This article is an overwrite of work done by Optimum Pensions’ Peter Rowe in Australia, I’m grateful to my friend Jim Hennington for sharing it. When I read it I was struck by the similarities that Australia’s Super system is facing relative to the UK’s Workplace Pensions… and the differences.
The Australians authorities are requiring workplace “Super” schemes to set up a Retirement Income Covenant with their members. In this blog I’m comparing where we are in the UK with where Australia is today, with particular regards to the problems both countries are having turning pots into pensions. I’m not commenting on the holistic retirement picture. That would focus on reliance on respective state pensions, DB pensions , investment income and work. I’m focussing on the savings we are making into DC pensions.
How mature are our respective DC systems?
The Australian market is bookended on one side by people retiring with low savings (about 20-30% of retirees) who will predominantly depend on the government pension in retirement. A number of industry fund members still retire with less than A$100,000, which they draw down on periodically during retirement.
At the other end, 10-20% of retirees will have more than A$1m in savings, including savings outside the super pension schemes, with little, if any, state pension.
Middle Australia (the remaining 50-60%) will live on a part “age” (State) pension for most of the retirement phase. As Australia’s super system matures, the number of retirees with savings of between A$250,000 and A$1m is expected to double.
The Australian DC System looks a little more mature than ours. There are parts of our DC system as mature – mainly where DC schemes have been well funded by employers for most of the century, but for the majority of savers, workplace savings is still a new phenomenon. The problem in the UK is that around 700,000 a year are currently drawing on their DC pots for the first time – right now. The UK’s issues is in scale of savers, not scale of savings. This is why our financial services industry and pension legislators are yet to implement something as radical as the Retirement Income Covenant.
There seems to be a “catch-up” going on in some parts of the UK pension industry though there is nothing in place from Government or its pension regulators like the Retirement Income Covenant.
So what are the Australians doing to help savers turn pots to pensions?
The Retirement Income Covenant will require trustees to formulate a strategy for members approaching retirement
With a July 2022 deadline for funds to formulate a retirement income strategy fast approaching, Australian Super trustees have their heads down trying to better understand their members and consider product offerings and tools to improve their retirement outcomes.
Retirement Income Strategy Objectives
The central focus of the Retirement Income Covenant (RIC) is a requirement for superannuation fund trustees to prepare, implement and review regularly, a retirement income strategy for the retired members of their fund and for the members approaching retirement.
This strategy must show how the trustee intends to assist ALL their members: those with high balances and low ones; those retired, in Ill-health or ailing, to achieve the objectives listed below.
- Maximising retirement incomes
- Managing risks to the stability and sustainability of retirement income (including longevity risk and investment risk)
- Providing flexible access to savings during retirement, and
- Balancing all of the above.
This simple approach to the problem is something we are yet to do in the UK, it will require a shift in thinking from legislators and workplace pension providers. Australia has been forced to legislate for change because it did not happen organically. It is hard to say whether the same will happen in the UK, that depends on the willingness of the UK financial services industry to recognise Australian problems are UK problems. Many think the two cultures so different that we can ignore their Retirement Income Covenant. But bearing in mind the slow speed of change in other matters (the introduction of auto-enrolment and the pensions dashboard, the sooner the UK starts addressing its retirement income issues, the better. I put Australia as clearly ahead in terms of Government and Industry strategy.
What the Australians are doing about “product”
1. Maximising retirement incomes
It is significant that the first RIC objective, “Maximising retirement incomes”, does not refer to any given year or specific period during retirement. Instead, it is a cumulative concept across the whole of retirement. In this context, trustees must now consider that the income needs to apply to the lifetime of the member (and possibly spouse). At present, the most common retirement product used by funds is an Account-Based Pension (ABP). This is what we in Britain would call a SIPP in drawdown.
By itself, this is unlikely to meet this objective, as the income from an ABP can significantly reduce over time and potentially run out.
Trustees will need to consider that retirees need to be confident that their retirement income will last as long as they do.
This question is simply not being asked by UK trustees. Even the largest DC schemes such as Nest, Lifesight, the insured master trusts and the big bank DC plans, do not offer longevity protection on drawdowns. Most do not even offer drawdown. Often savers are forced to take out a new policy to spend the savings they built up in their workplace pension. Although many people see their pots as too small for conversion into a pension, there are many people with combined pot values of over £60,000 who have little help with turning pot to pension. Australia is clearly ahead of the game when it comes to maximising retirement incomes. Without a distinct investment product that provides drawdown with longevity protection , middle Britain is not maximising retirement income from its savings
2. Managing Risks
The question of longevity risk is key to developing the basis on which trustees can rely to develop their strategy. Funds without a pension division have very little experience or data related to their members’ longevity. The Retirement Income Covenant states,
“This should be based on information the fund has on their membership” (as is the case for group insurance).
