January 2012

Viewpoints Q&A: 2012 — a year of transition? A look at the big picture for the superannuation industry

What should the super industry be aware of for the year ahead? Of the major reforms announced in 2011, what are likely to be the priorities for implementation? Will the industry finally come to terms with longevity risk? Andrew Boal talks to Sonja Lee about a year that promises to be a watershed for the industry.

 

 

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What do you think were the most important developments on the superannuation front over the past year and how do you think funds have fared?

The three big things in 2011 were the Future of Financial Advice reforms, Stronger Super and the commitment to an increase in the superannuation guarantee to 12 per cent over the next decade.
While the industry and government have widely discussed the various reforms, there are still some important issues that need to be resolved. These centre on dealing appropriately with financial advice and conflicts in that area, and how scaled advice is going to be paid for by members, such as a fee-for-service approach or shared across all members.

The equity issue around paying for advice needs to be sorted out. Obviously a lot of certainty was gained from the progress made on the Stronger Super initiatives, and we will see a lot of activity on this front in 2012.

The mining package going through parliament was a big positive for the industry because it confirmed the government’s support for the increase in the superannuation guarantee by 2019.

It’s also hard to talk about 2011 without mentioning global investment markets. Almost all super funds have a 30 June year end and the median super fund reported a pretty solid return of around 8.7 per cent for the year. But if you look back over the last five years, the return has been more like 2.5 per cent per annum, which is only in line with inflation. Obviously that period coincides with the start of the global financial crisis during 2007 and, with the continued volatility we’ve seen in investments in the last four years, it’s been particularly tough for super funds.

During 2011, listed equity markets generally peaked around April and since 30 June we have seen some quite dramatic declines of around 10 per cent.

What length of time is optimum to evaluate the performance of a super fund?

Superannuation is a long-term investment. I know it’s easy to keep saying that, but I think even a five year return is still quite short-term when you’re looking at investment cycles and long-term investing. For example, if someone is looking to invest over a four to five year timeframe, you’d approach it quite differently compared to the investment horizon for retirement where you may not be planning to spend the money for another 10, 20 or 30 years’ time.

Towers Watson believes it’s important to take a much longer term view than just five years when thinking about super returns and investment. A 10 year-plus timeframe is certainly what people should be using when they’re mulling over their super fund’s performance.

Against that backdrop, if you were the head of a super fund, what things would you be preparing for in 2012?

Well there are a few administrative issues that need to be taken care of. On the SuperStream front there is the ability to the use Tax File Numbers (TFNs) to track down lost accounts from 1 January. And by 1 July this year, you must consolidate any multiple accounts within your own fund using TFNs.

Funds will also need to start planning and preparing for any changes to their processes for rollovers and accepting new contributions because those are new requirements coming in from 1 July 2013.

One of the biggest questions for funds in 2012 concerns MySuper. Who exactly is a default member?

In this regard, APRA is talking about what constitutes a “disengaged member”. While the industry might think that if someone signs an application form to join a fund and has been active in other ways — such as nominating beneficiaries or selecting some voluntary insurance options — that might be regarded as being “engaged” with their super. But APRA seems to be saying that it’s only if the member has made an investment choice that they can be regarded as “engaged” for this purpose — and anyone who hasn’t made an investment choice is, therefore, a default member.

That seems a bit odd to us. If a fund has a really well designed default option, it seems that the only way a member could meet the definition of “engaged”, would be to move away from that really good investment option. These issues need to be thought through. Funds might have to go back to all their members to ascertain exactly who is a default member and who isn’t before they consolidate any accounts between a MySuper option or a choice option. There will be lot of preparatory work needed to be done well before the official introduction of MySuper in 2013.

APRA standards and the transfer of existing balances by 2017 is another major area to keep an eye on in 2012. APRA will continue to roll out discussion papers for a number of standards during 2012, and they will cover things like defined benefit funds, insurance arrangements and governance standards.

One of the things super funds will probably turn their minds to most during 2012 is operational risk requirement, with APRA already indicating that a level of 0.25 per cent of the fund’s assets might be a good starting point as an appropriate level for an operational risk reserve.

There’s a lot for funds to consider on the regulatory front. What about on the investment front?

Well, 2011 was a very interesting year and I think 2012 is shaping up to be even more interesting.

There has been a lot of volatility associated with the euro zone crisis, but we don’t think that a lot of markets are significantly mispriced. So making a call on what’s going to happen is very difficult. We think a good strategy in this environment is to continue to hold your “normal” strategic positions and rebalance back to your standard allocations regularly.

You’ve been doing some research and thinking into longevity and it continues to evolve. Are you able to talk about some of the latest findings from your research?

I presented on some of this at the ASFA conference in November last year. As part of our research we evaluated a whole different number of investment strategies to help member deals with post retirement investment risks.

We also tapped into research conducted by the American Association of Retired Persons in conjunction with the American Council of Life Insurance, which was done in 2007. This research showed that retirees are up to five times more loss averse then the average person. If the market is down as you approach retirement, you need to consider whether you should continue working for, perhaps, a year or two longer.

