Ensuring all retirees find a suitable retirement solution - Part 2

Part 1 of this article covered the retirement income covenant (RIC), where it seems to be headed, different kinds of retirees and some implications for how a super fund might cater for each type of retiree.

Part 2 details why fund-guided choice must be accommodated, safety net for those who don't choose and implications for the retirement system framework. There are three reasons why it would be worthwhile to accommodate the fund either recommending a solution to a retiree, or choosing one on their behalf are: some retirees might prefer it; their fund might come up with a better choice in some situations; it accommodates nudges.

The idea of fund-guided choice accords with the concept of libertarian paternalism (Thaler and Sunstein, 2003). It also accords with the suggestions of the FSI (2014) and the Productivity Commission (PC, 2018), both of which proposed putting forward recommendations to fund members to overcome behavioural biases and other hurdles to effective decisions.[10]

1. Some might prefer their fund to choose

The idea that some people just want someone to choose for them not only seems intuitive but has evidence to support it. Findings from a number of studies[11] are consistent with many super fund members being willing to trust their fund; and many embracing the default option not because they are disengaged, but because trust coincides with lack of self-confidence to make financial decisions. These studies also provide evidence that defaulting behaviour can coincide with broader signs of engagement. There is a strong hint in this research that many retirees are looking towards their fund for guidance, in particular those who are daunted by making financial choices.

The fact that decumulation is a more complex problem than accumulation might further fuel apprehension over selecting a retirement solution. Retirees who feel like this might welcome an opportunity to ask their fund to either assign them to an option or be presented with a recommendation, rather than being forced to choose for themselves, or seek out and pay for financial advice. Remember that some retirees might not possess even the basic skills required to use online tools or interpret intra-fund advice, let alone understand a Product Disclosure Statement. A fund-guided choice option might come as a relief for such individuals.

2. Fund-guided choice might (sometimes) provide better outcomes

Fund-guided choice might lead to better outcomes in some situations, specifically for many retirees who are not willing or able to take comprehensive financial advice. A majority of people have quite low financial literacy.[12] Added to this are the findings of behavioural research that suggest people can make poor choices,[13] especially when faced with complexity and choice overload.[14] In these situations, they might resort to making decisions based on simple rules of thumb or ‘heuristics’. They can be influenced by biases related to information availability and framing effects, or follow uninformed recommendations from friends, family or social media.[15]

People tend to suffer from myopia, and might struggle to account appropriately for the retirement time horizon or the compounding of returns over that horizon. Some might become prey to unscrupulous providers and marketing puff. Status quo bias and inertia can also play a role, as well as cognitive decline as people age. Further, people can struggle with interpreting financial disclosures, as ASIC (2019) points out. The Productivity Commission (see PC, 2018) placed particular emphasis on behavioural effects under choice as lessening the efficiency and competitiveness of the superannuation system.

Signs exist that the type of influences described above are at play. A vast majority of retirees (83%[16]) invest in account-based pensions and follow the minimum drawdown rules, which they appear to anchor on.[17] It is entirely possible that many retirees do so as these options are presented most clearly to them and are taken as a recommendation.

The Retirement Income Review (RIR, 2020) discusses how these features are contributing to inefficient use of retirement savings, serving as a warning of how choice does not necessarily generate the best outcomes.

Whether fund-guided choice would provide better outcomes than retirees choosing for themselves is difficult to assess. On one hand, only the retiree fully knows their own personal circumstances. Funds will not have complete information on their members and could assign retirees to options built for broad cohorts that might not be entirely suitable. On the other hand, funds could have better capability to determine what is the best option relative to a retiring member who makes poor choices under the influence of low financial literacy and behavioural hurdles.

Offering retirees the option to have their fund either recommend or choose an option on their behalf, ideally accompanied by well-presented information and interactive calculators, would allow people to balance these considerations. They can then decide if they are more comfortable with either choosing for themselves or accepting what their fund recommends.

3. Fund-guided choice can accommodate nudges

Fund-guided choice can have the spin-off benefit of providing scope for nudges[18] to be introduced into the decision process that could lead to better outcomes for retirees. Both FSI (2014) and PC (2018) explicitly suggested putting recommendations to retiring members for this reason.

Innovative and beneficial solutions run the risk of receiving minimal take-up in a member choice environment if they fail to get traction with individuals or their advisers. Meanwhile, it is well known that default settings are very influential.[19] Fund-guided choice could help support a broader take-up of beneficial solutions by presenting them as fund recommendations or offerings, thus positioning these solutions as a baseline that retirees might be predisposed to follow. An example of the power of such mechanisms to drive change was including the scope to offer life-cycle options under the MySuper framework. While life-cycle products were previously available in Australia, the introduction of MySuper resulted in 35% of default assets[20] being invested using a life-cycle approach.[21]

Three specific choices are currently being made by many retirees that arguably limit the amount of value they extract from their retirement savings: minimal take-up of longevity insurance, lack of willingness to draw down on savings to the extent affordable, and investing too conservatively.

Addressing these issues should allow retirees to enjoy higher income for longer into retirement.

Fund-guided choice could assist by offering the member a solution that embeds a suitable mix of longevity insurance, higher drawdowns and growth asset exposure. This could establish a more appropriate point of departure for those retirees who opt for a form of fund-guided choice, from which they might deviate if they so wish.

A safety net required for retirees who do not choose

Our fifth disengaged retiree type are those who take no action once they reach retirement, either because they are totally disengaged, suffer from inertia or are simply too confused. It is hard to gauge how large this cohort might be. However, it is worth noting that there is $175 billion related to 1.2 million member accounts[22] invested in superannuation funds by those of age 65 and over that remains in the accumulation phase.

