Is the retirement products sector prepared for an ageing population?

As Australia's population continues to age, Virginia Harrison looks at the recent developments in the retirement products sector, and asks: is enough being done to address the population explosion?

As our political leaders wage war over a big, small or sustainable Australia, there is one issue both sides can agree on. Australia is sitting on the edge of a population explosion – of the ‘100 club’.

Centenarians are now the nation’s fastest growing population segment and more people are entering retirement – and remaining there – for longer than ever before.

It’s a demographic that presents abundant opportunities for financial service providers, since the task of funding an ageing population broadens the scope and possibilities in longevity markets.

“Right now it’s the ‘back to the future’ debate. As an industry and a profession, how do you provide sustainable income and retirement planning to the baby boomers so they don’t outlive their savings?

"And what are the best products that can meet those requirements?” says Richard Klipin, chief executive officer at the Association of Financial Advisers (AFA).

The march of time

The 2010 Intergenerational Report released by Treasury indicates that between now and 2050 the number of people aged 65 to 84 years old is expected to more than double.

Those aged 85 and over will more than quadruple.

“The number of traditional working age people to support each retiree is expected to fall from five people today, to 2.7 people in 2049-50. In 1970, there were 7.5 working age people for each person aged over 65 years,” the report states.

“For those who are currently in the system and looking to retire, what these major demographic issues have raised, together with the global financial crisis (GFC), is the question: how do you build a sustainable retirement income portfolio to carry you through for the duration of your lifespan?” Klipin says.

Selling longevity

Getting clients to come to grips with living longer has traditionally been a tough sell for the financial advice industry.

“In the late 1990s it was very hard to get traction in the market for a longevity pitched product. People weren’t focused on longevity. The markets were going well, people had lots of money, the economy was booming,” says Louise Biti, director of Strategy Steps.

“People were more interested in putting their money into market-based pensions, and seeing it do well. The GFC has helped bed down the idea that things can happen, and that your money may not last forever,” Biti adds.

As a result, the trifecta of the GFC, longevity and more retirees has stimulated the next wave in financial product development and design.

Annuities: the perfect product?

A shift to conservatism has renewed appetites for guaranteed income streams and capital protection. The market has responded with significant growth in hybrid annuities, which combine an account-based pension with a guaranteed element.

“With the explosion of allocated pensions and the bull run we had through the 1990s and the [2000s] up until the great crash of 2007, the market moved away from providing long-term annuity capital guarantee type products, and moved more into the market-linked balanced environment.

"That conventional thinking is now being challenged,” Klipin says.

“What’s really clear is a strong foundation to a retirement income portfolio underpinned by an annuity or annuity type product is a key part of retirement planning,” he adds.

It’s a view shared by the World Bank, which identified annuities as the perfect product for retirees in a recent report.

“[The World Bank] says the ideal product is an inflation-indexed life annuity for a certain level of income in retirement. It doesn’t have to be for all of your savings, but for a certain level of income in retirement,’ says Michael Sherris, professor of actuarial studies at the University of New South Wales.

While the capital requirements needed to underpin a viable lifetime annuity have curbed growth of the product suite in Australia, developers have taken note of the shift in client desires and tweaked the offering.

The Association of Superannuation Funds of Australia (ASFA) CEO, Pauline Vamos, believes revamped lifetime annuities are central to a new phase in product development.

“We are seeing enormous innovation in the market. There’s ING’s MoneyForLife, Citi has also recently issued a product, Metlife is moving into this area and AXA has also launched a post-retirement product,” Vamos says.

The key change to the hybrid offerings is the dismantling of the historic provisions that saw clients’ money swallowed up in the event they failed to reach their life expectancy. Vamos says redesign has sanded the edges of a once hard-to-sell product.

“You get an income stream for life, you get access to capital if you need it, and if you die early your beneficiaries get access to at least part of your capital. That type of innovation makes annuities much more palatable and easier to understand and advise on,” she says.

Biti also welcomes the longevity-minded innovation in the marketplace. She says: “This is the first time we’ve really seen new types of products. Product innovation over the last 10 to 15 years has really been focused on ways of packaging up different asset classes into structured products or unit trusts.

"We haven’t seen much about a new product category and type for a long time, and these income streams are really the first ones doing that.”

The starting line-up

AXA, ING and Macquarie are currently the three key players in this space.

“AXA were the first to get the march on it with their North product. It just happened to be a really good time to launch a product with capital protection because we were in the middle of the GFC,” says John Goldie, co-principal of Paramount Wealth Management.

Quick to follow was ING, releasing its MoneyForLife product in October last year.

“It’s like an allocated-pension plus. It’s an account-based pension with a guarantee of income for life. It also gives you control in terms of access to your capital – either part or all of your capital at any point after you’ve invested.