But what if that is not an option? We looked at what funds have done with their post retirement investments. Most funds surveyed still have their post retirement component invested in much the same way as pre-retirement. This is something that I think funds will turn their attention to a lot more in the next year or so. When a member retires, they become more risk averse, yet they look at their fund’s investments they haven’t changed. As a result, the members increasingly seem to be taking these decisions into their own hands.

We’ve had a look at a number of options in dealing with this, including life cycle investments and whether age-based life cycling works.

We think it doesn’t necessarily add a lot of value to the “average” investment outcomes, but it certainly does address the behavioural issues about members wanting to see a reduction in the risk profile as they move into the retirement period.

Another option that we looked at was derivative strategies, but we found that approach wasn’t that useful in helping members to reduce their investment risks in retirement. We also found that derivative strategies tend to be very expensive and as a result were not an efficient use of the member’s capital in the post retirement period.

We also looked at other post retirement risks that members face and the biggest is actually longevity risk. The other thing we noted is that, in order to avoid the risk of running out of money, members actually hoard their money and try not to spend it as quickly.

Managing longevity risk is a huge problem for every individual and the best way to solve it is through an insurance program. In the retirement context, this is called an annuity. Rather than a lifetime annuity that takes up a lot of your capital and removes flexibility, we think a deferred annuity would be a good way to manage longevity risk in retirement.

For a premium of about 10 to 15 per cent of your retirement lump sum you buy a decent level of income after you reach say, age 85. That removes the tail risk of living beyond age 85, and you then can manage the remaining 85 to 90 per cent of your money to cover the known period from retirement to age 85. That makes things a whole lot easier for members and brings the risks really back to just having to manage the investment risk for a known period of say 20 years.

Unfortunately there are regulatory problems with deferred annuities. The definition of an income stream in retirement does not sit well with a deferred annuity and there is not the same tax treatment for deferred annuities as for other income streams in retirement. Typically, the investment income on retirement income streams is tax free, whereas with a deferred annuity you have to pay the 15 per cent investment tax up until the deferral date. This is something that we think needs to be addressed by the government as soon as possible.

Roger Urwin, Global Head of Investment Content compares global pension systems and one thing he always says about Australia is that we don’t have a “whole of life” approach. Do you think there will be much movement by the government to address our post retirement issues over the coming year?

Post retirement has been ignored or excluded from the MySuper program and I don’t think that’s going to change any time soon. In the meantime, I would like to see the government focus its attention on deferred annuities and making sure we have a regulatory regime that allows them to be part of a “whole of life” type program for members. Then financial planners, super funds and members can start thinking about designing a whole of life package. Until we have the final piece of the puzzle — of being able to have an insurance solution to longevity risk that members might be ready to accept — then we will still struggle with that.

We also shouldn’t forget that we have quite a high level of age pension in Australia that provides a really good base and helps most people in retirement to avoid poverty. Of course, we want to do more than that but the age pension is a good starting point. For a single person, including all the allowances, it’s about $19,500 a year. When you add superannuation on top of that, say an additional $200,000 or so, then they are looking at an income in retirement of around $30,000 a year.

About 75 per cent of current retirees in Australia access a part or whole age pension and, over the next 40 years as the superannuation guarantee matures, fewer people will have access to the full age pension. But, around 75 per cent will still have access to at least a part age pension. It is a critical part of the retirement package for a lot of Australians and will continue to be the case for the foreseeable future.

You’ve also been doing some research into benefit projections. Can you tell us why they’re so important for funds and their members?

One of the biggest issues at the moment is that members get their annual statement and just look at the bottom line, which is understandable — that is how much their lump sum superannuation is worth. That number might show $75,000 or $80,000. While it sounds like a lot of money — and it is — it can reduce in value quite quickly when you’re trying to make it last over 10 or 11 years in retirement.

Over the last 30 years in particular, we’ve seen longevity increase significantly. Now, when someone retires at age 65 they could be looking at funding another 17 or 18 years. Lump sums have to stretch that much further.

People need an idea of not only what their projected lump sum will be when they retire but also how much that’s likely to be worth as an income stream. What I would like to see happen is for fund members to receive a projection statement that shows that their current account balance of $75,000 is likely to turn into around $200,000 by the time they reach age 65, based on current contributions etc. More importantly though, it should also show what an equivalent income stream it would produce over your future life expectancy.

But as I’ve mentioned before, we also need to factor in any age pension entitlement, to show what a member’s total income in retirement will be. People will then be able to ask themselves — ‘is that enough for how I plan to spend my life in retirement?’ If it’s not enough, then for the first time they will be in a position to start making decisions about how they can change the outcome, by making more contributions or changing other options available to them to improve their circumstances in retirement. At the moment they have no idea how much income their lump sums will buy them when they retire.

You’re assuming that people actually open their superannuation statements. Member engagement seems to be a massive issue for the industry. You’ve developed some member engagement tools to help address this issue. Can you provide some more information on them?

You mention a good point about members reading their annual statements. I think most industry research says that their annual statement is the one piece of information from superannuation funds that members are most likely to read, but they don’t show much interest in a lot of the other information funds put out.

