Optimum Pensions (or “Optimum”) has developed and tested an innovative lifetime income stream solution, the Real Lifetime Pension, that may be delivered by Funds to their members to comprehensively address Australians' longevity risk while providing higher performance than solutions such as the current lifetime annuities in the market.
Australians are some of the longest living people in the world and currently, longevity risk is not being managed well.
All Australians who retire in future ought to have the option of insuring their longevity and thus lifestyle – which will give them a more satisfying retirement as they will have less worry about investment of their superannuation assets or running out of money.
Currently many Australians withdraw from their superannuation via Account Based Pensions at minimum rates and no doubt restrain their expenditures.
Each retiree needs an income post-retirement that continues for their lifetime and that of their dependants or spouses if needed, and broadly keeps up with inflation. This is the main purpose of superannuation – a purpose that is not currently being fulfilled.
At age 65 years a male has a life expectancy of 88 years – according to the Australian Life Tables 2010-2012. For females this is longer. Currently there are no efficient nor effective and competitive longevity solutions that people would willingly buy, to give “longevity protection” which is needed to give better security of lifestyle and thus peace of mind.
Most people merely effect Account Based Pensions. It can be made to provide an income for the whole of a member’s life but not without shortcomings, such as reductions in income in real terms for the 50% of people who live past their life expectations.
The following graphs show incomes in real terms i.e. after allowing for the expected cost of living.
A retiree who has a medium amount of retirement assets (in this example a $400,000 Account Based Pension), in addition to a home, has decided to draw down enough for a Comfortable Retirement ($48,000 pa) but may run out of money in their Account Based Pension. This is illustrated in the following graph where drawing from the Account Based Pension at the above rate is projected to, eventually means they fall back on just the Age Pension, with a dramatic 52% projected fall in income.
Retirees who try and self-insure their longevity risk, meaning they draw down on their Account Based Pension at the minimum rate, will make their Account Based Pension last for life BUT their projected income will be modest (average $32,500), 28% less than a comfortable income from ASFA’s Retirement Standards. This is illustrated in the following graph.
Account Based Pensions can provide an income for the rest of a person’s life but also possibly provide a lump sum payment at any time. Some people wish to leave a part of their superannuation money to their children – as well as their houses, cars etc. - although this was NOT the reason the Australian Government gave us all tax concessions in respect of superannuation.
Nick Sherry, former Senator for Tasmania and Minister for Superannuation, said that solving the longevity problem leads to “The last great reform of the Australian superannuation system”. Quite so, as this is what the system is meant to be all about – BUT we have changed and hopefully improved everything else about the superannuation system, except that way the retirement benefits can be delivered.
What people need at a minimum is a sufficient and regular payment, like a salary or wage, which roughly increases with inflation, and that is deposited into their bank account until they die – after which they (and any nominated spouse or other dependent) won’t need it any longer.
Australian retirees need new solutions to longevity risk other than those offered currently in the market. What we describe as “Conventional Lifetime Annuities”, involve the Life Insurer offering the annuitant a guaranteed annuity payment for life; either a fixed rate, or indexed to CPI and often with some capital access.
Conventional Lifetime Annuities offer only modest annuity payments (with underlying investment earnings after fees – as it appears to the consumer - close to cash return). This is due to the reserves needed to ensure there are no shortfalls in annuity income due to the asset-liability mis-matching risk, the reserves required to provide for any reductions in future mortality that haven’t already been allowed for in the product pricing and sometimes to both naturally conservative investment strategies. Annuity payments are reduced even further if “bells and whistles” offerings are provided such as capital access. In our view, the cost of these features are high and not always charged for in the product. In addition these “”access to cash” and “death benefit” features are best provided in related products such as Account Based Pensions which have been purchased in conjunction with the longevity solution.
