A New Era for Super

The federal government’s recent deal on reforming superannuation tax concessions may have taken some political heat out of the issue, but the challenge of building a more sustainable retirement income system looms larger than ever, writes Patricia Pascuzzo.

As the baby boomers begin retiring in droves and the government seeks to define super’s objective as providing income in retirement to substitute or supplement the age pension, the focus is rapidly shifting to the retirement phase.

Treasury is readying its position on the post-retirement regulatory framework, including the design of new “Comprehensive Income Products for Retirement” (CIPRs) proposed by the Murray financial systems inquiry.

Providing an important opportunity to directly influence the government’s thinking is next week’s Committee for Sustainable Retirement Incomes leadership forum, which brings together Murray and Financial Services Minister Kelly O’Dwyer, alongside policy, industry and community leaders.

 Since compulsory super was extended in 1992, the system has been designed around accumulation and savings. Now, the demographic bulge and the challenge of managing longevity risk demand a new focus on post-retirement.

These looming changes are likely to have just as profound an impact on the retirement market as did the regulatory arrangements introduced by then Treasurer John Dawkins in 1992. Back then, few foresaw the growth of a $3 trillion industry.

More importantly, the changes have the potential to influence living standards in retirement, a significant issue for government given the aging population.

Managing the Risks

Managing super is difficult for most people given the vagaries of financial markets and low levels of financial literacy. However, the risks intensify the closer the member is to retirement. Australia already has plenty of evidence to show retirees are having trouble managing their retirement income.

This is not surprising given the range of risks to be managed – market risk, inflation, and longevity risk. There is evidence that pensioners are living frugally for fear of  outliving their savings. At the same time, about 20 per cent of retirees are drawing on their super at an unsustainable rate.

Against that background, one of the issues is the absence of financial products to help retirees manage the risk of outliving their savings.

The absence of such products in Australia is to some extent stifled by overly prescriptive regulation, a factor that the government is seeking to remedy in its super bill.  However, a more pernicious issue is that the system has been designed for the accumulation of assets and therefore has a bias towards maximizing returns rather than providing secure income.

 More Advisers Needed

Even though people can benefit from seeking advice at retirement, figures show less than 20 per cent of those who want financial advice actually receive it. The need for advice is growing and will grow stronger as more people enter retirement.

One of the major hurdles is that Australia does not have enough trained financial planners. The industry has yet to work out how to ensure everyone has proper and sound financial advice ahead of retirement.

Given the difficulties that members face, the system gives superannuation fund trustees an important role in protecting the interests of their members. Where members are unable to make an investment choice, the trustee provides them with a default option that members rarely opt out of.

However, while defaults have been shown to be useful in guiding decision-making during the accumulation phase, they are less suitable in retirement because of the heterogeniety of member needs.

The government has accepted the Murray inquiry recommendation that trustees be required to preselect an income product in retirement. It now faces the challenge of implementing it.

CIPR Design

A key question is the degree of customisation in CIPRs. The more options, the more information trustees will need about members and the more onerous the process for determining whether the product matches each member’s needs.

This also effectively means trustees are providing retirees with financial advice, with all the compliance costs that that entails. Reduced customisation, however, may increase the chance that people are put into products poorly suited to their needs.

Another major issue surrounds the minimum requirements for the provision of CIPRs. While it is generally agreed that the income products should include some form of longevity risk pooling, policy makers need to consider what constitutes longevity risk protection and how much this protection retirees need.

A related issue is how to ensure that CIPR designs are driven by member needs and that any enhancements provide true value to the member rather than opportunities for the industry to build in additional cost.

With about 700 people reaching retirement age every day in Australia, more public discussion is needed on how to guide them to secure retirement incomes that address the risks of inflation, longevity and market variability.

The CSRI has initiated a collaborative policy development process involving industry, academia and consumer groups, to help guide policy and shape the market.

 Patricia Pascuzzo is the Managing Director and Founder of the Committee for Sustainable Retirement Incomes. These issues will be considered at the CSRI’s Leadership Forum on 12-13 October in Canberra. A version of this article appeared originally in the AFR.