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Superannuation needs greater outcomes focus

As the super industry shifts from a focus on accumulation to the full savings lifecycle, with an emphasis on retirement income, the measures the industry needs to gauge progress must change too.

The newly minted government-defined objective of super points the way. The objective of super is, “to provide income in retirement to substitute or supplement the age pension.”

This objective aligns with the views in an excellent paper, Governance: The Sine Qua Non of Retirement Security, by Michael Drew and Adam Walk, which argues that the fiduciary focus of defined contribution retirement plans has to be on outcomes of the process, not just on inputs. They argue the industry has been overly focused on fund returns as the key measure and not enough on the retirement incomes likely to be earned by members. Following Nobel Prize winner Robert Merton, they claim "retirement income is the true measure".

Put it in terms we each can relate to as participants in the super industry: do we care about what time-weighted rate of return the fund earns (or peer-relative performance) or instead the stream of retirement income we can draw down during retirement?

Now, most individuals don’t currently have access to forecasts of what their super savings will likely amount to as income streams during their retirement. And neither do trustees of most superannuation funds have good analysis of the likely retirement outcomes of their members.

What are outcomes-based objectives?

That’s got to change, even with the government’s minimalist definition of super’s objective. Individuals and funds need to get a handle on the likely income streams in retirement. For those with greater ambitions, like having a ‘satisfactory’ or ‘comfortable’ income in retirement, the need to switch to outcomes-based objectives is even more obvious.

What are the right measures for a fund that seeks to help its members get strong incomes in retirement? In my view, funds should be forecasting expected retirement incomes for all members, in effect establishing a baseline set of expectations for its membership. Funds should then set a course which seeks to improve on that baseline and then measure progress.

Expected retirement incomes could be measured absolutely or against relative indicators such as standard of living measures, like the ASFA Standards, or against replacement ratios (the percentage of pre-retirement income earned during retirement). What percentage of our members are expected to meet the ASFA ‘modest’ or ‘comfortable’ income during retirement? Or what is the distribution of retirement income forecasts versus current income levels? (for example, how many of our members will make a replacement ratio of 70% of pre-retirement income?) What percentage of our members will be on the full and part age pension?

Of course, retirement income forecasts are not certain predictions. We live in a stochastic world of unknown outcomes. So it’s important that we think in terms of a range of outcomes and the risk to our members of not achieving adequate retirement income levels. We need to think in retirement income security terms, not only in portfolio risk terms, then members can trade off appropriate portfolio risk and retirement risk decisions.

Some trustees may think it’s too difficult or uncertain to forecast the future for each member, but well-established techniques are available.

Outcomes-based measures change management

Instead of focusing on what the fund does – manage portfolios, administer accounts – executives will drive greater focus on what the member does which impacts their retirement outcomes. The trustee will think more about encouraging beneficial member behaviour to drive better outcomes.

For example, is it most important to offer a single strong MySuper default or better to encourage members to be in an investment option that suits their own needs to produce a target retirement income? Technology exists to give members personalised defaults.

Also, is it better to offer members more expensive actively-managed options or to invest more in passive funds and use the fee savings for delivering individualised guidance to the members on establishing and achieving their retirement income goals? Is there more pay-off or ‘alpha’ in good advice than in active equity management?

And will a focus on retirement outcomes drive a frank conversation about what members need to save to get a satisfactory retirement income? The way the industry tiptoes around the issue, it’s like we’re afraid to tell anyone that the guarantee charge’s 9.5% (6.65% to 8.06% after tax) contribution rate is just not enough.

Moving to outcomes-based measures of success will not only drive alignment with government objectives but ensure that we’re focused on what really matters to fund members.

 

Jeremy Duffield is Co-Founder of SuperEd. He was the Managing Director and Founder of Vanguard Investments Australia and he retired as Chairman in 2010.

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