Hatching a plan for better post-retirement outcomes
Good morning, and thank you for inviting me to address you today.
When you’ve spent as much time around superannuation as I have, you get to see a lot of images of eggs. Usually in nests. Often painted gold. Frequently laying on a bed of $100 notes. Yet for all the ubiquity of the “nest egg” as a symbol of planning for a comfortable retirement, I can’t recall ever seeing an image of the egg hatching.
This is indicative of the relative imbalance in focus in Australia to date between pre- and post-retirement planning. Over the past 30 years, the superannuation industry has grown into a financial behemoth, with 156 APRA-regulated funds at 30 June 21, comprising thousands of products and options, managing assets worth in excess of $3.3 trillion.
But the post-retirement phase remains very much a fledgling. Australians might be transitioning into retirement in ever-growing numbers and with increasingly higher balances, but the availability of a wide range of quality products to help them manage and ultimately use their savings, potentially over decades, has failed to keep pace.
The development of the Government’s retirement income covenant demonstrates growing recognition that trustees must focus on the retirement income needs of members and build the capacity and capability to service those needs. In turn the wealth management market in Australia needs to provide a wider range of high-quality options to help older Australians manage their life savings throughout the retirement phase.
Evidence shows that the majority of Australians do not adequately plan for their retirement or make the most of their assets in retirement. As was noted in the Retirement Income Review, many people die with the bulk of their life savings intact.1 Rather than a sign of generosity to the next generation, this is widely accepted as evidence that retirees often lack the necessary guidance or options to help them effectively manage their nest egg, and so often are more frugal than needed in their retirement spending for fear of running out.
This is not great for retirees, who may be unnecessarily compromising their quality of life. And it’s not great for the Australian community, because it means that our otherwise high-quality retirement system is not delivering to its full potential. There are many potential providers that can help address this gap in the market – but it needs superannuation entities, life insurers, investment managers and other players to work together. This is a space that is ripe for good innovation, by those organisations with the acumen – and possibly courage – to grasp the opportunity.
As with any opportunity, this one is not risk-free. In seeking to meet rising demand for retirement income products, it is critical that the challenge to innovate is undertaken in a thoughtful and considered way. It must avoid creating the legacy issues we have seen in the past, particularly in the life insurance industry, such as poor product design or unsustainable pricing and hence ultimately poor outcomes for consumers. We do not want retirement income products to head down the same path as we have seen in relation to individual disability income insurance products, for example, where the product design, terms and conditions and pricing have proved unsustainable, and caused significant losses for insurers that the industry has not been able to adequately address on its own. Nor do we want to see the proliferation of high cost, poorly performing products that we have seen in the choice sector of the superannuation industry, where consumers are bamboozled by having too many (often not very different) products to choose between.
Perhaps the biggest challenge, however, is changing Australia’s mindset when it comes to retirement savings – from one where outcomes are judged solely by the size of an account at retirement to one that equally values helping retirees manage that money for the rest of their lives. Perhaps put another way, in retirement, income is the outcome.
Delivering a speech to the Financial Services Council a few weeks ago, my APRA colleague Margaret Cole observed that super members in the accumulation phase were “spoilt by choice” due to the bewildering range of products and investment options available. Once members transition to retirement, however, they face the opposite problem; an under-developed market where only a relatively small number of companies offer a limited number of options.
This contributes to the majority of super members transitioning to the retirement phase choosing to take a lump sum, rather than investing their money in some form of retirement income product that will give them an ongoing income. The most popular option among retirees who invest their money in a retirement product is a simple account-based pension. This option gives them maximum control of their money, but also total responsibility for ensuring it lasts the distance while also continuing to bear the investment risk. The market for annuities – which can help to address the risk of retirees outliving their savings – remains small. Net premium revenue is sitting around $4.9 billion annually and steady, and overwhelmingly dominated by one company that has about 90 per cent of the market. And there are few other retirement products available to choose from – although we are starting to see some green shoots of innovation.
The lack of attention given to the post-retirement phase by both consumers and industry is largely a product of history and the evolving maturity of the industry. Given the relative youth of the compulsory superannuation system, it is only a recent phenomenon where more Australians are retiring with sufficiently large balances to justify the purchase of annuity or other retirement income products. In 1997, for example, five years after compulsory superannuation was introduced, the average super account balance was around $15,000. In 2020, the average account balance has grown to around $85,000 and many retiring members have much larger balances.
It’s worth reflecting at this point on whether the retirement product gap is really a problem that needs solving. Some may argue that, having worked all their lives and built up a nest egg, retirees should be free to access their money and use it however they see fit, whether it be paying off the mortgage, buying a caravan and travelling around the country or leaving it all for the grandkids. But the decisions retirees make regarding how they spend or invest their life savings have implications not only for their own well-being, but also the broader financial system and Australian economy. And at the moment, evidence suggests the status quo is delivering sub-optimal outcomes.