However, the only data relevant for group insurance relates to those who have died while still working, which is not a sound basis for judging the life expectancy for those who reach retirement age. There may be some data on the number and ages of Account-Based Pensioners who have died, but this will no doubt be limited.
In addition, where trustees provide advice, it is most common that they use planning software that uses the Australian Life Tables (ALT) to predict life expectancies. In some cases, planners may add a few years to the estimates ‘to be safe’.
In Britain we have both the Office of National Statistics and the IFOA’s Continuous Mortality Investigation to keeping us up to date on mortality on a weekly basis!
UK beats Australia in our understanding of our mortality! However we are not using this advantage to help savers turn pots to pensions. This could change.
The risks to stability and sustainability are key to developing a sound retirement income strategy. Trustees have had considerable experience developing sustainable investment strategies for the accumulation phase. Given the requirement that the retirement income should last for the life of the member (and possibly a spouse), they will need to pay more attention to the timeframe required to support income for this timeframe. It is worth noting that an approach that reduces risk and income as a person ages may not be the best strategy, especially in the early years of retirement.
Britain has only considered investment strategy for a collective decumulation in one case – Royal Mail. Their CDC scheme does use a de-risking path for the scheme, based on anticipated years to death of members. This however appears to be a means of protecting the scheme were it to go into decline and ultimately lose new members (becoming a closed DB scheme in all but name). Very little work is being done on what an open ended collective decumulation strategy would be. This diagram from my friend Derek Benstead implies that a scheme that is confident of staying open can maintain an investment sweet spot that is heavily weighted to growth assets.
Australia is ahead of the game in this respect. We need to work much harder in understanding how much investment risk people are prepared to take and design collective products that take into account people’s actual circumstances (reliance on partners, expected windfalls from inheritances etc).
3. Providing flexible access to savings during retirement
Any retirement strategy developed by a trustee needs to provide flexibility in several areas and access to savings is an integral part of such a strategy. In Australia, most trustees currently offer an ABP (Sipp drawdown) with access to savings – that is, until it runs out – which unfortunately may be before a person dies.
For this reason, an ABP can remain part of a retirement income solution, but reliance on this as the only option is flawed as it does not necessarily provide a lifetime income.
The Australians do not think “annuity” at all, the idea of a pension as a bequest is seldom mentioned. The Australian thinking on retirement income is very much more aligned to what we call a “pension”. In my view, this is more in line with what the majority of people in the UK consider the outcome of workplace pensions should be.
The retirement income covenant is adapting a flawed system with over-reliance on drawdown to a more balanced approach where the option of converting some or all of a person’s Super Account to a “wage for life, investment product” is available to all members. Australia is clearly ahead of the game in thinking inclusively. Right now, the UK system is based on “you get what you can afford” and if you can’t afford advice, you get little practical help in turning your pot into a pension.
4. Balancing it all
It sounds simple but is one of the most challenging aspects for a trustee to determine when developing a retirement income strategy. The needs of individual members are quite varied and trying to create a solution that fits a particular cohort will still need to be flexible.
One approach would be to assign members to different cohorts. Still, a smarter approach could be to develop different strategies so that members will be able to select which best fits their circumstances at their time of retirement.
To develop an appropriate retirement income strategy, trustees will need to model the impacts of the various factors on different segments of their membership.
Amongst many unknowns, whether members have a partner, own a home, have additional retirement income or assets. All that is known to trustees is their members’ age and account balance.
For this reason, it is essential that modelling allows for the unknown factors and that they are considered when testing different outcomes that demonstrate how income can be maximised whilst balancing it with access to savings.
Britain could learn from Australian actuaries like those at Jim’s Optimum pensions. Optimum Pensions has already developed an actuarial model that would allow superannuation funds to undertake this type of analysis, and Jim says it will work with the trustee to help them identify suitable solutions for their members.
Australia has first mover advantage here, but it is easy to see how the UK could catch up. I am a supporter of the ideas behind the FCA’s proposed Sales Guidance Model
Together with the development of modellers, we need to offer a non-advised service which can help the bulk of the 700,000 first-time pot spenders, toward the goals of the Australian’s Retirement Income Covenant.
A beefed up Pension Wise could do this, but it seems necessary for the pension providers themselves to adopt the ideas behind the FCA’s proto-consultation
My analysis of the respective responses to the problems people in Australia and the UK have in turning pots to pensions is that the Australians are ahead of the game in almost everything but mortality data.
That doesn’t mean that Britain can’t catch up. I think we have the capacity to do so because we have such a large and well funded financial services industry and because we are very much committed to workplace pension saving.
But we have to break down some of the taboos that exist in the UK. Firstly we need to confront the mantra that pensions are too hard to be managed without advice, secondly we need to provide products that can be managed without advice and finally we need to provide guidance to these products so people can use them to meet their particular needs. That seems to be what the Australians have decided with their RIC.