"It is certainty and control, so that’s a new concept in the market,” says David Kan, ING’s general manager of retirement and investment solutions.

However, despite the introduction of a new product, the market has been slow to embrace ING’s longevity offering.

“The take-up to date has not been large. The sales rate is increasing, but we haven’t had a large amount of sales yet.

"The challenge is it’s a completely new category of product. You’re talking about guaranteeing income rather than capital. It’s a very new concept in this market,” Kan says.

Part of the barrier for clients may be the cost of the products, he adds.

“When you look at the all-in price it’s around the 3 per cent mark. Certainly there are some financial planners who say they would prefer lower fees, and a more do-it-yourself management approach. But the fees haven’t come up as the major factor,” Kan says.

Kan argues that awareness is blocking higher take-up of MoneyForLife, rather than costliness. “These products have been very successful overseas.

"If you look at the US market, the category of product is generally known as variable annuities over there, and they sold about $US1 trillion worth of them around 2000,” Kan says.

So confident is ING of MoneyForLife’s success in the local market, it plans to introduce a number of new products in the same vein.

“MoneyForLife is the first of the range of products we plan to launch that offer guaranteed income for life and other guarantees. That’s a category that’s building in prominence, and as investors and financial planners become more comfortable with the concept I see that category growing fairly significantly,” Kan says.

The sentiment is echoed by Macquarie, which launched its Lifetime Income Guarantee product in March. Andrew Robertson, Macquarie Bank’s head of longevity solutions, says it will take a while for people to understand the concept behind these products.

“This is a new concept and it will take time for people and the advice industry to get familiar with how it works. People have gotten very used to buying life insurance. This is the new style of insurance that protects you should you die early,” Robertson says.

The investment giant is optimistic hybrid annuities will succeed in Australia. “We are late to this kind of innovation,” he adds.

“When you look at markets like the US, the UK or Canada, these products have been massively successful. So you can have a high degree of confidence that this type of framework is going to become a major part of the Australian superannuation industry over the next three to five years.”

Annuity specialist Challenger is also poised to storm the longevity market with its new product, tentatively titled Liquid Lifetime.

Due for release this year, Challenger says the product will edge out comparative offerings like ING’s MoneyForLife by not charging management fees. Guaranteed returns are earmarked at between 7 and 8 per cent.

“The marketplace continues to look to products with all the bells and whistles. The only problem with that is it comes at a pretty significant cost.

"They’re trying to be an allocated pension that guarantees some of the income stream, and it’s important to understand the cost and the impact that will have on your return,” says Matthew Gaden, Challenger’s general manager of distribution.

“In response to the issue of longevity we will launch a product that will be a lifetime annuity, but will carry a form of liquidity facility in it. This is where it is different to lifetime annuities of the past. The liquidity facility in place says you could get a percentage of your capital [at any time] in the first 15 years,’ Gaden says.

Like numerous providers, legislative and regulatory constraints pushed Challenger out of the lifetime annuity market in recent years. But it is confident the time is right for its reworked offering.

“We’re finding that increasingly there is interest. At our recent roadshow about retirement incomes, more than half of [the people] wanted to hear more about this new product. I haven’t seen a response like that for years,” Gaden says.

Worth the hype?

Not everyone is convinced the hybrid offerings are the best solution for longevity. While they go some way to addressing longevity concerns, cost and complexity are the key criticisms levelled at the new income-stream products.

Fees often require significant market outperformance to generate the same kind of post-fee return that you could receive with some standard annuities.

“They are still very complex and very expensive products. People are paying for guarantees that they might never need.

"You’re effectively paying an insurance fee every year. The amount that is guaranteed is not high, and it’s not indexed so over time it’s of diminishing value, but you’re still paying high fees for it,” says Biti.

McPhail HLG Financial Planning is one organisation that has elected not to advise on these products on the basis of price and complexity.

“Some of them are difficult to explain to clients, and the cost can be 100 basis points or more expensive than the typical allocated based pensions or income streams we use,” says Anne Graham, financial planner at McPhail HLG.

Graham represents the advisers who have been too burnt by the failure of other guaranteed-style products to entertain the new offerings.

“We’ve tried other protected products in the past and they have not lived up to what they were meant to do. These products have a place and they will grow in popularity. But it is too early for me right now to be using them as part of our general planning.”

However, Macquarie rejects criticism that its Lifetime Income Guarantee product is too complex.

“In some ways this type of product makes the account-based pension much simpler.

"It allows people to know with certainty that their income will never be less than a known amount. They are also able to get out of this type of thing at whatever point they want. In essence that makes it simpler,” Robertson says.

