NetActuary

Evolution of Pension Planning

In each of the SPAA conferences in recent years there has been at least one session on turning retirement assets into retirement income.  It is fascinating to watch the evolution of thought and collective wisdom progression.  Here is a summary of the good (and not so good) comments which were presented this year.

There is a very clear awareness of the sequence of return risks with drawdowns via an ABP.  The probabilities of outcomes – other than averages on the mortality side – are being well articulated.  SMSFs have an additional issue in that members tend to be more “white collar”, better educated and wealthier and this correlates to longer life expectancy than the average for the population – even allowing for trend improvements.  Presenting longevity as the opposite to mortality risk is neat.  Life insurance hedges against mortality risk.  Lifetime annuities hedge against longevity risk.  Life insurance becomes more expensive as you get older, while lifetime annuities become cheaper.

What is poor in these presentations are examples that don’t take the Age Pension entitlement into account.  This presents totally erroneous values of the level of income that is sustainable.  Even couples with considerable assets now, will have substantial Age Pension entitlement at some stage and the potential offset should be incorporated in a realistic plan.

The other aspect that I find most unfortunate is the lack of benchmarks in advisors’ heads about how future income will vary if you need to rebalance to longer payment durations for survivors.  If you start early and make small, frequent adjustments you can get a smooth appropriate income run in most cases.

How the mighty immediate annuity has fallen!  From talk of compulsory annuitisation some time back, there is now discussion on the problems of annuities regarding both the demand and supply sides.  On the demand side, the perceived shortfalls are:

• The risk of failure of the issuing organisation at some stage over a 20-30 year risk horizon – even if well regulated;
• Perceived poor value in the terms offered from a market with virtually no supplies;
• Lack of flexibility to deal with flexible retirement patterns;
• Social security and tax issues; and
• Loss of capital to bequest.

On the supply side the insurers have problems with:

• Capital adequacy requirements;
• The lack of long dated assets;
• High distribution costs; and
• Virtually no reinsurance available.

Personally, I think the pendulum has swung too far.  It is worthwhile (for example) to use an immediate annuity for some portion of the monies at some stage of the life of the member.  Annuities are suffering from the inability of consumers to establish quickly and easily what sort of return they are being offered.  They can’t separate what is return of capital and net earnings in each payment, or what is the internal rate of return.  This is an issue that NetActuary will solve for potential consumers with a complimentary and simple calculator to be available soon.

OK.  What is the next practical step to helping clients in this area?  There are quite a few steps that are necessary.  The first is to prepare more technical notes and other material to explain to retirees what longevity, market and inflation loss dangers they face.  The next step is to enhance the models so that all three risks can be consolidated into one plan.  The solutions will be different for each individual and will have a solution that has Age Pension, possibly some product, and certainly some process/strategy solutions.

For myself personally, I have another challenge.  I need increasingly to take the step beyond helping a small group of advisers to developing the tools and processes which bring this to a wider audience.

 
The NetActuary Team

 

SuperStream Exposure Draft

An exposure draft of the SuperStream reforms to make the processing of transactions faster and more cost efficient has been released.  The aim is to replace paper-based transactions with mandated data, payment and transmission requirements i.e. an e-commerce approach.  These mandated standards apply to both superannuation entities and employers.

The Commissioner of Taxation is given new powers in relation to these standards.  In particular, the Commissioner may issue standards by Legislative instrument after consultation with APRA.  There is a penalty regime for non-compliance.  There is flexibility for different types of superannuation entities.  The initial focus is on roll-overs, contributions and registration of new members.

The new standards apply to superannuation entities after 1^st July, 2013.  They apply to medium to large employers on 1^st July, 2014 with effect from that date.  For small employers at 1^st July, 2014 they apply from 1^st July, 2015.  A small employer is defined as an employer who employs less than 20 employees.  All employees are counted.

It’s not clear to me exactly what challenges this new legislation is likely to throw up for SMSFs and small employers.  NetActuary will keep a watch on developments in this area with a view to creating solutions for any difficulties that may occur.  It may be an area where accountants are ideally placed to handle the requirements on behalf of small clients.  In a way, this would not be dissimilar to clearing houses operating for large funds and employers.  It is likely that special computer/web applications will be needed to handle the e-commerce transactions.