Although lifetime annuity products do currently exist, the high costs deducted from this leakage of account balances out of the current system, to dependants after the death of member and spouse, can be retained with an appropriately designed pension system. This could increase annual pension incomes by roughly 30% over a person’s lifetime AND help to broadly deliver an income that broadly keep pace with inflation.
Looking at the current issues, retirees will have a need post-retirement for:-
Through legislation, the Australian Government has removed the barriers that can allow a vibrant retirement incomes annuity market to develop – to the benefit of all retirees. Further changes regarding CIPR requirements are expected in 2018.
This means that in future retirees will be able to receive an income that is a combination of :-
We expect the market for lifetime income streams, in retirees’ portfolios, to grow strongly due to the efficiency and effectiveness of the new breed of products, the fact that lifetime income streams are the only product to provide longevity (and thus income or lifestyle) protection (although to date they have been regarded as “expensive”) as well as peace of mind, the increased realisation that life expectations are understated AND have been increasing relatively rapidly in historical terms.
Adding to this is the Australian Government’s encouragement for super funds to offer members a comprehensive “My Retirement” or “My Retirement Products” solution. The pre-selected option should be a comprehensive income product for retirement (CIPR) that has minimum features determined by Government. These features should include a regular and stable income stream, longevity risk management and flexibility.
The Australian Government is doing this in order to better ensure that the benefits emerging from superannuation funds offset the cost of the Age Pension – which was no doubt one of the expectations when the superannuation tax concessions were started. To the extent this doesn’t occur, there will be a need to increase tax in order to pay for the rapidly increasing cost of Age Pensions and health care for the over 65 year olds.
Optimum Pensions' new CIPR solution, the Real Lifetime Pension, may be delivered by Funds to their members to address Australians' longevity risk while providing higher performance than current lifetime annuities in the market.
The Real Lifetime Pension(“RLP”) developed and tested by Optimum Pensions provides a key component for Funds to provide a great CIPR solution.
The RLP is a new retirement income solution for Australia, with a number of special design characteristics different from conventional lifetime annuities. It has been specifically developed by our team to meet the requirements of CIPR “My Retirement Products”.
The RLP allows the Fund to offer a CIPR with lower fees as it uses the Fund’s existing investment management and administration resources plus existing resources and services already provided by the fund.
The RLP is an investment-linked lifetime annuity, with choice of investment options allowing it to invest in high performing assets than a conventional annuity. The offers stronger (at least 20% more*) annuity payments than Conventional Lifetime Annuities and avoids the sequencing and asset/liability mis-matching risk normally incurred by the provider.
* Source: Challenger Enhanced Income Liquid Lifetime Annuity. Quote 12 September 2016 for Male aged 65 (born 11 September 1951, Australian citizen, $100,000 investment for non-super monies (tax free threshold claimed). No withdrawal period. CPI indexed. First year payment equal to $4,585.80- after tax and advisor fees (no deduction for advisor fees), multiplied by 5 for $500,000 investment).
Depending on the investment options chosen by the annuitant, lower fees and higher returns allow the RLP to broadly keep up with and stay ahead of inflation over long periods. We've also designed individual reserving and other strategies to offset shortfalls in income when they occur.
The RLP provides the ability for the pensioner perhaps on the advice of their financial planner, to switch between different investment options. Depending on how this might be used, it could provide some down-side protection and increased upside capture of investment performance
The RLP is offered as both an immediate pension payable to the member and any spouse, with a choice of minimum payment periods (to ensure that a large part of the investment can be returned on an unexpected early death) and a deferred pension with a choice of death benefits before the pension starts.
Assumptions: Pension payable according to Assets Test rules at May 2017 for single person owning their own home with $400,000 of assessable assets. Where immediate pension is given a deemed capital return which reduces assessable assets by purchase price/life expectancy*time elapsed.
Assumptions: Deferred Pension deferred for 19 years to age 84. Invested in a Balanced portfolio with 1.1% fees. Social security treatment of deferred pensions was not known at time of modeling. We assumed Assets Test deductible amount similar to immediate pension.