When we talk about member engagement, there are many different ways you can think about it. Funds will probably talk about engagement in terms of getting members to read their information and make investment choices or take other actions. For me, the most important part of this issue is engaging members so that they understand how well placed they are to retire.

I think the benefit projection statement we talked about before is critically important to that. If we can get members to understand what income they are likely to have when they retire, it would be a huge positive not just for the member, but also for the whole industry.

We’ve been developing a range of tools to help members better engage with their super. The main aim for us is to get members interested enough to find out how well they’re tracking against their retirement goals.

We developed a game application called SaveMySuper and that can be used on an ipad or similar technologies. The idea behind this is that the game is fun and engaging for the younger fund members, in particular, to play. As they play the game, they are provided with education about superannuation and hopefully it will engage them enough to go onto the fund website and start using some of the other tools that we’ve developed, such as retirement calculators and so forth.

For us it’s all about trying to get younger members interested in superannuation. They can find out early on what their retirement might look like so they have plenty of time to start saving more or changing their behaviour to make a real difference for their retirement.

At ASFA2011, Towers Watson had a booth where the theme was The Strength of Towers Watson. What did you think of the booth?

I think the booth was an outstanding success. We had a lot of people coming through during the whole conference. SaveMySuper, our game app, generated a lot of interest with people wanting to play and learn about its educational aspects. I think there will be significant ongoing interest in it in 2012 as a result of its launch at the conference. And actually, the launch was so successful, we won ASFA’s prize for the Best Product Communication which was a fantastic effort. I should congratulate the Technology and Marketing teams for all the hard work they put into developing the game in time for the conference and its launch.

We also had members from our other teams attend, including our Employee Engagement Survey business. Our Survey team has been working with our Superannuation, Technology and Communication teams to develop an engagement survey called SuperEngaged and we’ve started to talk to a few funds about launching it early in 2012. This tool will help funds to measure how their members are engaged with super, across different age groups or other demographic categories.

A key element of SuperEngaged is that they can compare their engagement scores with other funds who participate in the survey. Over time, they’ll also be able to see how their activities have improved member engagement as they go along the journey.

Will SuperEngaged apply some of the techniques that large organisations in Australia use to gauge what their staff are thinking and feeling, so that funds can better understand their members?

Absolutely. Our Survey business has been operating in Australia and around the world for many years and it provides engagement and culture surveys for some of the very largest employers. The trained psychologists in our business spend a lot of time developing questionnaires to get to the root of the issues of engagement. We have drawn on those skills, and combined them with our knowledge of superannuation, to come up with an engagement survey for the super industry that not only talks about actions that members make but also two other very important aspects: how they think and how they feel about their fund.

What else is in store for Towers Watson Australia in 2012?

Well I think a lot of the things we talked about earlier that were very important developments in 2011 will continue to keep us busy in 2012 — things like SuperStream, MySuper and APRA Standards. But I think one of the key priorities for us this year will be to work with the government to try and make some progress in the area of deferred annuities and being able to provide better post retirement solutions for our client funds and their members.

Across all the businesses, we will continue to push ahead in our research efforts and thought leadership. The Retirement team will continue to explore post retirement and longevity risk, as well as benefit projections and underinsurance.

The Investment team will issue their annual surveys such as the Global Pension Assets Study, plus research in new areas such as Project Telos, a comprehensive study on ESG done in conjunction with Oxford University.

Our Risk Consulting business provides advice to insurers and banks around their capital and funding requirements and will help our clients keep on top of Basel III and other regulatory developments.

And our Talent & Reward team will push out major global research, such as the Global Workforce Study.

So across all of our lines of business, I think 2012 is going to be another extraordinarily busy year!

On a personal note, I saw that you grew a moustache for Movember. Can you tell me how Towers Watson supports Movember?

Six people at Towers Watson signed up for Movember in 2011 and I thought it was a good idea for me to join in. Despite the discomfort that the moustache caused in the second and third week, when it got quite itchy, it was a great thing to be part of.

Each month, our staff provides suggestions for a charity and we collect donations from a casual day. Towers Watson has a policy of matching those charitable donations each month. For November, we supported Movember, which is about raising awareness for men’s health issues, including prostate cancer and depression, and encouraging men to have an annual check up. Health and wellness is becoming a big issue for Towers Watson globally and we are helping a number of our clients think through the issues about how they support their staff appropriate programs. We will hopefully be launching some new initiatives around health and wellness in 2012 ourselves.

We’ve recently established a Towers Watson book club via Twitter #TWABookClub. What was your book of the year in 2011, and what’s on your summer holiday bookshelf?

My pick of the year, funnily enough, is a book authored by Towers Watson associates Tom Davenport and Stephen Harding called Manager Redefined. It’s about how important middle managers are for improving talent management and employee engagement.

I’m currently reading The Art of Possibility by Rosamund and Benjamin Zander and on my holiday reading list is A Whole New Mind — Why Right-Brainers will Rule the Future by Daniel Pink.

 

2012 — a year of transition? A look at the big picture for the superannuation industry