New thinking on how to solve Australia s post-retirement challenge. Paul Newfield

Transcription

1 New thinking on how to solve Australia s post-retirement challenge Paul Newfield Paul Newfield This presentation has been prepared for the Actuaries Institute 2014 Financial Services Forum. The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the Institute and the Council is not responsible for those opinions. 1

2 What will we cover Mission Stakeholders Needs & Risks for Retirees Current Options today The history of the tontine A modern, implementable model Why Australia 2

3 Mission and start What is the Mission? If you do not know where you are going then any road will take you there There are no wrong roads to anywhere. Cooper Review and Stronger Super 3

4 Stakeholders AUSTRALIANS FUNDS AND TRUSTEES FUND MANAGERS MEMBERS REGULATORS 4

5 Needs & Risks facing retirees Longevity Investment risk (during the journey) Flexibility Erosion of purchasing power Customisation Stable cash flow management Market risk at date of purchase Financial literacy Complexity 5

6 Three distinct phases of retirement Active Ages 60 to 75 Continuation of lifestyle but more time for leisure, travel and family Passive Ages Shift to more passive activities; travel is closer to home Frail Ages 75 to 100+ Restricted mobility means leisure activities are limited Some part-time work Some unpaid charitable work Reduced contribution to economy and society Increased expenditure on leisure. Majority are still nett savers Increased expenditure on health. More frugal lifestyles. Increased dependency on health and aged care expenditure Housing upgrade Housing down-sizing Retirement village or nursing home 6

7 Pension risk spectrum: Defined Benefit to Defined Contribution Employer Risk DB Pension Known benefit Unknown cost DB Retirement lump sum Cash Balance Unknown benefit Known cost DC Employee Risk 7

8 Today s Options Longevity Risk Uninsured Insured Investment Risk Unprotected Protected Allocated pension (AP) with choice of investment risk AP with outcome based/controlled investment approach Term Annuities and Guaranteed Products Pooled mortality solutions Deferred annuity with AP Lifetime Annuity 8

9 Collectivism/Pooling and Prisoners Dilemma RAND 1950 Attempts by individuals to maximise may result in both collective and individual minimisation Prisoner A Stays Silent Prisoner A Confesses Prisoner B Stays Silent Each prisoner will serve 2 years Prisoner A is freed and B gets 5 years Prisoner B Confesses Prisoner B is freed and A gets 5 years Each prisoner serves 4 years 9

10 Collectivism/Pooling and Prisoners Dilemma What would you do Option for the individual Their expected outcome/result Expected Term if they stay silent = 50% times 2 years + 50% x 5 years = 3.5 years Expected Term if they confess = 50% times 0 years + 50% times 4 years = 2 years 10

11 Collectivism/Pooling and Prisoners Dilemma But in total for society as a whole (and if this is represented by the A and B pooling and thinking collectively): Combination of choices for society as a whole If no one confesses, then the total number of years served by both prisoners = If both confess, then the total number of years served by both prisoners = If one confesses, then the total number of years served by both prisoners = Outcomes for Society as a whole 4 years (2 years by each A and B) 8 years (4 years by each A and B) 5 years (by one of A and B) 11

12 Collectivism/Pooling and Prisoners Dilemma Each person acting solely in their own interests will often result in both collective and individual outcomes being sub-optimal Pooling and working collectively works in maximising both collective and individual outcomes Collective DC and Pooled Survival Funds ( PSFs ) are the most efficient way of achieving these outcomes 12

13 Pooled Survival Funds of the 21st Century Edward Lloyd 1688 Adam Smith, The Wealth of Nations, 1776 Tontines were popular in the United States in the early 20th century. In 1905, it was estimated there were 9 million tontine policies outstanding among a population of 18 million households with a total estimated value of $6 billion. Historical issues of moral hazard and governance 13

14 Pooled Survival Funds of the 21st Century Capital Invested Investment Earnings Mortality Profits Total Account Balance Traditional Allocated Pension 14

15 Annuity Challenges and the PSF solution Margins and Costs Longevity Integration with MySuper Investments and net societal benefits Scale (no. of lives) Annuity Higher margins.some may see as not a fair value trade Contingency margins built in.. Complex and involves third parties Primarily invested in bonds (issues re issuance and current yields) Reasonable size but not as large as MySuper funds Costs and margins allocated to policyholders The Law of One Price! suggests same longevity protections Can be integrated to the back end of MySuper and managed by the Fund Can be invested over a longer term Substantial size Pooled Survival Fund 15

