The financial services industry can learn an important lesson from the surprise Brexit vote, according to Milliman Australian practice leader Wade Matterson.
The British public’s decision to leave the European Union on June 23 came despite a weight of factual evidence warning of dire economic consequences, sending another wave of volatility through global markets.
“Why was there this backlash against these expert opinions that were well considered, well researched and well thought through?” Matterson said at a Milliman industry briefing in Sydney.
“What these experts were lacking was empathy for how people actually feel and respond.”
Matterson said there were strong parallels in the retirement industry, particularly as the industry slowly shifts its focus from the accumulation phase to drawdown and prepares to roll out default comprehensive income products for retirement (CIPRs).
“As actuaries we can deliver solutions, but if we base them purely in our own analytic framework without any hint of empathy that’s inevitably going to lead to a 50:50 or random outcome. We need to focus more on the behavioural aspects – what will encourage people to make the right decisions – and design solutions which also deal with some of the behavioural problems at the same time.”
More than 100 financial services executives attended the Sydney and Melbourne industry briefings on developing better default retirement products.
Milliman outlined three approaches which considered different aspects of concern to retirees: their level of funding, sequencing risk, longevity risk and liquidity.
Craig McCulloch, head of analytics – Australia, outlined a framework for funds to develop a more nuanced and effective default CIPR.
“The notion that a single default will actually meet disparate needs of people, even within a fund, is going to be problematic,” McCulloch said. “We need smarter defaults that can be tailored to meet the needs of different groups.”
CIPRs should be designed to meet the goals of fund members rather than by the attributes of members – an approach that will require better benchmarking and customer data.
“Technology has now advanced to the point where we can start to gather better information and ask fund members some of these questions which can be used in any default retirement product design.”
The specific needs of members can then be analysed against various default retirement product strategies, using Milliman’s proprietary cloud-based stochastic modelling platform.
Michael Armitage, head of fund advisory services, outlined the reasons that retirees need to control volatility and minimize the potential for early capital losses.
Losses early in retirement have major ramifications for longevity and form a toxic combination that can strip years from a retirees expected level of funding.
For example, a retiree with a $500,000 account plans to draw 6% annual income over 30 years. They would need to generate investment returns of 4.2% above inflation (assuming a rate of 2.5% inflation rate)
However, a 60:40 growth defensive fund hit by an 18% drawdown in the first year of retirement radically changes those goals. The investor now needs to generate a return of 6.9% a year above CPI over the remaining 29 years to catch up.
“That downturn, which is lower than what we experienced during the GFC, reduces the longevity of the fund by a third.”
The bucketing approach – keeping a portion of the portfolio in cash for drawdowns – is a popular approach however risk still lurks in the growth buckets. This can be lowered through managed risk strategies using derivatives such as futures.
Milliman’s managed risk overlays are used by a number fund managers and recently passed $1 billion in the Australian market. Maritime Super also employs Milliman’s expertise to manage risk across its entire $4.8 billion portfolio.
Jeff Gebler, head of portfolio management, outlined the benefits of a new Milliman offering to super funds: the Retirement Enhancement Trust. It is a pooled annuity that has zero upfront costs, allows retirees to make their own investment choices, and retains some liquidity.
The Retirement Enhancement Trust RET product can be white-labelled by super funds and works with their existing offerings.
