Retirement income products and the need for innovation

The retirement incomes market has experienced a degree of innovation over the last 12 months, but as Angela Faherty discovers, more change is needed.

Retirement income and the issue of longevity risk are frequently debated in the Australian life market.

The ageing population is a large and looming problem, and poses a very real threat to workforce dynamics in this country.

It also raises the question of how people will fund their retirement in the future.

While the introduction of compulsory superannuation in 1992 was brought about with the aim of ensuring people had sufficient savings in order to fund their retirement, unlike those joining the workforce today, the baby boomer generation have not been contributing to a fund their whole working life.

As a result, there are concerns that many of those approaching retirement could run out of money during their retirement years.

One of the key factors behind the concerns is due to increasing life expectancy. While a 65-year-old man retiring today can expect to live until the age of 83, if life expectancy rates continue to improve at the current rate, the average man will live to be 92 by 2050; and the average woman to 93.

This means there is a distinct possibility that many people could spend more than 30 years in retirement.

The increase in the number of years people are living in retirement coupled with the growing threat of rapidly depleting or insufficient funds means there are concerns about how people will fund retirement in the future, says Melinda Howes, chief executive officer at the Institute of Actuaries Australia.

“There are two things happening at once in the retirement market. There is the concern about longevity for individuals and how they will save enough for their retirement, and then there is the issue of how this money will be managed and that is where financial planning comes in,” she says.

Howes says while these factors have always been issues affecting the market, they have only recently come to the fore.

Previously they took a backburner as the number of people working was high enough to sustain those who drew the age pension, but as people live longer and fewer people contribute to the system, there are real challenges ahead as the number of people in retirement will eventually outweigh the number of people in employment.

Product development

In addition to the systemic challenges embedded in the retirement market, the sector has also struggled to develop new and innovative products. But that is not to say that the industry has stood still, and changes are certainly afoot.

However, product development and the implementation of change has been difficult, yet it is a problem that needs to be tackled if the life market is to address the ever-changing needs of Australia’s retirement population.

Change has occurred, albeit at a slow pace, and the introduction of new products in the form of lifetime guarantees and variable annuities has gone some way to moving the retirement incomes market forward. But people still remain hesitant.

“We are starting to see some positive signs in the market with the introduction of variable annuities and more product development,” says Richard Howes, chief executive officer at Challenger Life.

“The previous belief in allocated pensions (AP) has been shattered and low sales volumes in traditional annuities because of their apparent complexities and cost means the industry is calling out for new income streams.

“One of the major impediments to traditional lifetime annuities is the reluctance to lock money up for long periods of time; and if the annuity holder dies, the estate loses the money.

"In the annuities market, the solution will be the introduction of liquidity features and the introduction of deferred lifetime annuities,” he says.

Richard Howes says Challenger plans to roll out its Guaranteed Liquid Lifetime product early next year on the basis of responses it has received from adviser and consumer research.

The product provides a guaranteed regular income for life in exchange for an initial lump sum investment amount. While plans are also in motion for a deferred annuity product, Howes says legislative restrictions have stifled innovation in this area of the market.

“There are a number of restrictions preventing life companies from bringing out new products and that has been part of the problem.

"There are a couple of rules in the SIS act and some small issues around the tax act that are preventing these changes,” he says.

The introduction of deferred annuities, which enables the annuity holder to delay the receipt of payment until they elect to receive them, could lead to greater choice in the annuities market for consumers — but the restrictions currently imposed on life companies is preventing change from occurring rapidly.

Melinda Howes says the IAA is currently calling on the Government to implement changes in the legislative barriers that are stifling the market.

Melinda Howes says: “The definition of an annuity in the SIS regulations is 20 years old and this needs updating.

"This is the main piece of superannuation law and it does not treat annuities very favourably. There is also a need to change the tax rules and the social security and aged care rule. Many people who opt to take out an annuity now would lose their social security allowance. The market needs to move forward.”

Another problem facing the annuities sector is the product providers do not have Government long-dated bonds to match the cash flow needed to protect themselves against interest rate risks and this has added to the cost of annuities, which is one of the reasons that they have not been popular since they have been traditionally perceived as too expensive.

"Add to the mix the numerous regulatory strangleholds and the market is far more complex than it needs to be, according to Melinda Howes.

“To get an annuities product rolled out, providers need to get approval from four or five regulators which means it can take a whole year just to get approval for a new product,” she says.

“What the industry needs is a ‘one-stop shop’ where all these issues can be addressed to help speed up the process.”

Richard Howes says the sector is working towards the removal of the impediments to deferred annuities, and that this is good news as the sector has seen a significant increase in the sale of annuities so far this year.

“We are seeing Australians’ love affair with risk assets dissipate and as a result annuities are becoming more popular, and this trend can continue,” he says.

“Along with other life companies, Challenger is working towards the removal of the impediments that are prohibiting development in the sector. It is more than just a theoretical discussion at the moment and any change will lead to more choice for consumers.”