16 PSF s are akin to bucket based lifecycling a potentially simpler version of dynamic lifecycling Replenish (except after poor return years) Liquidity Portfolio Long-term Portfolio Retiree 16

17 Fairness If a person perceives a product as being unfair, they may ignore it or make a poor financial decision Solutions? Provide sufficient information to combat perceived unfairness Education Presentation of retirement income solutions to promote fairness Example Retiree may perceive that lifetime income providers unfairly profit from early deaths Explain mortality credits: early deaths subsidise those who live longer 17

18 Australian legislation PSF s are already consistent with the sole purpose test already embedded in Australia s Superannuation legislation (SIS Act, Section 62) which says that.each trustee of a regulated superannuation fund must ensure that the fund is maintained solely: for one or more of the following purposes (the core purposes): and then says that benefits based on attainment of certain ages (which is consistent with how a PSF would operate). Life Insurance Act (See Section 11 of the Life Insurance Act 1995) which specifies that the following item (and there are other exclusions) does not constitute life insurance business: business in relation to any scheme or arrangement under which superannuation benefits, pensions or payments to employees or their dependants (and not to any other persons) on retirement, disability or death are provided by an employer or by employees, or by both, wholly through an organisation established by the employer or employees or by both; 18

19 Benefits of Collective DC or PSFs Consistent with where many countries are presently or are moving The Netherlands Israel Australia UniSuper is a defined ambition fund South Africa see this

20 Benefits of Collective DC or PSFs

21 Pooled Survival Funds In Action 75% In traditional Allocated Pension 25% In Pooled Survival Fund Total Account Balance Invested based on member choice Invested in single investment strategy Assume three individuals join the Fund: Curly is 65 and has an account balance of $300,000; Larry is 70 and has an account balance of $150,000; and Moe is 80 and has an account balance of $250,000. We will ignore any investment earnings for simplicity. 21

22 Pooled Survival Funds In Action Pooled-Survival Fund Curly Larry Moe = 25% x $300,000 = 50% x $150,000 = 25% x $250,000 = $75,000 = $75,000 = $62,500 Account based pension (member investment choice = MIC) = $300,000 $75,000 = $225,000 = $150,000 $75,000 = $75,000 = $250,000 $62,500 = $187,500 22

23 Pooled Survival Funds In Action Name Age Sum in Pooled- Survival Fund (taken for each member from table above) (A) Probability of Death * (B) Sum at Risk (expected amount defaulted to pool or expected amount you will receive if all deaths occur as expected) = (A) x (B) Curly 65 $75, $830 Larry 70 $75, $1,385 Moe 75 $62, $1,937 Total $4,152 (C) 23

24 Pooled Survival Funds Member Statement Account based pension (Unrestricted) Pooled-Survival Allocation Opening Balance $240,000 $80,000 $320,000 + Investment Earnings $12,000 $8,000 $20,000 + Inflows (rollovers) Refund from Survival Pool $88,000 ($88,000) - +/- Mortality Profit Received 1 $2,000 - $2,000 - Drawdown from account based pension ($41,900) - ($41,900) - Expenses ($100) - ($100) = Closing Balance at year end $300,000 - $300,000 +/- Allocation to Survival Pool ($75,000) $75,000 - = Opening Balance at Start of year $225,000 $75,000 $300,000 Investment Strategy Subject to your investment choice Based on the long term strategy of the Survival Pool Receive this on Death Yes No Proportion of total account balance allocated to the pooled-survival fund (this can be changed at the your election) Expected Mortality Profit this year (an estimate only with disclaimer) Total 25% $848 24

25 Why Australia? Desired industry characteristic A large defined contribution/accumulated framework Australia today A well regulated superannuation and Trustee environment A relatively concentrated number of very large funds (as envisaged under Australia s MySuper framework) An environment on the verge of potential medical advancements which could increase life expectancy (and where there is much uncertainty as to how profound the impact would be) 25

26 Benefits of PSF s (Sailing the 7 C s) Continuity Cost Capital Efficient Comfort for members Consistent with trends Controlled by Trustees Compliance with 26 Regulators

27 Conclusion It is critical that the Government and Industry define our mission The industry has numerous stakeholders (some with vested interests) Historically tontines and a modern Pooled Survival Fund can provide an improved post-retirement solution (as a default) for the modern DC world Other countries are moving, and I believe will continue to move, down a Collective DC path All stakeholders will benefit from a PSF solution Australia has precisely the right ingredients for a PSF to work well 27