Investing in the Post-Retirement Years
1.
OVERVIEW
1.1
B y definition, the “sole purpose test” in the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) sets the
parameters for the superannuation industry in Australia. 1.2
S uperannuation trustees must ensure their fund is maintained solely to provide benefits for members when they retire (or
reach age 65) and/or for the members’ estate or dependants when they die.1
1.3
Unfortunately, while most trustees have well-developed processes for investing their members’ benefits during the peretirement (or accumulation) phase, less attention has been given to the post-retirement phase.2 Post-retirement income has
been labelled as one of the “weakest” parts of the Australian superannuation system3 and a market failure.4
This may not be unexpected. The Australian superannuation guarantee (SG) system is, after all, relatively young.
2.
DEFAULT INVESTMENT STRATEGY FOR POST-RETIREMENT
Current trend
2.1
Most superannuation funds currently use the same default option for post-retirement products as for those held for preretirement (accumulation) products.5
2.2
This may be intentional. Two reasons that trustees take on investment risk for members in retirement are:
(a) t he existence of the Age Pension, which is a means tested, lifetime annuity indexed to inflation. This effectively
provides a defensive asset in retirement (a safety net), so that retirees can take up some risk in retirement; 6 and
(b) managing longevity risk requires retirees to earn as much as possible from their investments.7
2.3
owever, increasing analysis shows that using the same default option for both pre and post-retirement products may not be
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an optimal strategy for many retired members and that superannuation trustees should look closer at the way they invest the
benefits of post-retirement members. The legislation also allows a fund to be maintained solely for one or more core purposes and for one or more prescribed ancillary purposes. See s 62 of the SIS Act.
See for example the discussion in Commonwealth of Australia, Super System Review Final Report Part 2, June 2010, 202 (Cooper Review); Rice Warner Actuaries
Pty Ltd, Investing in the Retirement Years (July 2011) 1.
3
Mercer, Securing Retirement Incomes: The Australian Retirement Income Challenge (November 2010) 1.
4
David Knox, ‘Addressing The Market Failures In Post Retirement Products – Actuarial Issues’ (2011) Law Council of Australia Legal Practice Section, 1.
5
Rice Warner Actuaries Pty Ltd, above n 1, 7.
6
Towers Watson, Finding The Balance: Strategies To Improve Post Retirement Investing (2012) 3; Commonwealth of Australia, above n 2, 196.
7
Towers Watson, above n 6. Towers Watson analysis supports bearing as much risk as possible throughout the retirement phase. A 90% growth strategy had the
lowest probability of ruin (running out of money) beyond age 89.
1
2
Why is there concern that using a single default strategy for both pre and post-retirees may not be optimal
for retirees?
2.4
Concern exists that using the same default strategy for retirees as for members in the accumulation phase is not optimal
because retirees face a number of issues that either those still working do not, or that impact more heavily on retirees.
These issues include:8
(a) longevity risk – the risk that a person outlives their retirement savings or must draw down lower pension payments
and become frugal in their spending. This arises essentially because an individual has no way of knowing when they
will die and so cannot plan their retirement income with certainty or budget a prudent amount to withdraw each year
during retirement. As Rice Warner points out,9 this is essentially a problem of adequacy; living a long time is only a
problem if it cannot be done comfortably and with dignity. If individuals had more money accumulated, it would be a
joy and a privilege to have abundant leisure time backed by financial freedom. However, Rice Warner reports that most
Australians are not saving enough to provide them with a comfortable living in retirement. Their benefit will run out
relatively early in the retirement years or they will need to draw lower annual benefits than expected;10
(b) inflation risk – inflation can dilute fixed incomes in real terms.11 Although inflation levels are currently low, many
retirees have lived through periods of high inflation and may fear the return of high inflation;12
(c) c apital losses from volatile investments – even with a long time horizon, retirees are risk averse13 and want “peace
of mind”14 Capital losses are more painful when income from personal labour no longer exists and this is especially
concerning when markets are depressed, such as during the Global Financial Crisis. The risk is that assets must be
realised at depressed values when liquidity is needed in retirement.15 Research has shown that the income certainty
is more important for retirees than tax breaks or exceptional returns16 and this aspect is difficult to capture in most
quantitative frameworks;17
(d) liquidity risk/uncertain expenses – although retirees can predict regular expenses to some extent, individual health
expenses are virtually impossible to predict. Further, expenditure patterns may vary during different periods of
retirement, such as active, passive and frail periods. Individuals move through these phases at different rates, so it is
difficult to budget with certainty;18
(e) bequest motives – many retirees have a strong desire to leave some money to their children or favourite charity;19
(f)
m
ental faculties – while some retirees enjoy managing their money shortly after retirement, this can become
impractical or impossible later in life;20 and
See for example, Rice Warner Actuaries Pty Ltd, above n 1, 2; Knox, above n 4, 3; Towers Watson, above n 6, 4.
