The concept of a post-retirement investment product was flagged in the Super System (‘Cooper’) Review in 2009-2010, but accumulation was the main area of focus for superannuation at that time. The concept, and associated CIPR acronym (‘Comprehensive Income Product for Retirement’) was an important recommendation in the Financial System (‘Murray’) Inquiry in 2014. It was noted that a 15% – 30% uplift in retirement income was possible, based on modelling by the Australian Government Actuary.
CIPR is a good idea in concept. However, taking an idea from concept to in-practice in a big complex system is difficult. That is the challenge currently faced by the policymakers at Treasury. Where they land will have a significant industry and system impact one way or the other. The stakes are high.
There is a strong commitment to continue down the CIPR path (or MyRetirement, as the Government plans to name it). An important next step announced last week by Kelly O’Dwyer is the proposed development of a retirement covenant which would require superannuation fund trustees to design and offer appropriate retirement income solutions to their members. An advisory group of industry professionals has been created to provide feedback to the Government.
CIPR and the desire to pool risk
The motivation for CIPR is that there is little pooling of longevity risk in post-retirement. Many people are frugal with their superannuation savings, a result of a combination of conservatism and an element of bequest motive. These savings were tax advantaged and remain tax advantaged while in an account-based pension. The outcome is a below potential post-retirement lifestyle and a tax advantaged bequest, neither of which meet the objectives of Government policy.
The concept of a CIPR is a default (i.e. unless otherwise selected by an individual) solution designed broadly to provide constant income for life, regardless of lifespan. This sounds intuitive, but as responses to the consultation paper identified, is difficult in practice.
What are the main immediate challenges?
I would summarise the main challenges, in order of priority as:
1. Reconciling the difference in objectives between policymakers and super fund trustees who act on behalf of their members
The preferences of the Government implied by the consultation paper and the design of the proposed Actuarial Certification Tests (required to be passed for a post-retirement product to be certified as a CIPR) suggest a focus on expected retirement income with little concern for variability of outcomes, the value of residual benefits or access to capital.
In practice, a trustee of a super fund needs to respect these other preferences (variability, residual benefits and access to capital). Consider two examples:
First, a male primary income earner, who unfortunately dies in the first year of retirement (around a 1% chance) and the trustee’s CIPR has no reversionary benefit for the surviving partner.
Second, a non-home owning member requires access to capital for one of many possible lifetime events, but unfortunately the trustee’s CIPR provides no access to capital.
Surely, a trustee is obliged to consider these issues in the design of their post-retirement default solution. There has been case law in the UK which has confirmed as much.
Do these differences mean much? Resoundingly yes! I was part of an industry project to establish a sensible set of preferences for trustees to assume on behalf of their members. These preferences were then developed into a metric known as the Member’s Default Utility Function (affectionately ‘MDUF’, see ‘Utility function’ research wins Retirement Innovation Award for more). At Mine Super, we then used MDUF to calculate the benefits of CIPR and we found that the proposed CIPR framework actually subtracted from retirement outcomes (Mine’s submissions are here and here).
A possible solution is that the trustee of a super fund must codify their own set of preferences that they assume on behalf of their members.
2. Incorporating the age pension into CIPR design
The original CIPR consultation paper framed a post-retirement solution which focused on consistent income for life in absence of the age pension. In practice, this guarantees an inconsistent retirement income profile for households.
Perhaps policymakers are frustrated at the current status quo of using an account-based pension and relying on the age pension for longevity insurance. However, ignoring the existence of the age pension risks over-insuring against longevity risk especially for members with lower retirement savings and experiencing lower income as a result. I believe that the age pension should be incorporated into CIPR design.
3. Interaction with the means testing for social security
Concurrently, the Department of Social Security (DSS) is developing means-testing rules for lifetime income stream products such as life annuities, deferred life annuities, and group pooling equivalents. The proposed rules appear fair in isolation but deeper analysis at Mine Super suggests that the treatment of account-based pension solutions is much more generous.
When we account for the new rules, incorporate the age pension, and assume the sensible preferences of MDUF, we find no rational demand for lifetime income stream products. In fact, the optimal solution would be not too dissimilar to the status quo (use the account-based pension in conjunction with the age pension).
Hopefully DSS and Treasury will together find a solution so that this issue does not become a sizable disruptor to the intentions of CIPR.
4. A reassessment of the realistic gains from CIPR
When the Murray Inquiry suggested that a CIPR could deliver a 15% – 30% uplift in retirement outcomes, I was perplexed. Eventually we got to the bottom of this claim: it was based on a hypothetical product design and only assessed retirement income with no value placed on residual benefits or access to capital. I feel the hypothetical product would not be acceptable to the public and could create risk for any trustee who used it.
A realistic improvement in retirement outcomes (using a more holistic measure, such as MDUF) would be in the order of 5% – 10%, still a large number at a system level.
5. Industry cost and ability to opt out
The cost and effort of developing a CIPR could be large, much larger than that associated with MySuper. But would this ‘retirement covenant’ allow for some funds to opt out and not offer a CIPR? What would happen to members of those funds at retirement? Would these funds be allowed to be specialist accumulation-only funds? Could the covenant be used to drive further consolidation of the super fund industry?
CIPR could provide a high-quality safety net but it could prove under-utilised as members leave for reasons such as becoming more engaged or after receiving financial advice. It could be a lot of industry expenses if many people opt out, and getting the system-level cost/benefit analysis correct is a difficult challenge.
These are exciting times for retirement planning. While some people may feel regulatory fatigue, I find the opportunity to be part of a system delivering good retirement outcomes a great motivator.
There are complex issues to be resolved. Broadly, everyone is pushing in the same direction but there remains a large dispersion amongst stakeholders. With such a complex area, there is the chance of a policy mistake. The welfare cost and industry cost of a policy mistake could be large. This risk is partly reduced by the quality of the advisory group which has been assembled.
David Bell is Chief Investment Officer at Mine Super. Estelle Liu is a Quantitative Analyst in Mine’s Investment team. Together, they led the working group which generated the Member’s Default Utility Function, an award-winning, freely available, advanced framework for assessing retirement outcome design. The views expressed in this article are their own and may differ from those at Mine Super, a sponsor of Cuffelinks.