New framework from Mercer is first to test retirement strategies
against income expectations and needs, not just returns
Australia’s retirement income challenge needs to be re-framed, according to Mercer. Super funds need to re-state their investment objectives in terms of what matters most to members - which is the level of income they can expect in retirement - rather than focusing solely on returns.
More importantly, super funds need to be able to test retirement income strategies against their members’ retirement income based objectives, which is a complex task, says Mercer.
A new report by Mercer titled, ‘Retirement Income: A framework for a complex problem’, outlines a new framework for super funds to test and determine what the best retirement income strategies and products are, in order to meet the needs of their retired members.
The framework and modelling approach is the first of its kind in the superannuation industry and is a significant step forward in helping super funds better understand the retirement income needs and expectations of their members, and how the likelihood of achieving that income will be impacted by adopting different retirement strategies.
Mercer’s report was co-authored by Principals at Mercer, Jacki Chorazy and JP Crowley. Ms Chorazy said, “The entire superannuation industry, not just pockets, has to shift its focus from wealth maximization to investment objectives based on members retirement income needs and expectations.
“The development of new innovative retirement income solutions remains absolutely critical, but it’s only half the battle.
“Unless we develop clear retirement income objectives and a strong framework for comparing different products and solutions, it will remain very difficult to confidently determine the strategies and products that best meet the needs of retirees and the industry is unlikely to solve the retirement conundrum we face today,” Ms Chorazy said.
JP Crowley added, “Defining retirement income based objectives as opposed to simply aiming to outperform CPI plus a margin is not a simple task and this complexity has stifled innovation in this area to date, but we believe our new framework will change the game,”
“Our framework and modelling cuts through the inherent complexities in the retirement phase of super. It allows us to test the efficacy of different retirement strategies against criteria we know is important for retirees,” he said.
Mercer’s Retirement Income Framework combines member outcome based investment objectives with tools to assess potential retirement income products and suites of products against a member’s expected income in retirement. The framework is based on three pillars that are fundamental to the analysis of the retirement phase; Adequacy, Sustainability, and Behavioural Finance.
While acknowledging the benefit of universal yardsticks such as ASFA’s Retirement Standards, Mercer believes their absolute nature makes them inherently unable to account for the subjective nature of adequacy and differentiating factors, such as retirement balance and Age Pension entitlements, across a broad membership base.
Mercer’s adequacy test, the first pillar, defines the levels of income required to afford the ‘essentials’ and ‘extras’, considering them from an absolute and relative perspective.
The second pillar, the sustainability test, prioritizes the need for members to sustainably afford the ‘essentials’ for the rest of their life, taking into account longevity risks, but it also seeks to maximize the probability they can afford the extras.
dequacy and sustainability are inextricably linked when it comes to retirement incomes, but the third pillar in the framework, behavioural finance, is less understood by the industry.
Mr Crowley said, “The third pillar is crucial because it ensures our framework is not overly reliant on investment theory and takes account of factors such as a retiree’s increasing conservatism as they get older.
“The super industry’s focus on the retirement challenge is only intensifying with the likes of the Financial System Inquiry’s (FSI) recommendations and recent Intergenerational Report. There is growing appreciation that we need clear objectives for the superannuation system enshrined in legislation and that these should be positioned in terms of delivering incomes in retirement. We believe our Retirement Income Framework is a critical tool in helping the industry work towards this goal and overcome the retirement income challenge,” said Mr Crowley.
Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in more than 40 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy and people. With 57,000 employees worldwide and annual revenue exceeding $13 billion, Marsh & McLennan Companies is also the parent company of Marsh, a leader in insurance broking and risk management; Guy Carpenter, a leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a leader in management consulting. For more information, visit www.mercer.com.au Follow Mercer on Twitter @MercerAu