New Products Needed

Andrew PodgerAustralia should consider creating a proper lifetime income product that would allow super to cover us all for living longer and maybe should even make it mandatory, writes ANU Public Policy Professor and CSRI member Andrew Podger.

Australia’s retirement income system has great potential. By the time it matures, it will deliver accumulated savings for nearly everyone sufficient to maintain living standards through retirement and to avoid poverty. It can do so without further increases in mandated contribution rates, and at lower cost than forecast.

But it will not realise this potential until there are products available to direct accumulated savings into suitable income streams that ensure people can maintain their consumption levels with confidence, and until people take up such products.

This will require the government to give as much attention to the drawdown phase of the superannuation system as it now gives to the accumulation phase.

First, consideration needs to be given to limiting the ability to take benefits in the form of lump sums. This can leave people with insufficient funds for their later retirement years and make them over-reliant on the age pension. Evidence gathered by the financial system inquiry suggests that this is not yet a major concern, but it could become one.

Of more concern, according to the FSI, is that too many people are trying to manage longevity risk on their own.  To do this, they are holding back consumption from their accumulated savings so as not to run out of savings before they die.  The result is lower consumption (and a lower standard of living than their accumulated savings suggest they should be able to have in retirement), and much larger bequests to the next generation than they would have planned (and much more than the system was intended to provide).  Also, some still live to a very old age and run the risk of running out of savings.

A final concern is the capacity to exploit the tax concessions to accumulate wealth, including for planned transfer to the next generation rather than for genuine retirement purposes.  This can be curbed by placing limits on contributions, but care is needed not to hinder the ability of people to vary their contribution rates, as their capacity to do so varies (the system needs considerable flexibility to cater for wider variations in employment and family circumstances during the accumulation phase).

Perhaps more important is to ensure accumulated funds are indeed directed towards retirement income and consumption, removing much of the incentive for excessive savings.

All concerns point to the need for products that deliver retirement streams and provide insurance against the risk of longevity, and for policies that promote the take-up of these.  It is truly odd that the absence of lifetime annuities in Australia is so rarely commented on when they are the only form of benefit in national super schemes in other countries, and indeed in our own age pension.

The price of annuities in Australia is extraordinarily high, perhaps reflecting a number of factors: the likelihood of adverse selection as people consider family history as well as their health when considering such products; the uncertainty about average as well as individual life expectancy;  and the fiduciary requirements forcing sellers of annuities to invest very conservatively. The latter is particularly problematic right now, with record low official interest rates. All three factors suggest the need for government intervention to create a genuine market in longevity risk.

The Murray inquiry proposed requiring superannuation funds to offer their members a “comprehensive retirement income product” that would include a longevity insurance element. It hoped these would become the default retirement-benefit products that most will take up, and thereby also address in part some of the “market failures”, such as adverse selection.

I am not sure this will be sufficient, but it may be worth implementing with a view to going further should it fail to lead to widespread take-up of comprehensive income products.

For example, a mandated approach would be more likely to address the risks of adverse selection (and keep annuity prices down) and of high-income earners continuing to use the system for purposes other than genuine retirement income should Murray’s approach prove insufficient.

Complementary action may also prove necessary to address market failure such as the options identified in the Henry report, including the issue of longevity bonds and the sale of annuities by government to supplement the age pension.

Andrew Podger is ANU professor of public policy and a member of the Committee for Sustainable Retirement Incomes. This article first appeared in the Australian Financial Review on 2 June 2015.

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