Starting with retirees themselves, the results of a survey published in the Retirement Income Review make interesting reading. It examines how Australians who consulted financial planners used their retirement savings compared to those who didn’t. Among those who used a financial planner, 70 per cent invested their money into a retirement income product. That figure dropped to 47 per cent among those who didn’t use a financial planner, and many kept the money in cash2. Separately, research by one superannuation fund found that members who received advice were 11 times more likely to convert their savings into an income stream3. Being better informed about one’s options clearly makes a significant difference to the decisions retirees make about how to use their retirement savings, and yet we know that most retirees could be better informed at the point of retirement.
Further, although multiple studies have shown that leaving a bequest is one of the lowest money management priorities for retirees4, many die still holding around 90 per cent of the assets they had when they retired5 – chiefly because they fear running out of money, rather than being motivated by a desire to live frugally. Not only does this excessive financial caution undermine retirees’ quality of life, it means they are not fully using their accumulated savings for the purpose it was intended: to provide income in retirement.
This segues into the question of the national financial interest. From a policy perspective, as confirmed in the Retirement Income Review, compulsory superannuation is designed to relieve pressure on budgets and vital services by helping older Australians use their own savings to supplement the Age Pension. If retirees are running out of money too soon, or reluctant to spend it at all, this has implications for other systems, such as tax, social security, aged care and housing.
Finally, the under-developed market for retirement income products is a missed opportunity for the wealth management industry; not because it poses particular risks – at least for now – but because the sector could be doing more to demonstrate its valuable contribution to solving the retirement puzzle by offering high quality financial products now and into the future. The expected market for quality retirement income products is not getting any smaller. According to the Australian Bureau of Statistics, there are currently about 4.5 million Australians over the age of 65. That’s forecast to grow to 6.7 million by 2040, and 9.3 million by 20606. At the same time, average life expectancies continue to extend, which increases the imperative to better enable older Australians to manage their financial affairs in a way that minimises or eliminates the risk of outliving their savings. For life insurers in particular, an expansion into the retirement income market represents a significant opportunity – if managed well and with some innovative thinking – to both address their ongoing profitability and sustainability issues while also providing value for, and addressing the needs of, consumers.
Chicken or the egg?
So, what comes first: strong consumer demand for innovative, high-quality, value-for-money retirement income products? Or does the availability of such products lead to increased demand?
The Government’s retirement income covenant, which is proposed to take effect from 1 July next year (subject to the passage of the Bill), attempts to resolve this “chicken and egg” riddle by requiring superannuation trustees to develop a retirement income strategy for their members. The covenant doesn’t mandate trustees to develop or even offer a retirement income product to their members – the actual provision of products can be outsourced to others in the wealth management industry. However, in pushing trustees to think more seriously about this missing piece of the retirement puzzle, we do expect the covenant will start to drive the demand for, and development of, new solutions for retiring members. In the highly competitive super landscape, the ability for a fund to offer a higher quality of member service – and generate income at the same time – could be an important point of difference for those trustees seeking an edge on their competitors.
And as noted earlier, there is an opportunity for super trustees to collaborate with other providers to develop a (simple) suite of options that could be made available to help retirees make sound choices in managing the longevity and other risks they face through retirement. There is unlikely to be a single product that meets the needs of all retirees – offering a set of well-designed options that can be combined or changed as retiree needs change over time may well be a better approach.
What retirees want
Although the covenant, if passed, won’t become law until the middle of next year, trustees don’t have to wait until then to start developing or offering innovative income products to their members. We are already starting to see movement among some leading super funds, life insurers and other providers to bring new products to market. With the value of superannuation savings transitioning from accumulation to retirement tipped to grow significantly in the years ahead, those that choose to sit this one out and leave the market to their competitors are taking a risk.
But plunging into a market that is yet to really take off in Australia also carries risks, especially as this is uncharted territory for most providers. As you would be aware, some entities have launched new retirement income products over recent years, only to be so underwhelmed by consumer demand that the projects were quickly abandoned.
From this vantage point, simply doing the same thing and hoping for a different outcome, notwithstanding the growing number of retirees and the imminent commencement of the retirement income covenant, doesn’t seem the wisest strategy. If the wealth industry wants their offerings to meet a more successful fate, they need to innovate – to somehow both design and offer retirement product options that meet retirees’ needs and persuade them that they need them.
The first step is to know your customers. The more product providers take the time to understand and engage with consumers and understand their needs, the less of a risk they face because they can be confident that their products meet real needs. It will also help to give industry a better understanding of why retirees aren’t rushing to take up some of the products already on the market, including whether or not many are even aware of, or understand, these products. But it requires making sure you have the data and information you need, and the ability to analyse and use it effectively.
