Every Australian deserves a confident answer to basic questions like “How much do I need to retire?”, “How much can I spend in retirement with a high level of confidence?” and “How much Age Pension can I expect to receive?”. They also need to know how this will change if they contribute more or less to superannuation. However, the mathematics and assumptions to answer these basic questions with high confidence are surprisingly complex and deeply ‘actuarial’.
Over recent decades, financial risk and decision-making that used to be shouldered by governments, employers and financial services providers have increasingly been transferred to individuals. This is a global trend and is referred to by The Institute and Faculty of Actuaries in the UK as ‘The Great Risk Transfer’.
Consumer and behavioural research shows that individuals are often not equipped to deal with the complexity of the decisions required of them. In Australia, superannuation is the second-largest asset most people will ever own and generates about half the income received by retired Australians. Deciding how to draw down from superannuation is particularly complex, especially for the over 840,000 Age Pensioners (about a quarter of those over 65) who are currently impacted by complex means tests. They can receive highly erratic cashflows because the amount of a part Age Pension varies considerably with the value of the pensioners’ assets rather than the amounts they draw down. Despite this, only a minority of Australians engage with a financial planner.
The Government and regulator (ASIC) believe technology has the potential to help bridge this advice gap. Examples of this are online calculators, projection tools used by planners and digital advice systems.
The Actuaries Institute has recently published a set of Good Practice Principles to help raise standards for the modelling behind these tools. The principles are also relevant to the user interfaces and the documents they produce, which are the artefacts subject to regulator scrutiny.
Retirement models are needed by:
- Retirees: To make informed decisions about managing capital in retirement that considers the Age Pension and risk.
- Financial planning firms: To ensure their advisers have the tools to model risk and retirement trade-offs in a prudential way that is on par with the standards used elsewhere in the financial services industry (e.g. where financial institutions manage their own risk exposures) and in other industries where consumers face risk.
- Superannuation funds: To provide engagement/educational tools for their plan members, for product design and for member retirement estimates and advice.
- Regulators and policymakers: For making policy decisions that affect retirees, as well as modelling the macro-economic impacts of retirement system settings and ensuring intergenerational fairness.
- Those who design products: For example, adhering to the new Design and Distribution Obligations.
Australia is sometimes quoted as having the most complex retirement system in the world. It is vital that the technology to help solve the advice gap meets very high standards. Like in other industries (such as health, automotive and construction) the public relies on highly trained experts to design infrastructure that is safe and easy to use but takes risk and complexity into account on their behalf. Consumers need to be able to trust the expertise of the professionals who build and maintain the infrastructure that we all depend on when making retirement planning decisions.
Actuaries are naturally placed to contribute to the setting of appropriate standards for modern retirement modelling. Retirement modelling involves assumptions about the future and differences in approach can lead to significantly different outcomes. A level of standardisation across the industry can help consumers. Models are of little value unless retirees can have full faith that they have been built by and audited by appropriately qualified professionals who work to the highest ethical and professional standards.
The Actuaries Institute principles are based on a paper I co-wrote and presented at the Financial Services Forum in 2016 – to encourage good practice in this area in Australia.
The high-level principles are listed below but the explanatory notes for each one are important. A key principle is the need for models to calculate the probability that a household’s lifestyle will be sustainable for life – in light of market risk, inflation risk and uncertainty around their potential lifespan. See Principle 2. Surveys show that top concerns of retirement relate to the fear of outliving their savings.
Principles about the scope of a retirement model
- Principle 1: Retirement models should provide information and results that focus on the household’s financial goals, the most important of which are their lifetime consumption needs and wants.
- Principle 2: Models should be able to demonstrate the variability of future outcomes to facilitate informed trade-offs (e.g. using stochastic models).
- Principle 3: Models should be able to project all significant assets, liabilities and incomes at the household level (e.g., all super, non-super and income sources for both spouses of a couple).
- Principle 4: Models should consider all issues that will have a material impact on future outcomes so that informed decisions can be made.
- Principle 5: Retirement models for households who are still working should take into account a household’s ability to change its circumstances over time (e.g. saving more or working for longer, including part time).
- Principle 6: Models should be able to provide year-by-year projections of expenditure and assets and be able to allow for changes in personal circumstances and expenditure levels in any future year to allow for dynamic behaviours (there is an interplay between spending level, asset values and hence investment income and Age Pension income).
- Principle 7: Except where required by legislation, economic and investment assumptions should be set on a central estimate basis. Variability around the central estimate should be accompanied by disclosure on confidence levels.
- Principle 8: Models should consider the range of uncertainty for an individual’s/household’s (joint) lifespan and include a realistic allowance for future mortality improvements (it is inappropriate to use population average life expectancy).
- Principle 9: Models should be able to facilitate annual reviews to take into account the household’s actual experience.
- Principle 10: Models should come with an easy, standardised summary of what has/hasn’t been modelled and certain key assumptions.
- Principle 11: Models should be built to be easily updated as required to consider changes to assumptions and legislation.
|Read the Institute’s information note Good Practice Principles for Retirement Modelling.|
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