Since March 2019, legislation changed such that instead of leaving pensioners to their own devices, funds had to have in place “default” retirement products, secured at institutional pricing and appropriate for the needs of most members. These “default annuity strategies” have been in place for almost 5 years now and funds have recently been reviewing the appropriateness of their chosen strategy.
Natasha Huggett-Henchie, Past President of the Retirement Matters Committee of the Actuarial Society of South Africa and Consulting Actuary at NMG Benefits
The results are alarming! In every review that we have undertaken, almost no one has selected the trustee default choice. The automatic conclusion is that the default product choice is inappropriate. Surely not all products – ranging from guaranteed annuities (with different types of increases) to living annuities to hybrid offerings (a blend of living and life annuities), and with a range of insurers across the industry – are inappropriate?
What exactly is the problem?
The simple answer is the advice that the pensioners are receiving prior to retirement. The reasons for this are:
- Members seem to follow a herd mentality of doing what the last person did! Are they simply taking “advice” from HR gatekeepers where the paperwork involved in offering an option other than just the cash is too onerous, or who get a kick back from the friend who is a financial planner?
- When a board has set up a retirement benefits counselling (RBC) service through the selected product provider there seems to be a “disconnect” between the parties. It’s the classic scenario: everyone is waiting for someone else to make contact and so nobody does. Even if systems are set up to allow the parties to get together, it’s usually either too late and the members have consulted with their own financial advisor, or there is a lack of trust towards the benefit counsellor.
- In some instances, members choose (to their detriment) “retail” versions of the cheaper “institutional” product that the board has selected. The reason usually given for this is that the investment choices on the default product are too limited. (Could it be capped commissions and fees on default products?)
So how do we solve the problem?
Firstly, there is an engagement and marketing perception around “free” RBC offered by the product providers. We all know the difference between the “free App” with limited functionality versus purchasing the full version, and the same seems to apply for RBC – a perception of a “lesser product”.
The solution is therefore for the parties to “buy” or at least to “buy into” the benefit counselling process. However, the key “purchaser” is the employer! The employer will be the primary communicator with the member as they retire. The employer and needs to facilitate counselling for staff (time off work, venue, catering, etc). The Financial Director who has paid for an RBC course is going to make sure that course takes place and is best value for money, compared to leaving it up to the parties to get organised around the freebie (see problem above).
Secondly, the process needs to start early! Contacting members 3 months prior to their retirement is way too late.
Thirdly, there needs to be trust between the parties. I am not going to listen to advice from someone around arguably the most important financial decision of my life unless I know them, and that they know what they are talking about. The best way to develop this trust relationship is through constant engagement and demonstrated knowledge. How? Training and talking to members, regularly and long before retirement.
The company needs to engage with a training provider who will start offering different levels of courses aimed at tranches of members: 10-6 years to go, 5-3 years away, 24-12 months and so on. The courses must be structured for the needs of those members and their partners (who should be able to attend), and they should attend repeat courses as they age. The training team should include a mix of retirement benefit counsellors and financial planners so that members can feel comfortable getting “unbiased” advice or information around what to do, without feeling that they will be “sold a product”. But at the same time having a qualified professional who is licensed to offer real advice for the specifics of the circumstances. Having repeated exposure over 5/10 years will build trust and vastly improve the outcomes for the members!
Lastly, it is also around the chosen default products. We live in a binary world of members choosing either a life or a living annuity. Products have emerged which start in a living annuity and transition to a life annuity as you age. However, that is also not optimal. The best solution based on actuarial modelling is a combination of both types of annuities from inception.
Figure one shows the traditional projection of having a guaranteed with profits annuity which could offer inflation linked income for life (brown line), compared to drawing income from a living annuity (grey bars) which starts off okay, but quickly tapers off as the capital (yellow line) reaches tipping point. If the member lives longer than age 76 their income reduces and the capital to be left to the beneficiaries is depleted.
Contrast this to figure two below where 75% of the retirement capital is invested in a guaranteed with profit annuity and 25% into a living annuity. The drawdown on the living annuity is structured to maintain the capital at roughly the same level over time. With the same starting capital, the member is able to maintain an almost fully inflation protected income for life and still leave a decent legacy to beneficiaries.
The split between living/life annuity is not fixed at 25/75 but would be dependent on an individual circumstances (consult a financial planner!). However, boards of trustees who build a default strategy which accommodates both, and importantly that communicates that a blended solution may be best in most circumstances, will improve the outcomes for the members who can be empowered to have the right conversation with their financial planner, rather than being directed where the commissions are highest.