution pension plans”. The seventh recommendation was “for the payout phase, encourage annuitisation as a protection against longevity risk … A combination of programmed withdrawals with a deferred life annuity (e.g. starting payments at the age of 85) that offers protection against inflation could be seen as an appropriate default”.

In addition, the US Government recently made changes to allow 401(k) savings to be invested in deferred annuities, whereas the UK Government removed the compulsory annuitisation. And there are changes happening locally. The Government is looking at deferred annuities, with Treasury having released a detailed discussion paper.

There are also changes in sentiment by financial advisers. Inflows into lifetime annuities increased  35% last year according to Plan for Life, and Zenith recently created a model portfolio for retirement which includes an allocation to annuities. Furthermore, a recent Investment Trends survey showed that 37% of advisers said they would like to use some sort of annuity in the following 12 months (Investment Trends Retirement Income Report 2013).

Using scenario modelling

Our approach to trying to find the silver bullet was to commission Ernst & Young to do some scenario modelling. Their quest was to find what product combination delivered the best outcomes for customers in retirement. They built a stochastic model of the different products that are available in the market – lifetime annuities, deferred annuities, term annuities, variable annuities and account based pensions. There were two key conclusions.

Firstly, the variable annuities didn’t model well, mainly because of the high fees and the lack of flexibility in the product design.

Secondly, the ‘hybrid’ options, where an annuity (lifetime or deferred lifetime) is combined with an account based pension often delivered superior outcomes for members.

Much as I would like to think our modelling delivered unique insights, similar conclusions have been derived elsewhere.

In particular, there is academic work showing that a small allocation to an annuity (say 10-20%) can deliver better outcomes for customers. Indeed, David Bell wrote an article in Cuffelinks entitled ‘Why academics like lifetime annuities’ where he commented, “financial models suggest life annuities are beneficial to rational decision-making individuals, yet in Australia the number of life policies purchased remains small.” There is also work by Mercer on behalf of Challenger which has similar findings. Given the OECD roadmap and the US changes, it appears they might have also reached similar conclusions.

Closer to the silver bullet?

It would have been great if I could say that I have discovered a new, sexy, amazing, innovative, silver bullet. Instead, I’m afraid the answer is rather dull.  ‘Partial annuitisation’ with a modest allocation might be as close as we can come to the product silver bullet.

If combining an annuity and an account based pension is the answer, we need to make it easy for advisers to construct, report on and maintain such portfolios on behalf of their clients.


Nicolette Rubinsztein is General Manager, Retirement and Advocacy, Colonial First State. She has been on the Board of The Association of Superannuation Funds of Australia (ASFA) since 2007 and chairs ASFA’s Super Systems Design Policy Council. 

SMSF Trustee
October 28, 2014

Limiting super to 50% growth assets - perish the thought.

I want to make that decision, whether that's the right amount for me, not have some bureaucrat artificially dictate that I'm a conservative investor.

Forcing me to hold a properly diversified portfolio, that's what they should be doing. That would avoid the horror stories. Watching your portfolio fall and rise with the market is not a problem - no matter what Challenger's ads might say. Watching it go down the toilet because you've got it all invested in only a few assets that actually go broke so there's no hope of rebound over time, now that is the true horror story.

Stuart Barton
February 20, 2015

You're right. Watching your portfolio fall and rise with the market is not a problem - if you don't need to consume any of your capital to provide additional retirement income to your investment earnings, and can live with variable income with just the occasional need to tighten your belt.

For the non-affluent, the mathematics of portfolios in decumulation mean that market volatility is absolutely critical to their ability to meet their objectives. A share market that falls 10% requires a 20% recovery to regain its losses, and even more if you've reduced your capital base with an income drawing. It's like reverse dollar cost average during accumulation.

If you need to sell down shares at cyclical low points due to minimum drawdown rules, or simply to meet your normal income requirements, you will prematurely deplete your super if you are subject to an unfortunate sequence of returns.

