Key News Summary – Treasury has issued a consultation paper aimed at establishing simple and standardised disclosure of the key features of various types of retirement income products, to match retirees’ needs, together with a ‘retirement income risk measure’ paper, issued by the Government Actuary (which is to feed into the standard disclosure product). Comments are due by 29 march 2019.


 

On 10 December 2018, Treasury released the Retirement Income Disclosure Consultation Paper which is the next step in developing a retirement income framework to give members a wider choice of products (‘comprehensive income products for retirement’ or CIPRs) and simple standard form of disclosure to help them select, to suit their needs.

The Consultation Paper seeks views on:

  • The appropriateness of the proposed metrics, to be given to retirement income customers.
  • The method of calculating risk to retirement income.
  • The presentation of the metrics for the fact sheet format of disclosure.

A ‘Retirement Income Risk Measure’ paper prepared by the Australian Government Actuary, is also included – outlining the retirement income risk measure and the method of calculation.

The consultation paper

The Paper says that the retirement phase of the superannuation system is currently under-developed and needs to be better aligned with the underlying objective of the system – to provide income in retirement as a substitute or supplement to the Age Pension.

The Financial System Inquiry and the Productivity Commission’s Superannuation Draft Report found consumer-led competition in the superannuation market is weak due to a combination of:

  • the compulsory nature of superannuation contributions,
  • disengaged members,
  • complexity of the underlying decisions, and
  • the lack of simple, relevant information to assist members.

A retirement income covenant for superannuation funds, is a key focus in remedying this ‘under-developed’ system. In its 16 May 2018 Position Paper: More Choices for a Longer Life Package (in the 2018-19 Budget), Treasury sought community input on this.

The overall process, of developing better income product ranges and support for members to pick an appropriate one, is listed as follows.

  • Removing the barriers to lifetime products
    • Tax treatment (Capital Access Schedule)
    • Social Security means test
  • Retirement Income Framework
    • Retirement income covenant
    • Simplified, standardised disclosure for retirement products
    • Retirement income projections
    • Regulatory Framework.

Development of simplified, standardised metrics, for a manageable, mandatory disclosure product, is the current step, and is the subject of this consultation.

Currently, when people approach retirement they are confronted with complex legal and financial information. In almost all cases, consumers are provided with lengthy Product Disclosure Statementswhich focus on discharging the product issuer’s legal responsibilities. Complex disclosure and a lack of simple, clear information can lead to people relying on behavioural biases to make decisions and choosing a default retirement product, which may not suit their circumstances.

Choosing an appropriate retirement income product necessarily requires consideration of trade-offs between income, flexibility and risk management. However, it is rare for these trade-offs to be made explicit in product disclosure documents. In general, PDSs for retirement products rarely include information about levels of expected income or cash flow in dollar terms, the likelihood of money running out under certain withdrawal or drawdown strategies or the likelihood that income would be lower than expected.

A more effective disclosure framework would enable consumers to find and compare information about the income, risk and flexibility associated with different products. This should better equip consumers to choose a product that best suits their preferences.

Standardised metrics

Fact sheet format is what is proposed for the retirement income disclosure – focussing on the characteristics of retirement income products that are relevant to consumers when making a decision.

  • Income

Given the core purpose of superannuation is to provide income in retirement, a central consideration for consumers is the level of periodic income a product is expected to provide each year. The level of income provided is connected to the product design and features that ameliorate the risk of income variation.

  • Variation in expected income

There is a trade-off between income and risk. Reporting average retirement income alone could be misleading for consumers, as all retirement products are subject to risks that could mean that income would vary over time. Reporting a standardised measure of risk would allow consumers to balance their risk appetite against their desire to maximise income.

  • Access to underlying capital

Individuals with sufficient funds may wish to set aside some of their superannuation or have other assets available for planned expenses.

  • Death benefits and reversionary benefits

Although superannuation is accumulated on an individual basis, the majority of people approach retirement as a member of a couple. In most cases, superannuation balances will differ between partners and the couple may want to be able to plan together how to make the most of those savings. For some consumers that are a member of a couple, providing income for a surviving partner may be important.

Retirement income risk measure

The potential range of retirement income products is diverse.

