Filling the retirement incomes void

With retirement income products emerging as one of the fastest-growing segments of the financial services market, it is little wonder that ING Australia has joined the fray and is set to launch what it claims is Australia’s first allocated pension offering guaranteed income for life this month, changing the landscape of the local retirement income market in the process ING appears to have found a key point of differentiation. A few Allocated Pensions (APs), including those launched by AXA North this year, offer capital protection but ING’s MoneyForLife is the first AP to offer a guaranteed retirement income for life.

Some providers indicate they are reviewing their AP product lists, with an eye to launching something similar to what ING describes as a “combined pension life insurance” offering.

However, others question the need for such a product, which uses ‘dynamic hedging’ to provide the guarantee, suggesting income can be ‘guaranteed’ by existing APs in the market through the sheer scope of investment opportunities they offer.

Annuities specialist Challenger, on the back of a doubling of demand for annuities-type products in September, has also been quick out of the blocks and earlier this month launched the Challenger Guaranteed Income Fund, to be offered on BT Wrap Administration Platforms.

The bottom line for all the recent launches is that the products have been developed in response to what is perceived to be a growing need in Australia, in part generated by the global financial crisis (GFC) but also given impetus by suggestions that, ultimately, the Government might tighten up access arrangements around superannuation lump sums.

But even before the GFC, there was plenty of evidence to suggest that Australia had insufficient products in the marketplace. The ING and AXA North products have been launched against the background of recent reports, including from the Organisation for Economic Co-operation and Development (OECD) and World Bank, suggesting Australia’s retirement incomes (RI) market lacks innovation in offering products that manage longevity risk for pensioners.

In addition, this year’s Milliman Report into ‘trends in retirement income solutions’, compares Australia unfavourably to the US in ‘longevity protection’ innovation.

The Milliman Report, which has been included in IFSA’s submission to the current Henry review, compared the use of different retirement products and strategies in the international market to what is currently being used in Australia.

It found the US market was innovative in encouraging a wide range of competitive products, which works generally to the consumer’s benefit, according to Milliman practice leader, Wade Matterson.

He has called on the Australian government to create better policy that will give rise to the need for Australian pensioners to have an income stream rather than a lump sum.

Matterson said Australia currently had only two options in terms of RI products, both of which were at the “extreme end of the scale”.

“Australians can either have an allocated pension that passes the risk on to the investor or a lifetime annuity, which might protect against market downturns but means less flexibility,” he said.

“There is a lot of debate around the government’s role in the pension system and there is no silver bullet,” he acknowledges.

However, Matterson believes “a different combination of products would be the best thing for Australia.

“I also think we will see a lot more products going forward that provide more middle ground for Australians,” he said.

A World Bank research paper issued in October last year, entitled ‘The market for retirement products in Australia’, revealed that Australians are generally not significantly concerned about longevity risk.

“This attitude must change if people want a standard of living well above that afforded by the age pension,” it concluded.

An OECD report, ‘Pensions at a glance 2009: Retirement-income systems in OECD countries’, said there is a lack of longevity protection products in the market.

According to the OECD report, nearly 27 per cent of over 65s in Australia have incomes below the OECD poverty threshold.

Of all the OECD countries, it found Australia has the third most pensioners living beneath the poverty line, which it attributed to Australian remaining uniquely overexposed to risky assets as they neared retirement age.

The report found older workers in other OECD countries generally switch to less risky investments as they near retirement — but not in Australia.

More than 60 per cent of Australians stick with the default investment options of their super fund plan, and equities typically make up around 60 per cent of this portfolio.

The OECD report revealed that Australia’s superannuation funds experienced real losses of 26.7 per cent in 2008.

Compared to the 30 other OECD countries studied in the report, this is the second worst investment performance for private pensions.

The consequence was significant, firstly because private pensions and other investments provide 45 per cent of retirement incomes in Australia (more than double the OECD average of 20 per cent).

Secondly, it was because of the large share of equities in pension fund portfolios, which was around 57 per cent before the start of the GFC (compared to an average of 36 per cent in the 20 OECD countries).

However, according to Mark Kachor, director of research at DEXX&R, the release of the ING and AXA products suggest the absence of longevity products is being addressed.

He said the protection products are essentially a type of investment option within an AP, designed to give retirees an income for their life expectancy, and believes more will be on the local market because they are specifically designed to solve the problem of pensioners’ current APs running out before they die.

The products’ attraction is that they give, at certain points in the future, the benefit of the upside movement in equities markets, but they can’t go backwards.

“So you are not at risk of a downturn.”

However, he said that the products would not find favour with all pensioners because the guarantee would inevitably have to be paid for in higher fees.

Only time will tell whether the products will overcome a traditional reluctance that many retirees appear to have to invest in lifetime annuities, he added.

Future projections

Nevertheless, growth projections from DEXX&R for flows into the RI market in Australia to 2018 suggest there will be ample opportunity for the protection products to flourish.

It is estimated that flows into AP products will grow by an average rate of 12.94 per cent p.a. over the next 10 years to $263 billion at 31 December, 2018.

Net cash flows are estimated to be $17.4 billion in the year to 31 December, 2018.

Over the past two year, the RI segment of the market, including APs and annuities, has experienced the “smallest of downturns,” Kachor said.

The RI segment recorded a net decrease of 7.29% over the 12 months period to June 2009, with total funds under management and advice (FUMA) decreasing from $87.65 billion as at June 2008.

