With the Financial System Inquiry (FSI) due to release its final report to the Treasurer within weeks, Rice Warner senior consultant Alun Stevens reaffirms the importance of superannuation funds delivering an effective, long-term default framework for retirement incomes.

The much-anticipated final report of the Financial System Inquiry (FSI) is expected to be delivered to government within the next couple of weeks.  Retirement incomes and the financial services needed to support them will feature prominently.

Many commentators consider that super funds should have a default retirement product and that members should move seamlessly into these products.  It is Rice Warner’s considered view that product alone will not resolve the underlying issues.  An effective, cogent default structure will provide older members with a package to deal with the complexity of retirement adequacy.  Based on its interim report, Rice Warner expects the FSI to make key recommendations around retirement incomes.

It is hoped these recommendations will recognise the essential need for flexibility and account for the need for high levels of growth assets to protect against inflation and longevity.  Australia’s superannuation pool has been enhanced by the wise decisions to invest heavily in growth assets for the last 25 years (far more than in other jurisdictions).  Similarly, retirees will benefit from enhanced earnings on their pension accounts.

Rice Warner believes the best approach is for the industry to establish a number of principles that need to be applied to default retirement structures.  These would include adequate:

• Provision to be made to meet essential expenditure (lump sum benefit) at point of retirement – free of risk of market fluctuations.
• Provision to ensure stability of incomes in retirement.  This should be based on income of four per cent to six per cent of the retirement account balance each year.
• Provision to ensure incomes are protected against inflation throughout retirement.
• Provision to ensure that incomes last as long as possible and preferably for life.
• Flexibility to allow members to respond to changing circumstances and the contingencies of life.

In Rice Warner’s submissions to the FSI and in our comprehensive analysis provided to clients, we have recommended a flexible, comprehensive default system that also provides for:

• A nominated default ‘retirement’ age around which the solution can be planned, but which members can change.
• The movement of assets to a stable investment portfolio (probably cash) in the lead up to this age to meet expenditure requirements at the point of retirement and income requirements in the initial stages of retirement.
• The retention of the remainder of assets in growth assets to provide inflation protection and the maintenance of income over the longer term.

This allocation to separate ‘buckets’ and the movement of assets will need to be linked to customer segmentation and profiling as the solutions for those with high balances will not be the same as for those with small balances.

• The communication of this approach to all members (and their partner where possible) and the active engagement with members some five years prior to the default retirement age.
• Advice to support members.

Funds will also need to cater for members with different objectives.  Some will be risk averse and want capital security through short duration Term Deposits or longer term annuities.  Other members will want to draw more than six per cent of their balance each year so they should not be placed in volatile asset classes to the same extent.

 Whatever the recommendations of the FSI, all super funds will need to develop better solutions to cope with the growing numbers of baby-boomers entering retirement.

Alun Stevens, Senior Consultant