  • Term Annuities: Payment guaranteed by a life company for a specified term. Residual risks to the retiree include counterparty, re-investment risk and longevity risk. Inflation risk may also apply if the payment structure is not indexed.
  • Lifetime Annuities: Payment guaranteed by a life company for life. Commencement of the annuity may be deferred for a specified period. Longevity risk is mitigated by lifetime annuities and inflation risk may be mitigated if the payment is indexed. A residual risk is the counterparty risk.
  • Unit linked annuities: Payments equal a guaranteed number of units cashed (at their then future value) for life. These products may offer investment choice. Commencement of income payments may be deferred. These products mitigate longevity risk. Inflation risk may be mitigated by the payment structure and investment return over the medium term. However, some inflation risk is retained by the member if the investment strategy does not meet its objectives over shorter time frames. Residual risks to the retiree include counterparty and market (investment) risks.
  • GSA: A pooled annuity product that can be managed according to a range of product rules. These products may offer investment choice. Commencement of income payments may be deferred. These products mitigate longevity risk through mortality credits. As mortality credits are a function of the experience of the pool, the retiree may retain some exposure to the risk that the pool, on average, survives longer than expected. Inflation risk may be mitigated by the payment structure (supported by the investment return and mortality experience over the medium term). However, some inflation risk is retained by the member, for example if the investment strategy does not meet its objectives over shorter time frames to deliver the expected ‘inflationary’ increases to payments. Market (investment) risk and the risk of unexpected future mortality improvement by the pool are retained by the retiree.
  • Account Based Pensions: An account, where the pattern of payments is determined by the member, subject to regulatory minimums. All risks are retained by the member.

Income risk mitigation features, for inflation risk, longevity risk and market risk, can be tackled as follows.

  • Market risk may be managed (in part) by the introduction of a process to match short term payments. For example, a ‘bucket’ of short term fixed interest investments can provide a stable source of immediate income. The ‘bucket’ is then topped up when market conditions are favourable to ensure continuity of payments in the short term whilst seeking to minimise the realisation of growth assets during a short term market downturn.
  • Market risk may be managed (in part) in a unit linked annuity through target date funding. The asset mix underlying the units to be cashed in a specific year could progressively be invested in a matched portfolio as the payment date approaches. This could increase the capacity for the member to plan for their expected income in any given year.
  • Longevity risk can be mitigated by participation in a longevity pool. The pool may provide increasing mortality credits as the ability of the account to fund income payments from its own resources reduces.
  • Inflation risk can be mitigated by a product that seeks to increase payments over time in line with increases in the cost of living for the retiree.

Other risks that this paper is not seeking to measure, for example:

  • Timing risk associated with the date of retirement (or commencement of a retirement income stream product), where a market crash immediately before retirement (or low interest rates in the case of annuity pricing) may reduce the level of retirement income that a member’s lump sum has the capacity to purchase.
  • Event/liquidity risk, relating to the member’s access to capital for emergencies. For some retirees, capital may be sourced from a separate investment account that does not impact the retirement income stream. However where capital is accessed from a retirement income stream it will generally reduce the sustainability of income over time. The amount of capital that can be accessed is also likely to diminish over time. The scope of this paper does not intend to measure the access to capital or the market risk associated with the amount that may be available at any time.

[Treasury website: Treasurer’s Media Release, Consultation Page, Disclosure Consultation Paper; Income Risk Measure Paper; LTN 238, 10/12/18; Tax Month – December 2018]

FJM 12.1.19

CPD (comprehension) questions

  1. Has Treasury released a consultation paper on they types of metrics that might be in simplified, standardised forms of disclosure for the key choices they have to make?
  2. Does the Paper assert that the retirement phase of the superannuation system is currently under-developed?
  3. Why does the Productivity Commission say that consumer competition has not driven the development in products and the quality might have hoped to see?
  4. What are the 4 factors, on which the Paper is seeking to give guidance to members?
  5. What 5 types of income products are identified in the technical risk measures paper?
  6. What is the first of the ‘market risk’ mitigation strategies (for income security, whilst keeping access to good investment returns)?
  7. What does the Risk Measure paper say that ‘longevity risk’ can be mitigated?
  8. How does the paper say that inflation risk can be mitigated?

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