Is it time for the last great superannuation reform?
The government as well as the superannuation and life insurance industries need to take action to improve the lifestyles of retirees while reducing the cost of the Age Pension
David Orford has been in the business of helping people prepare for retirement for his whole working life. He started and grew the very successful business of Financial Synergy, which became Australia’s leading provider of superannuation administration software, while helping to positively change the laws and rules which govern the superannuation industry. Today, he serves as Managing Director of Optimum Pensions, which provides a range of sustainable white-label retirement options for customers in the form of lifetime income products.
Mr Orford has travelled the world to better understand optimal retirement solutions, and has found the large majority of people (including current retirees) do not understand how to adequately provide an income for the rest of their (and their partner’s) lives, in a way that broadly increases with inflation. He has worked with governments for more than two decades to bring about changes to the retirement system that will benefit the government through reduced expenditure on the Age Pension, while providing retirees with more effective solutions than lump sum superannuation payments, including through account-based pensions.
“I remember when I was working in Canada, almost 100 per cent of Canadians are on lifetime pensions,” Mr Orford recalls. “When I started working in Toronto, they asked me what sort of superannuation system we had in Australia, and I replied that we basically offer lump sums that people can take as account-based pensions. And they fell on the floor laughing, because it was so foreign to them. They asked me why we would have a system where people could take a lump sum, because they then had to worry about the investment value of their retirement savings.”
They also suggested that “kangaroos jump down the main street”, to which Mr Orford replied, “well of course they do, and we even have them in parliament.”
This was an eye-opening experience for Mr Orford, who likened it to someone who knows they’re blind versus someone who doesn’t. “The blind person may not know about colours, and people that know about colours may not know what it’s like to be blind. We in Australia don’t yet know what it’s like for everybody to be on lifetime pensions, and that’s where we should be going. This is the last great reform of the superannuation system, because we should be providing benefits in income forms that people really need – and that’s not what we’ve been doing,” he affirmed.
Solutions to a systemic problem
A root cause of the problems with Australia’s post-retirement system is that it is not fit for purpose. “The system we have in Australia is essentially an accident of history,” according to Mr Orford, who explained that when the British founded the colonies of South Africa, Australia, New Zealand and Canada, they set up lump sum systems. While the British relied on pension-based systems for hundreds of years, Mr Orford explained that they introduced lump sum systems because there weren’t any old people at the time in the employment of the British empire in the newly founded colonies.
“So, you couldn’t get the average mortality experience in retirement, and you couldn’t actually provide an annuity on a viable basis. So, they gave us lump sums,” he said.
This “accident of history” has not been corrected in Australia, which is out of step with many of its peer economies around the world. A World Bank report, for example, found that in 2011 for at least four countries in the world (Switzerland, Denmark, Sweden and Chile), 80 per cent of retirees voluntarily take lifetime pensions when it comes to their retirement. Canada mainly has a pension-based system, while pension-based retirement systems are employed in many other countries including New Zealand, South Africa and many countries in Europe. “In Australia, less than 1 per cent of retirees take lifetime pensions. We’re really the odd country out,” said Mr Orford.
Understanding what is needed in retirement
The retirement savings gap is a very real problem for both current and future retirees in Australia. This gap, which is the difference in the amount of money people have to retire, and how much they will actually need, stands at about 23.4 per cent, according to a 2022 Association of Superannuation Funds of Australia (ASFA) research paper. There are a few major systemic issues as well as demographic trends that are contributing to this gap.
One of the main problems is that people don’t understand they need to save themselves by saving enough during the accumulation phase of their superannuation membership, according to Mr Orford. “They don’t understand the increasing length of retirement, whether they’ll get to retirement, or how much to save in order to enjoy retirement – and our industries have not done enough to help our fellow Australians to understand and motivate them to save enough.
For example, recent research by the Actuaries Institute of Australia found that the tools used by financial advisers to look up life expectancy may dramatically understate reality for many of their clients. To illustrate, using a simplified lookup table approach has men living 19.9 years and women 22.5 years on average beyond the typical age of retirement, which is currently around age 65 years, according to The Australian Government Actuary (however, these figures were from 2016 and don’t allow for improvement trends).