During the three months to June 2009, however, the market recorded a strong recovery, increasing by 6.97% to $81.54 billion at June 2009 — from $76.29 billion at March 2009.

Most of the top 10 companies experienced falls over the year to June 2009, with BT/Westpac and IOOF Group as exceptions, having acquired St George and Australian Wealth Management respectively (See Table 1).

Kachor said the projected growth figure to 2018 is demographically based on an increasing proportion of people moving into the retirement phase.

Secondly, depending on the rate of the recovery in the current market, most people will have a higher account balance to put into an AP in the longer term than those who retired, say, five years ago.

“So, effectively, you are going to have more people with more money moving into the RI space, and those in the employed phase will continue to make contributions as well.”

ING’s executive director, retirement and investment solutions, David Kan, said MoneyForLife had been launched into an RI market that does not adequately address the longevity risk peculiar to Australia.

“There are lifetime annuities that provide you with a guaranteed income for life but you pay a significant price for these in terms of giving up access to your capital.

“Then you have (standard) APs, which offer greater flexibility in allowing access to capital, and investing in growth assets, but they protect neither your income nor, in most cases, your capital.

“There are some capital-protected variants within the AP product set, but they don’t provide income for life,” he said.

By contrast, according to Kan, the ING MoneyForLife offers a guaranteed income for life, plus flexibility in terms of access to your capital.

“That’s a unique combination not available currently in Australia (prior to the MoneyForLife launch).”

He said that technically the MoneyForLife product is an AP bundled with a lifetime guarantee provided by a life company (ING Life).

“However, we prefer to call it a ‘combined pension life insurance offering’.”

It’s possible that others will follow MoneyForLife onto the local market, Kan said, but he doubted there would be many.

There are not many providers that could offer a lifetime guarantee as you need to be a life insurance company, and you also have to have experience running a dynamic hedging program to ensure the guarantee, he said.

“Generally, only the international providers can offer this combination, and therefore it is really only local providers with offshore operation that will be able to provide this type of offering.”

On the hedging process, Kan said an investor’s investments in the underlying managed funds are separate to the statutory fund that provides the guarantee and carries out the dynamic hedging — thereby providing an additional layer of protection.

“Therefore, while the dynamic hedging strategy assists with reducing risk associated with market changes, longevity risk, and interest rates, it utilises a separate fund to the investor’s fund.

“This is quite distinct from a hedge fund where the clients money is invested directly into that fund,” Kan emphasised.

Andrew Hobern, director wealth management products at AMP, said the group was currently reviewing “these sorts of products”, which have been “available in overseas retirement markets for years”.

“However, before we develop a product we would need to make sure that they are cost effective and provide the benefits and protections that clients really need.”

Hobern said the existing AP product set in Australia is “very strong” in terms of its tax-free benefits for consumers, and its flexibility.

“Some products may offer a few extra bells and whistles in terms of protection options, but don’t underestimate the relative simplicity and attractiveness of the (standard) AP.

“We don’t need a wide range of options if the core options that are available (in an AP) are actually working properly.”

AMP was also “currently renovating its super product list to try to make it much easier for advisers and their clients to turn on an AP as part of their retirement strategy.”

At the same time, he said now that markets have improved, AMP planners were “getting back to advising on the advantages of APs in a transition-to-retirement strategy.

“There are still a large number of customers out there who haven’t been advised on the benefits of transition-to-retirement or allocated pension strategy.”

These customers are leaving their money in super during the pre-retirement phase, when they could be getting significant advantages from moving to an AP, he said.

“APs have significant benefits, particularly in the lead-up to retirement, and I am talking here about the 10 years prior and not just at retirement”.

The value an adviser can give at this point is “very significant”, he added. “Often they can increase someone’s retirement income by up to 20 per cent.”

MLC MasterKey head, Brent Howells, believes “demand for capital secure-type offers will become more topical” over the next 18 months, driven by recent market conditions.

However, Howells said MLC was “not expecting to add to its pension product line-up within the next few months”, after launching two new products at the end of 2007.

“We are reasonably comfortable that our current offer on the market is meeting the vast majority of planners’ needs and their clients,” he said.

However, he anticipated that demand in general would grow for capital secure-type offers, driven by market conditions over the past 18 months.

“Clearly, the concept will become more topical, and we’re certainly always looking at new product opportunities.”

The outcomes of various federal parliamentary reviews over the next 12 months will set the scene of where government policy is headed in terms of “encouraging savings and retirement incomes”, Howells said.

In turn, this would enable MLC, and our competitors in the space, to “look for those innovation opportunities”.

BT Financial Group senior super manager, Patrick Clarke, said it was “not necessarily a bad thing that there are virtually no examples of these hybrid type (RI) products in Australia.

“There are ways of protecting your assets in retirement without having these guarantees, which are a lot of what these US hybrids are essentially about.

“The investment options (in APs) in Australia — from traditional retail products through to wraps and master trusts — gives sufficient investment-option scope to planners to construct a portfolio that can give clients protection,” he said.

Clarke described the Milliman report as a fair assessment of our RI market compared to what is available by way of the product ranges overseas.

“You can pretty much characterise our market as annuities or account-based pensions with very little in-between.

On the other hand, he said, one of the “great challenges of providing guaranteed products” is the cost of those guarantees, already evident in the US.

“There is currently a considerable shake-up in the US market among providers of these hybrid products because of the costs involved.”