Times are changing

While the barriers for product development in the annuities sector are being stifled by red tape, innovation in the retirement income products market has still been seen, albeit at a moderate pace.

Perhaps the most touted is ING Australia’s MoneyForLife product, which following its launch in October 2009 has been hailed as one of the first products to help tackle the longevity risk by guaranteeing income for life even when the policy holder’s original investment has run out.

David Kan, general manager of retirement and investment solutions at ING Australia, says the threat of retirees exhausting super funds before they die is very real — and that the popularity of guaranteed income products in the US and Japanese markets proves they work.

“There is likely to be much more innovation in the market going forward as the demographics shift and the demand for retirement income products increases,” he says.

“Guaranteed income has always been a popular concept, but it is the lack of flexibility that lacks appeal to clients.

"Existing products such as lifetime annuities offer that guarantee but they are not flexible, that is why the market needs something new.”

Hot on the heels of ING’s MoneyForLife product, Macquarie Life launched its Lifetime Income Guarantee product in March this year.

The product is similar to an account-based pension, but if the retiree outlives their savings Macquarie will step in to provide an income stream for life.

“The inflexibility of lifetime annuities together with low returns made them very unattractive products, but we are now seeing the emergence of products that flit between the two,” says Andrew Robertson, head of longevity risk at Macquarie Life.

Robertson is keen to point out exactly what clients are paying for when taking out a guaranteed income product.

“Effectively, what people are paying for with guaranteed products is a form of longevity insurance. There is a difference between a fee and a premium and it is important people understand that.

"Fees are a one-off payment, while paying a premium means the individual is buying a contingent right to use a pool of money that will pay out if it is needed,” he says.

Robertson says the new Macquarie product is specifically targeting the self-managed super fund (SMSF) market and after a period of working with advisers on an education program, Macquarie is beginning to see volume growth.

He adds that people holding between $500,000 and $2 million in a SMSF are more exposed to long-term risk as they will draw a higher percentage of their investment as an income stream.

He says: “If someone has $50,000 in their SMSF fund then social security will always pay a significant proportion of the income they draw down.

"But if you have a million dollars and you outlive the funds, you could go from getting $60,000 a year to $20,000 a year and that is a significant difference. This is where a guaranteed income would step in.”

Tapping into the SMSF market is a good business strategy given the fact that the SMSF sector has grown substantially over the past few years.

The fundamental reason for the popularity of the products is the control they offer members, echoing the much-lauded appeal for greater flexibility in the retirement market.

Sharyn Long, chair at the Self-Managed Super Fund Professionals’ Association of Australia (SPAA), attributes the growth of the sector to the demand for greater control and improved flexibility offered by SMSF products.

She says: “The SMSF market is performing well because of a number of factors. The funds are economical to run, they offer members control and flexibility and they can bundle and unbundle options as and when they please.

"Admittedly, they are not for everyone and those with small account balances should weigh up the cost of compliance against the account balance before making any decisions. But essentially, these are the factors driving the success of the sector.”

Greater control and flexibility seem to be the key themes pervading the retirement incomes market, and it seems the sector is making tentative steps towards addressing these issues.

"However, new products are not the only injection the market is craving, says Melinda Howes — there also need to be new ideas and changes to the wider retirement incomes market legislation.

“There needs to be new legislation that will allow retirees to defer drawing their age pension entitlement until their super fund is exhausted, perhaps 10 years after they retire instead of as soon as they reach retirement age.

"The age pension would go up in value during the 10-year period and there would be more to live on when they came to claim,” she says.

Such a move, Melinda Howes says, would be a win for the Government and a win for the retiree as the solution would provide no additional costs for the Government while deferring receipt of the pension would allow a more substantial claim when drawn.

It would also allow the retiree to live off their super fund for as long as needed, knowing the age pension will be there when the funds run out.

“There is a popular misconception that people spend all their own money and are then forced to live off the age pension, but that isn’t true.

"Many retirees live a terrible lifestyle as they do not want to run out of money so spend as little as possible, only to die having not enjoyed their wealth and retirement,” she adds.

“A better way to address this would be to allow the deferment of the age pension.”

Another way to address the issue of people living for longer in retirement is to eradicate the barriers for people who wish to continue to work.

Currently there are not many incentives for those of retirement age to keep working, as the extra income they earn will go against the age pension they are allowed to draw down.

Melinda Howes says: “The IAA is suggesting that the Government remove the earned income from the age pension.

"The fact is that the workforce needs these older workers because of the dwindling workforce, plus there are health benefits which may eventually have an impact on the cost of medical care.”

It seems the retirement incomes market is facing something of a crossroads and the path it takes could determine its success. The drive for innovation pervades the sector, with many companies spearheading product innovation and calling for legislative change to help move the market forward.

Yet there are a number of obstacles preventing the sector from maximising all possible opportunities, and these must be overcome if the industry is to address the growing problem presented by the ageing population of Australia.

Longevity risk is a very real threat and with people living longer than ever before, the retirement incomes market needs to ensure it works together — and with the Government — to offer greater solutions and choice to consumers.