Also, more than 50 percent of retirees live longer than the average, creating a significant risk that pensioners’ retirement funds (and thus income) may run down and possibly out before they die. “They may end their lives living in a caravan in their daughter’s backyard. Longevity risk is the least understood risk in retirement by most working Australians,” said Mr Orford.
A long-term focus and the aged pension
This point is underscored by Anthony Asher, an Associate Professor in the School of Risk and Actuarial Studies at UNSW Business School, who observed that we don’t normally hear from retirees whose savings have run out. “They’re usually too old to complain that they’ve run out and they’re at a disadvantage. They are highly unlikely to blame the system at that point; they blame themselves that they didn’t save enough in retirement,” he said.
This also comes back to focusing too much on short-term investment and other problems earlier in life, Associate Professor Asher added. “As a society, we spend far too much time focusing on short-term investment issues around liquidity and accumulating money and tax dodges, when we should really be focused on something that is much longer term. But we don’t know how much to save. We also don’t have a bottom drawer product (apart from maybe the Age Pension) to help us come out at retirement, where we can just draw the pension and savings down in a way that delivers a relatively smooth flow of money.”
Mr Orford also said lifetime pensions are important in offsetting the cost of the Age Pension, which is going to cost the government (and thus taxpayers) significantly more over the coming years unless it introduces lifetime pensions. “Young people are going to have to pay more tax to support all the old people in the country that are on Age Pensions. These are the baby boomers and there are a hell of a lot of us. And we are living a really long time, so the cost is going to be really high,” he said.
“Lifetime pensioners will get far more income after they pass their life expectancy, and 50 per cent of us do live that long. Those people that do use lifetime pensions will receive at least 30 per cent more income from their superannuation account balance. The government has set the scene, but industry hasn’t responded to the opportunities.”
The role of financial advisors
There are a number of reasons why industry has not responded with appropriate solutions. One of the more significant contributing factors can be traced back to the financial advice industry. In retirement, Associate Professor Asher explained that investment-linked annuities are relatively new and trustees are also hamstrung by restrictions on their ability to explain the new products on the market. The federal government’s Quality of Advice Review also recommended that things be made easier for super funds to provide advice to their members.
“About 25,000 people are retiring a month, but they don’t have much guidance. They can’t get guidance from their super funds,” said Associate Professor Asher. “They can’t get guidance from financial advisors, because they charge an absolute bomb. And in many respects, they haven’t been able to get suitable products. David (Orford) has been involved in developing one with Generation Life, Q Super (part of the Australian Retirement Trust) has one, Allianz has one, AMP has one and Challenger also has an investment-linked annuity, so they are coming.”
However, there is still “a great deal of reluctance” on the part of advisors to suggest them because they get income from giving you advice, and they have an interest in continuing to give you advice throughout your retirement. “A lifetime annuity means that I’ve parked it. My dad was on a defined benefit pension plan. They just pay you the amount, you spend it and you don’t have to worry about it. And you don’t need a financial advisor after you’ve made the decision. Now that makes it quite difficult for financial advisors to tell people that they should have lifetime pensions,” he said.
Superannuation funds, products and advice
Mr Orford underscored the challenge posed by financial advisors and observed that many superannuation funds employ advisors. “But most super funds don’t offer a lifetime product – a real lifetime product with longevity protection. They offer account-based pensions. So, there’s a conflict between what the advisor can offer as part of their super fund, and what they should offer, which is some longevity protection. These are some issues that we need to get through in the quality of advice review. We need recommendations whereby people need information which is sufficient to enable them to make an informed decision.” he said.
Mr Orford said more super funds should be taking advantage of the legislation to offer lifetime products, because they are meant to act in their members’ best interest. “And if they don’t have a lifetime product to offer to their members, then they’re not acting in members’ best interests. They might disagree with that view, but that’s my view,” he affirmed. “Retirees don’t need to invest 100 per cent of their account balance – just enough to get the longevity protection that’s right for them.”