However, Biti believes more work still needs to be done to develop hybrid annuities.

“We need a lot more innovation around how we can do the guaranteed part at the end in a different way that allows for indexation, and also allows for cheaper pricing because it is an expensive premium people are paying. Different methodologies of structuring and financing will help,” she says.

Legislative barriers

Concerns also remain around the legislative framework that governs annuities and income-stream products.

The Henry Review addressed the issue of longevity but rejected the need for a state-provided annuity to tackle the problem.

“One of the possibilities was for the government to offer an indexed-annuity product on top of the pension.

"The Henry Review didn’t support that, but it supported the Government actively making sure this market can develop – for example, by issuing longevity bonds or long-term indexed bonds that the private providers could use to actually issue products themselves and manage that risk,” Sherris says.

ASFA used the Henry Review to call for reform of the tax obligations applying to deferred annuities.

“With a deferred annuity you are, under our existing taxation arrangements, deemed to be receiving income from your deferred annuity – even though you’re not. That stops a lot of people buying these products,” says Vamos.

As a pure longevity hedge, companies like Challenger believe deferred annuities will be the easiest product to market in the future and have the power to completely change the way financial planning is conducted, should the tax burden be removed.

Additional concerns stem from the way the current regulatory regime supports innovation.

“Where the Government really has failed is in the product development space. The way the legislation has been written to determine what is a retirement income stream has been very descriptive legislation,” says Biti.

“We saw that a few years ago when they brought out the term allocated pension – everyone’s product looked exactly the same, because the product was described so specifically in legislation.

"You didn’t have the ability for people to really innovate, look at issues and come up with what might be a better way of dealing with those issues.

"We need more flexible legislation in terms of what is defined as an income stream and still meets the tax requirements to be classified as an income stream and still gets the tax concessions,” she adds.

In the UK, the government recently announced plans to relax laws relating to the compulsory deadlines for the purchase of pensions.

“If you look at what’s happening in the UK, the risk in the pension funds and annuity funds, they’re using longevity swaps and more advanced financial market contracts to manage this risk now.

"The risk management of that market is developing much more than you see in other countries.

"You can see how an annuity market can be developed, and how the risk can be managed from some of the things going on in the UK,” Sherris says.

On the product horizon

Klipin believes the market will see more innovation around income stream products. “Are there companies out there prepared to innovate in the product set around the retirement income requirement? The answer to that question is yes,” Klipin says.

Expect alternative styles of income protection to lead the next wave of product innovation for the post-retiree market.

“We may have the ability to purchase a stand-alone insurance policy just in case your money runs out. An annuity is like joining a life insurance product and an investment product.

"So just in case my money runs out, or my allocated annuity runs out, I will purchase a stand-alone insurance policy that may kick in at age 85,” says Vamos.

Vamos believes as Australia’s population continues to age, the increased number of retirees will create a viable foundation to launch these kinds of products.

"It’s certainly on the drawing board, and some of that is happening overseas where you have stand-alone longevity products. To provide an insurance market, you need to have an insurance pool,” she says.

Infrastructure bonds represent an area for longevity innovation. “Particularly with post-retirement, this is one of the best areas to do long-term investment.

"Your ability to invest in infrastructure and assets is important. This is where the industry and Government should really come together, in looking at those Government infrastructure bonds,” Vamos says.

Product developers could also use healthcare costs to underpin new offerings.

The 2010 Intergenerational Report found real health spending on those aged over 65 years is expected to increase around seven-fold from 2009-10 to 2049-50. Over the same period, real health spending on those over 85 years is expected to increase around twelve-fold.

Biti identifies the burden of funding aged care as a possible focus for innovation.

“Aged care is going to become a very big issue, and the costs of funding aged care are becoming more and more expensive. It would be good to see products that are designed specifically to help with that area, and provide concessions and incentives to save for that,” she says.

Back to basics

Independent research commissioned by Challenger found that above all, retirees want certainty of income from their investments.

Lower risks, preserving capital and less complex products were also high priorities for the retiree market. Biti argues the way planners think about wealth creation needs to change.

“We need to be more creative around strategy and how you actually use normal portfolio construction rules, how you use legislation and how you use various products to meet those needs,” she says.

She hopes the current challenges will drive something of a renaissance in the financial advice industry.

“We need to see people moving back to the essence of what financial planning is about. In the past a lot of the portfolio construction has focused too much on picking products first, and looking for so-called ‘sexy’ products and trying to outperform the market.”

“In a lot of the portfolio construction the strategy was lost. Now what we’re seeing is people coming back to ‘what does the client want to achieve’ to put in place a strategy around certain elements, and then think about the products and how we package that up,” she says.