By the same token, you might exceed your plan forecast if you are lucky enough to receive a favourable sequence, with positive returns for the first years of retirement and any negative returns only coming later when your balance is much lower.

Sounds like you're fortunate to not have to worry too much about market volatility, but most people aren't so lucky, especially if they've also planned on the assumption of "average" returns in volatile asset classes. This is a common approach but one which fails to acknowledge sequencing risk and can make retirement outcomes a lottery in which there inevitably winners and losers.

Stuart Barton
Challenger Limited

October 27, 2014

I think the conversations we are having at the moment would be very different had the government legislated that, perhaps no more than say 50% of a superannuation member's account balance can be invested in equities/LPTs. This would have avoided many horror stories.

With investment choice, can individuals be trusted to get the asset allocation right and avoid the bubbles? There is a lot riding on this philosophy.

Dennis Barton
October 27, 2014

There is an alternative. Read SIS Section 10 carefully.

October 26, 2014

The problem of silver bullet derives from the almost evangelistic fervour exhibited in exhorting people to save for retirement, ignoring current pressures:
* the legal rort of salary sacrifice pretending, with ATO as an accessory, that somehow otherwise taxable income is pre-tax if spent on super and cars;
* the short-lived Costello-time increase of contribution limit to dizzy $1 million;
* the pernicious pleasure of saving on tax regardless of the ultimate outcome, disengagement,
* propensity to have the cake and eat it too (want equity exposure but not the inevitable volatility: like getting on a roller coaster for a smooth ride)
* and, as pointed out, longevity.

Conflicts of interest and duty rife in retail and industry sectors have by no means been addressed yet. The only retirement security seems to apply to those who have a career in super making believe there is still hope.

Compulsion and preservation, combined with this sprawling industry of rent-seekers, seem a necessary condition for security. But by no means sufficient.

To move towards a solution we should
* encompass non-super assets (family home subject to a state-administered statutory reverse mortgage scheme, so before absent inheritors collect on the will, the taxpayer can have priority rights),
* bring the family back into caring for retired parents (symmetric with the current legal obligation not to abandon children on pain of wages being suborned),
* limit inheritance of super under the sole purpose test (by clawing back tax concessions if anyone other than the member or spouse claims the residual balances on death, a sort of reverse anti-detriment clause, calling it 'potential inheritance detriment'?).

To this we should add some hard work on managing material expectations down. Figuratively speaking, unite Adam Smith and Confucius in holy (retirement) matrimony, proving Rudyard Kipling wrong: the east can and should meet the west....

Virginia Lloyd
October 24, 2014

It’s fantastic to see this edition – shows real leadership. And lots of great articles!

October 24, 2014

Bravo for the all women line-up! A pleasant surprise, that makes even me ponder that yes, most financial advice does come from men (due to men being in higher, more influential positions etc etc, how about that), but that women work in finance, and have their own money too.

"Not trying to make a feminist statement" though?? Don't be afraid to!! Or afraid of offending your (male) readers. I do see it as a feminist statement, at least of awareness raising, and I appreciate it.

October 24, 2014


A very refreshing and concise summary.

Women are at the forefront of this issue - on average they live the longest and many spend most of their retirement leaving men and government to handle their money management (in whose interest?). For many women who face retirement from a background of divorce, part time work, family elder care and fragmented finances, their silver bullet should be an age pension from age 60 at least. If they were lucky enough to have been advised by their mum to go into the public service when they finished high school they would no financial worries with a lifetime indexed pension from 60.

As for the more fortunate with reasonably adequate retirement savings but unpredictable longevity, your final summation is "on the money" but will not work unless a minimum component in deferred indexed lifetime annuity is compulsory and government protected for tax concessional savings. We could leave it to everyone to choose which side of the road to drive on - we accept compulsory left side driving - seat belts and brethalysers are now accepted. Preservation is now generally accepted and is the main reason we have a huge savings industry measured in trillions - what's the problem with the last simple missing piece? It's also environmentally friendly because a deferred indexed lifetime annuity is the most equitable and simple way to recycle concessional retirement assets to the needy.


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