Providers should also think carefully about creating products that will achieve the right objectives for consumers. Importantly, they need to strike the appropriate balance between pricing and features, whilst simultaneously managing the complexity of offerings. As I have noted, what APRA wants to avoid is a repeat of some of the legacy issues we have spent years trying to fix or eradicate, especially in life insurance. It’s not a good outcome for consumers to have either low-cost products of little value, or all-inclusive products few people can afford, let alone understand, or which are priced at unsustainable levels.
Simplicity both in the product and how you communicate its features will help to build trust and confidence in the developing market. Consumers need to be able to understand the options available and make well-founded choices. Given the low take-up levels of existing retirement income products, there is a strong case for innovative product design, but with some caution. It may be true that you need to break a few eggs to make an omelette, but remember that this is other people’s money. Safe (and ideally low cost) experimentation and innovation is the key.
One of the biggest challenges is finding a way to shift the community’s mindset around their retirement savings. One of the problems with the “nest egg” motif is that it puts a focus in the consumer’s mind on accumulating the largest possible pot of money and then sitting on it. Minimal emphasis is given to using the golden egg, and consequently retirees often struggle with the idea of using some or all of their accumulated wealth to fund their retirement. This mindset may in part explain why annuities continue to struggle to gain widespread acceptance as a retirement income solution, despite gaining popularity in overseas markets where retirement income products are more the norm. Having spent decades waiting to access their retirement lump sum, it’s perhaps understandable some retirees may feel resistant to immediately losing control of it again – even if in exchange for a safe, stable income for life.
At one level, this is a marketing and distribution challenge for the financial services sector to collectively overcome. As the gatekeepers to members’ superannuation savings, trustees are arguably in the best position to engage with members as they approach retirement age, and – at the very least – make them aware of their options, and should be considering the different ways in which this can be done effectively. Ultimately, however, all of us with a stake in seeing a stronger retirement income system, including APRA, have a role in changing a mindset that currently thinks about retirement savings almost exclusively through the lens of accumulating the largest lump sum possible – rather than helping members manage that money for the rest of their lives.
Like other stakeholders, APRA is also increasing its focus on the provision of better retirement income solutions as a key aspect of delivering quality outcomes to retirees. From our engagement with the industry on this issue, we’ve heard feedback from entities that they’re reluctant to put products on the market until they have a better sense of the direction regulators are heading. APRA is already thinking about potential changes to the regulatory framework that may be required, however it’s difficult to make informed judgements about the types of risks that would demand APRA guidance until we see what types of products are coming to market – another chicken and egg-type impasse!
APRA will instead continue to engage with the wealth management industry on these issues. We continue to make clear that APRA is thinking carefully about what might be needed in terms of guidance, but we don’t plan to issue extensive or detailed guidance on the covenant in the short-term. We want to allow time for industry thinking and approaches to develop.
That’s not to say that APRA has no immediate role. APRA is well-placed to collect and publish insights from our improved data collections to help industry better understand member needs across different stages of life. This will reduce one of the key obstacles to product design – lack of access to meaningful information. As the market evolves, APRA will be keen to support the industry through sharing examples of better practice to further assist the development of new products.
Income is the outcome
Over the next 10 years, an estimated 3.6 million Australians will move from the accumulation phase to the retirement phase of superannuation, with somewhere in the region of $750 billion in aggregate retirement savings. As life expectancies continue to extend, Australians will need to manage that money for increasingly longer periods yet, on current trends, most will not seek formal guidance or advice to help their decision making, and fewer still will invest in a product that manages longevity risk. While retirees are ultimately entitled to use their savings any way they choose, their quality of life could be compromised if their choices are not well-informed and they can’t choose from a range of good quality products.
Yet in spite of the size of the potential market, and the clear need for better retirement income solutions for retirees, there are relatively few products available, and demand for them is low.
In seeking to address this and capitalise on this opportunity, participants in the business of helping consumers with their wealth management need to understand the needs, motivations and fears of their customers, and design products accordingly. They need the boldness to innovate, but the caution not to take unnecessary risks or create unnecessary complexity in managing retirees’ nest eggs. Above all, they need to help change hearts and minds around why Australia mandates retirement savings. If the purpose is to provide an income in retirement, then a much stronger focus on delivering for retirees in the retirement phase is needed. Eggs are not meant to stay in the nest forever. And as any bird watcher could tell you, the moment an egg hatches is a beginning – not an end.
1 Retirement Income Review - Final Report | Treasury.gov.au p 19
2 Retirement Income Review - Final Report | Treasury.gov.au p 452
3 https://treasury.gov.au/sites/default/files/2021-09/c2021-188347-cbus.pdf p 3
4 Retirement Income Review - Final Report | Treasury.gov.au p 436
5 Retirement Income Covenant - Consultation paper (treasury.gov.au) p 4
6 Retirement Income Review - Final Report | Treasury.gov.au p 108