The NetActuary Team

 

UK Annuity Chaos

With the push for annuities in Australia, it is worthwhile to monitor countries with experience in this area.  The UK has abolished the requirement for pensioners to use part of their retirement monies to buy an annuity.  It is now possible to use income drawdowns as an alternative.  The reduction in interest rates means that currently a £100,000 purchase price buys only an annuity pension income of around £3,800 p.a. in the UK for a 50% reversionary, 3% escalation joint life policy with no guarantee period.

The Pension Institute and the National Association of Pension Funds engaged one of the top business schools’ Sir John Cass (at City University London) to undertake a study.  It does not make comfortable reading.  They found that a 65 year old man wanting annual cost of living increases and a spouse pension might need to die after age 90 to even get their own money back – let alone any investment gain for their cash!

Retirees who like to monitor the rate of return they receive find it impossible to worth out a “clean rate” based on mortality and net of expenses gilt returns for these products.  To quote the study: “without this, it is impossible to know even if the best available rate is fair”.  The study found that 80% of the annuity purchases were under £50,000 – a “level at which advisers earn too little to bother offering individual help”.

There was a severe lack of transparency about how annuities were priced especially for those with medical conditions who could qualify for enhanced “impaired lives” payments.  Annuity rate bands in the UK have “cliff edges” which means that rates outside of that suddenly drop off in the expectation that the insurer’s first quote will be accepted.  So, lower rates are perversely offered to those that are not healthier (correlated to wealthier).

The advantage that the UK retiree does have is a reasonable number of providers to enable shopping around.  I am not opposed to annuities – I would love to see a strong, fair annuity system operating in Australia with retirees having the ability to voluntarily purchase these products, not being compelled into what might be an unsuitable product for them.  Deeply deferred annuities may be a good starting point to develop this market in Australia.  However, even the current Australian contracts available are worth looking at.  A check which I did in the past few days showed about a 3.5% net real rate of return.  That is worth considering.

What can NetActuary do to assist retirees?  As a minimum we can develop a tool that allows retirees to evaluate what is the net rate of return they are receiving on their products.  By using expected mortality and feeding in the purchase price and annuity payments offered, we can evaluate what is the net return.  Having to allow for multiple lives and yearly increases is hardly going to require an actuary to go back to his text books – even if it is a difficult calculation for an average retiree.

 

The NetActuary Team

 

 

 

Changes Observed in the UK

I like going to Britain! 

3D television uses two slightly different pictures to give a sense of depth.  That’s what the UK market provides for me.  This trip's insights have not been in the pension area.  Changes there are basically to push back "auto enrolment" dates for small business.  This is the Brits copying our SG system.  There is also the usual outrage about bankers’ salaries and pensions and Sir Fred (the ex Royal Bank of Scotland CEO) losing his knighthood!

What is far more useful is how ordinary people are buying goods and services.  I was sitting in the study in my Cotswold Cottage looking out at the sun (and minus six degrees). This window affords a view of two of the three roads in the village.  A TNT van shot down one street, while at the same time a FedEx van appeared from the other direction.  Minutes later, a department store lorry (see I speak local!) appeared.  Stores are becoming small display areas and collection points.  The real trading area is the online store. Goods often don't even come from the store, but rather direct from the manufacturer.  I have got used to going to Debenhams if I want a British Telecom service centre, House of Fraser for a Virgin travel agent or WH Smith for a Post Office, but it was a surprise to see a "legal services access point" in the same WH Smith newsagency!

Some innovations impress me.  BT and FON have linked to provide 3 million WiFi access points in the UK.  Yes - you read that correctly ... 3 million hotspots!  What they are doing is providing a lot if you give a little.  Let me explain.  Virtually all of their broadband routers supplied to customers can accept an outside signal ... they are piggy backing the infrastructure.  The customer gets a world-wide WiFi pass for no cost; the router does not visibly slow their connection; it has firewalls so there are no dangers there; and people like me can pay BT-FON for access all over the place!  We need that sort of creative idea for our businesses.

The government’s aspiration is to give 90 percent of homes and businesses fibre-optic super broadband with speeds up to 300mbps by 2015.  Some of it is already running.  Businesses like booking companies are relocating from places like London to villages in Cornwall.  If you are a smaller Australian firm or a regional firm like NetActuary, project your business forward a few years.  We will have the advantage of lifestyle without the disadvantage of not being in Collins or Pitt Streets.  This is also a space where we need to see collaboration as an opportunity rather than a threat.

The NetActuary Team