Living longer is usually viewed positively. However, if one’s assets are outlived, longevity can be another story entirely: The 2015 HSBC Future of Retirement report states that 72% of working-age Australians are concerned they will run out of money in retirement.
Australia’s retirement system is recognized for its strength – the Mercer Global Pensions Index for 20141
ranks Australia’s retirement system as #2 of 25 countries overall and #4 for sustainability.
Currently, most retirees achieve a ‘Comfortable’ living standard2
by combining their savings with a full or partial age pension from the government, which about half the population now relies upon at least partially. Those scheduled to retire in the next five years, according to a white paper on retirement by the Australian Actuaries Institute3
, are planning to rely mostly on the age pension, which right now comprises 44% of the total retirement income for Middle Australia (50% of the population).
The older cohort is growing fast: according to the 2010-12 Australian life tables, the average 65-year-old male in 2011 could expect to live to 86, and 2050, to age 914
. In addition, those 65 and older will increase by 2055 to 23% of the population, so instead of 4.5 working-age people supporting every over-65 individual, in 40 years there will be just 2.7.
Age-related costs could definitely burden Australia’s pension system in the future. Over the next 40 years, age-related expenditure is slated to rise by 3% of gross domestic product, according to the 2015 Intergenerational Report (IGR).5
Younger cohorts might benefit from a longer period of compulsory superannuation contributions, but forecasted budget deficits and debt due to age-related spending would have to be funded by increasing taxes on younger generations or reducing government services6
. As Australia’s population ages, it could become politically more difficult to make policy changes that will impact age-related spending.
The recent increase of Australia’s pension eligibility age to 67 by 2023 might help retirees sustain their savings longer, but more can still be done. Workforce participation rates for older individuals could be increased by removing superannuation contribution age limits and linking the pension commencement age to longevity. Australia’s work culture could be changed so that those who need to continue to work have employment opportunities. Insurers could assist by finding ways to provide affordable insurance cover to these older workers.
At this point, however, longevity risk is a reality for older Australians. Account-based pensions, where retirees choose where to invest and how quickly to draw down their pension savings, continue to be attractive (making up 94% of pension assets in Australia) because they are flexible and easily understood, but they retain all of the investment and longevity risk.
Generally, the more longevity risk is shifted to the private sector, the lower the overall risk is to the taxpayer.7
But the 2014 Financial System Inquiry (FSI) report noted that superannuation assets “are not being efficiently converted into retirement incomes due to a lack of risk pooling and an over-reliance on account-based pensions,”8
so pensioners are bearing longevity risk as well as the risk of their pensions losing much-needed value. The use of products that pool longevity risk could increase their retirement incomes by 15% to 30%.
Significant change would need to occur to encourage the use of viable longevity protection products such as annuities, which currently only have a limited product offering. Tax barriers and other regulatory impediments to developing income stream products would need to be removed – a move supported by the FSI.
To help achieve this, superannuation fund trustees could opt to preselect an annuity-type Comprehensive Income Product for Retirement (CIPR) for account members. Such a product might provide a regular stable income stream as well as longevity risk management and flexibility.
However, if the CIPRs are not compulsory, would there be enough takeup and pooling of risk?
Arguments against annuity products9
, such as loss to beneficiaries of the remaining capital upon early death and poor potential returns due to the current low interest rate environment, are of course out there. Although the cost vs. perceived benefit of guarantees might be challenging to manage due to low interest rates, developing and selecting the right products and strategies can mitigate these risks.
Even though various longevity product innovations have been attempted in the last seven years with only limited success, there are clearly opportunities in Australia’s retirement income market. Regulatory and tax changes are difficult to effect, but other changes, such as improved member guidance and advice as well as richer product offerings, are within the control of the superannuation and insurance industries.
Some change seems worthwhile to improve the efficiency in a retirement income system that is already a cut above the rest. Fortunately, considerable research seems to be under way on this topic, and interest from both government and industry continues10