More information and advice are needed to help educate people – and he said it’s challenging for this education to be provided through financial advisors because of the aforementioned reasons as well as the fact that the number of financial advisors in Australia has dropped from 25,000 down to 15,000. “Each advisor can only really look after about 100 people, so that’s 1.5 million people, that’s just not enough. We need a new breed of financial advisors, we need more of them, we need to loosen the rules and we need another form of advice or kind of information to educate people,” said Mr Orford.
Consumer awareness and attitudes
Another contributing factor lies in a lack of awareness of lifetime pensions as a better option for retirement (in addition to a general lack of engagement in retirement and superannuation-related matters, particularly on the part of younger generations). “The average Australian is not aware of this product. That’s a real problem. And we need to educate them on its benefits,” said Mr Orford, who cited a federal government report which examined consumer attitudes towards such products. When lifetime pensions were explained to survey participant groups and they understood that they could get an income for the rest of their life (that increases with inflation), roughly 50 per cent indicated they would be interested in buying such a product.
“That’s the market. So we can’t use the word annuity or pension. But if we say it’s an income for the rest of your life (or some other similar phrase) then this is what people want. From a financial planning point of view you want an income for the rest of your life when you retire. Retirees are often too scared to spend their money due to fear of running out. But you don’t need an income after you’re dead, and you don’t need to leave money to your children,” said Mr Orford, who noted that at least 30 per cent (and up to 90 per cent) of super balances are projected to end up being paid out as a lump sum death benefit to children. “This is probably an ‘unintended consequence’ of our superannuation system – leaving tax-enhanced money to the children of members.”
Similarly, Associate Professor Asher also noted a reluctance on the part of some people who don’t want to draw down on their superannuation savings and prefer to keep these as a nest egg for later in life. He recalled conversations with some wealthier individuals working in the financial industry who are able and happy to retire on their dividends and/or non-super savings. “They might have $3 million on a flat 4 per cent (which equates to $120,000 a year); that’s a lot of money, you don’t need anymore. It’s the folks that are sitting between $100,000 and $500,000, which is about 70 per cent of the retirees – they’re the ones that need the lifetime annuities, but managers in the industry just can’t see it. There is also a backlog of older retirees who could not access lifetime annuities in the past. Once you get to age 75 years and your super balance is getting lower, your life expectancy is also shorter and annuities are even more attractive,” he said.
Healthy priorities in retirement
Another important consideration for ageing retirees is declining intellectual capacity, which opens the door to elder abuse (very often from within the same family) as a result of increased vulnerability, according to Associate Professor Asher. “Parents will often draw on their retirement savings and give it to their children who come up with stories about needing money for grandchildren or their business or another reason. Lifetime annuities protect the elderly against this kind of abuse, because once you’ve locked them in there is no going back. So, there is an argument for their case from a social welfare perspective too,” he said.
Mr Orford underscored the importance of physical and financial health and cited a longitudinal survey of 26,000 American retirees (conducted by the University of Michigan) that has been running for just over 30 years that has consistently found there are only three things that are of real importance in retirement. The first thing retirees value is their health. “Because if you’re not healthy, you’re not going to enjoy life. Health is number one,” said Mr Orford, who added the second priority is money. “The survey shows that the more money you have, the happier you are. And related to this is the third priority, which is a regular income that is payable for life. So, people who have worked all their lives, they need to be happy because they’ve earned it.”
This research underpinned an analysis which underscored the importance of the third priority: receiving a regular income without worrying too much about investment and fully reinsuring longevity risk. “This increases retiree’s happiness, and that’s great news,” said Mr Orford, who concluded: “But we’ve only got just a small fraction of Australians who are not in defined benefit schemes getting longevity protection in their retirement. What about the rest – they also deserve happiness in retirement right?”
The Innovations in Risk, Insurance and Superannuation (IRIS) Knowledge Hub serves as a bridge between UNSW, the insurance and superannuation industries, regulators and public policy. The hub is currently undertaking two research projects, funded by the Orford Foundation: Supply-Side Failures in the Annuity Market (led by Associate Professor Anthony Asher) and Explaining Consumers’ Progress through Annuity Decision States (led by Professor Hazel Bateman, with Associate Professor Katja Hanewald, Jiamin Yan and Chelle Wang).