Australian DC pensions: at-retirement market

The UK defined contribution (DC) pension market is well behind its Australian counterpart in many aspects. In a new series of blogs, we highlight the advancements the Australian DC pension market has made, and what this could mean for the UK in the future. In part two, we focus on Australia's ‘Retirement Income Covenant’.

Consolidation of pension funds as they accumulate member assets has largely been a success in Australia, but challenges have arisen in the at-retirement phase that can lead to poor outcomes for savers. 

One of the issues is members having a poor understanding of how much money they will need in retirement. Often, individuals do not draw enough from their pension pots, leaving assets when they die rather than live as full a life as possible. Capital preservation seems to be a key objective among retirees, often driven by advice provided by independent financial advisors (IFAs).

As it stands, when they hit retirement age, members are likely to transfer into account-based pensions where they are left to manage many financial objectives and risks by themselves. 

This results in the platform providers retaining members’ assets for longer, but not necessarily helping them to make wise decisions about how they take their retirement income, which could lead to poor outcomes. 

In this second blog looking at the Australian DC market, we examine what measures regulators are putting in place to deal with these issues – offering a glimpse into what the future may hold for the UK DC market as it continues its own journey towards improving at-retirement outcomes.

What is the Retirement Income Covenant?

The Australian Prudential Regulation Authority (APRA) is tackling these challenges through its Retirement Income Covenant (RIC), which came into effect on 1 July 2022. The RIC is a legal obligation requiring superfunds to have a strategy to help their members draw pension income during retirement.

While there were already covenants requiring superfunds to have an investment and insurance strategy, there was no covenant focused on encouraging superfunds to develop a strategy to assist members with their retirement income needs and objectives. 

This has led APRA to focus on the ultimate purpose of superannuation, which is to provide members with an income for life. 

The intended RIC outcome

The RIC puts the onus on superfunds to focus on what their members need in retirement by mandating them to have relevant at-retirement strategies that help people deal with investment risk, inflation risk and longevity risk.

The objective is to ensure superfunds have strategies for helping members manage the impact of these risks on their income. These strategies also need to be published on publicly available websites.

The intended outcome of the RIC is for members to spend down assets, to allow them a good standard of living in retirement. It combines the following three objectives:

• Maximise retirement income.
• Manage risks to the sustainability and stability of members’ retirement income.
• Facilitate flexible access to savings during retirement.

This should lead to increased innovation and competition among superfunds in the retirement space and better outcomes for members. 

All aboard?

Despite the admirable objectives of the RIC, the response to it has been mixed. 

Some superfunds have developed quite comprehensive strategies on their websites while others have just produced documents with two or three pages. The regulator is concerned that some providers are just repackaging propositions they have already created. 

Apart from a couple of exceptions, at the time of writing, the industry has failed to launch products that help with investment, inflation and longevity risks. 

The regulator continues to be frustrated by responses to the RIC and has undertaken a thematic review. The areas where it believes providers and trustees need to improve include:

• Addressing gaps in data to support strategy and enhance modelling and analysis to better understand how members’ financial position and retirement spending needs could change over time.
• Better tailoring of member communications and improving metrics to assess the effectiveness of assistance given to members.
• Developing metrics that focus on member outcomes to measure the success of retirement strategies.

It’s clear the regulator is turning up the dial, setting clearer objectives and increasing its demand on superannuation funds to provide more and better solutions for the at-retirement market.

What this all means for the UK

Why have Australian providers so far been slow to do more? Perhaps some have been reluctant to be the first mover and others may just be uncertain about what to do, taking time to analyse cohorts of savers. There is also little demand for new products from pension savers. And, of course, the cynical view is that if the status quo is maintained, providers retain assets for longer. 

But the RIC needs to result in members receiving the solutions they need. The current market of annuity products does not offer enough options, and the products offered are relatively unpopular. The regulator could also dig into solutions around longevity pooling, for example, or broader cohort-driven investment options. 

As the UK industry draws closer to recognising and working towards the consolidation solutions that help achieve better outcomes, we will keep an eye on the developments on in-retirement options in Australia. Maybe pension leaders from both countries can work together to create something that could benefit members on both sides of the world.