While there are a number of potential explanations,[23] there is a hint that a significant number of retirees might not have transferred their superannuation balance to the retirement phase due to lack of knowledge or apathy, and might be missing out on retirement income as well as paying unnecessary tax.

While the spirit of the Government’s retirement income policy appears to be that retirees always exercise some form of choice, we are concerned about outcomes for the heavily disengaged. The alternative of leaving them in the accumulation phase and possibly wholly unsuitable solutions needs to be avoided if at all possible. The next section provides suggestions for creating a safety net for this retiree type.

Implications for the retirement system framework

We argue that the retirement framework should cater for all the types of members highlight above, and the associated decision frames. Informed member choice, ideally supported by financial advice, should be seen as the gold standard.

Unfortunately, financial literacy is too low and comprehensive advice too costly and capacity constrained for a system based on self-directed and fully-advised choice to operate effectively for all retirees. Rather than relying on these two frames, the boundaries of choice should be expanded to permit retiring members to opt for a form of fund-guided choice. There should also be mechanisms to address retirees who do not engage at all. We now put forward suggestions for how this might occur through placing certain obligations on trustees under the RIC. Our suggestions are formed on the basis that the policy intention is for individual choice to sit at the foundation of the retirement system.

Fund-guided choice might be facilitated by placing an obligation on trustees under the RIC to engage with retiring members[24] to ascertain their preferred mode under which a suitable retirement solution is identified, and to accommodate their wishes accordingly. Figure 3 provides an indication of how the engagement process might be initiated by the fund through asking members to make a simple election at retirement. An election of the fund-guided choice options of A or B might then be followed by an invitation to furnish the fund with additional information to assist in making the selection of a suitable solution.

Figure 3: Choices put to a retiring member by their fund

Note: A prior step would establish the balance that the member wishes to transfer into a retirement solution with their fund

For members who fail to respond (i.e. ‘disengaged’ member type 5), there could be a further requirement to constantly attempt engagement to establish their retirement status and preferences. Those ultimately confirming their retired status could then choose their decision frame, including potentially outsourcing the choice of retirement option to the fund (i.e. request to be treated as ‘guided’ member type 4). No compulsory retirement default mechanism would be imposed under this approach. However, it could leave the accounts of some retired members in the accumulation phase. 

The most effective way of ensuring that totally disengaged members are assigned to a retirement solution would be to empower trustees to default members into a retirement option[25] under certain conditions.

A policy solution might be to legislate automatic transfer (say, at age 65) into a retirement account, with the ability for members to opt-out. The main challenge would be specifying the conditions under which an assignment can be made. One major hurdle is that the trustee would need a way of ensuring that the member is indeed retired, and be confident that transferring their balance into the retirement phase is in their best interests. There are also a range of operational challenges (one example being the need for bank account details to direct ABP income payments). While such a compulsory default mechanism runs counter to the prochoice sentiment outlined by the Government, it could be justified on consumer protection considerations.

Closing comments

Marrying up retiring fund members with a retirement solution that accords with both their desires and their needs is arguably the major challenge facing the superannuation industry in catering for retirees.

We argue that solely relying on retiring members to choose for themselves – be it either self-directed or advised – might not suffice to deliver reasonable outcomes for all types of retirees. We suggest that some retirees might welcome another kind of choice: the option to ask their super fund to select a solution on their behalf, either as a recommendation or an assignment. An effective method for achieving this would be to place an obligation on super fund trustees to engage with their members at retirement to establish their preferred mode for identifying a suitable retirement solution, which funds would then be required to deliver.

Consideration should also be given to how the retirement system will address the heavily disengaged who do not choose at all. While a default mechanism or the development of automatic transfer policy (potentially with the ability to opt-out) would provide a solid safety net, a second-best alternative might be to place onus on the trustee to continue seeking engagement with such members to confirm their wishes.

*Geoff Warren, Associate Professor, Australian National University and David Bell, Executive Director, The Conexus Institute.

Originally published here. Republished with permission from The Conexus Institute. 

References:

[10] For instance, FSI (2014, page 91) said the following about CIPRs: “Pre-selected options have been demonstrated to influence behaviour but do not limit personal choice and freedom. They would bring the policy philosophy at retirement closer to that of the accumulation phase.”

[11] See Bateman et al. (2014), Butt et al. (2018) and Deetlefs et al. (2019).

[12] For example, see Agnew, Bateman and Thorp (2013).

[13] Authors that discuss behavioural effects in a retirement savings context include Mitchell and Utkus (2006) and Benartzi and Thaler (2007).

[14] These issues are addressed in Section 5A of RIR (2020).

[15] Hirshleifer (2020) discusses social transmission bias.

[16] RIR (2020), see page 439.

[17] Discussed in Section 5A of RIR (2020), see page 445.

[18] See Thaler and Sunstein (2009)

[19] See Beshears et al. (2009) and Bateman et al. (2017).

[20] See Chant, Manokumar and Warren (2014).

[21] We do not comment on the efficacy of life-cycle products here, but merely illustrate the power of defaults.

[22] This estimate arises by comparing Tables 7c and 8a in the APRA Annual Superannuation Bulletin, (APRA, 2021).

[23] Potential explanations include: some members still working beyond 65; accounts over the $1.7 million cap; deliberate decisions to retain the funds in retirement to avoid drawdown; as well as lack of knowledge or apathy. (We thank Jeremy Cooper for suggesting this list.)

[24] Trustees currently have no obligation or incentive to do anything when members meet the age-related condition of release.

[25] This default could be designed to allow full flexibility under a scenario where the member subsequently engages.

For detailed references, please refer to the original thought piece.