Rice Warner Actuaries Pty Ltd, Surviving Longevity (March 2010) 6.
10
Ibid 5.
11
Rice Warner Actuaries Pty Ltd, Investing in the Retirement Years, above n 1, 2.
12
Knox, above n 4, 3.
13
PIMCO Australia Pty Ltd, Behavioural Finance and the Post-Retirement Crisis (May 2011) 12.
14
Towers Watson, above n 6, 4.
15
Rice Warner Actuaries Pty Ltd, Surviving Longevity, above n 9, 3.
16
PIMCO Australia Pty Ltd, above n 13.
17
Towers Watson, above n 6, 4.
18
Rice Warner Actuaries Pty Ltd, Investing in the Retirement Years, above n 1, 2.
19
Rice Warner Actuaries Pty Ltd, Surviving Longevity, above n 9, 4; PIMCO Australia Pty Ltd, above n 13
8
9
(g) legislative risk – superannuation, taxation and pension rules are constantly changing and this can scare retirees.
2.5
In a nutshell, most retirees wish to be protected from risks to their capital (such as longevity, inflation and investment),
achieve good returns on their retirement benefit and have access to their capital to meet unexpected expenses or to leave
some money as a bequest.
2.6
Of course, individual retirees will look at each risk differently. For those with retirement balances under $250,000, investing
to counteract longevity risk is nonsensical because they have insufficient assets to fund themselves to their life expectancy,
let alone an advanced age. They will be more focused on liquidity risk. More complex considerations are required for those
with balances above $250,000. Once a member's balance reaches over $750,000 they should be able to live off the earnings
on their account and only draw down capital later in life.21 Further, it has been found that individuals with more labour supply
flexibility are more likely to invest a larger proportion of their portfolio in risky assets, regardless of their age.22
2.7
ccordingly, the use of a default option for retirement products that is identical to that in the accumulation phase may
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insufficiently cater for the particular issues facing retirees, and also implicitly combine the highly individual investment
needs and aspirations of retirees into an "average" strategy.23
2.8
owever, industry continues to grapple with the "ideal" post retirement investment strategy.24 Strategies that manage both
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liquidity and longevity risk remain elusive25 and it may not be possible to address liquidity and longevity needs via a single
composite investment option.26 An "ideal" solution probably does not exist, but trustees will need to consider whether there
is something better than what they are currently doing.27
Why is it so important to look at default options set by trustees?
2.9
It is particularly important to look at default options in the post-retirement space for a number of reasons:28
(a) d ifficulties in engaging and educating members about superannuation, together with decision-making inertia, have led
to default investment options being overwhelmingly the most common investment strategy used by investors;29
(b) m
embers often see default options as an "endorsement" by the trustee.30 This issue arises particularly with respect to
older retirees when the quality of their decision-making decreases. Research has shown that:31
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garwal. S., Driscoll, J, Gabaix, X., and Laibson, D. (2009) The Age of Reason: Financial Decisions Over The Life-Cycle and Implications for Regulation (Brookings
Papers on Economic Activity) 2, 51-117 cited in Allianz, Behavioural Finance and the Post-Retirement Crisis A Response to the Department of the Treasury/
Department of Labor Request For Information Regarding Lifetime Income Options For Participants and Beneficiaries in Retirement Plans (29 April 2010) 9.
21
Rice Warner Actuaries Pty Ltd, Investing in the Retirement Years, above n 1, 5.
22
PIMCO Australia Pty Ltd , above n 13, 7. 23
Rice Warner Actuaries Pty Ltd, Investing in the Retirement Years, above n 1, 7.
24
Towers Watson, above n 6, 2.
25
Ibid.
26
Rice Warner Actuaries Pty Ltd, Investing in the Retirement Years, above n 1, 2.
27
Towers Watson, above n 6, 2.
28
See also National Bureau of Economic Research, The Importance Of Default Options For Retirement Savings Outcomes: Evidence From The United States (January
2006).
29
Mercer, Default Investment Options Strategies Puts Australians’ Retirement Funding at Risk (21 April 2010)
https://secure.superfacts.com/public/MWS/article.tpz?contentId=d2d1e5f8-ec51-4bf6-8e34-3124893c831a.
20
(i)
after age 53, the quality of financial decision-making deteriorates;
(ii) after age 60, the prevalence of dementia approximately doubles every five years;
(iii) more than half of those in their 80’s will suffer from dementia or significant cognitive deficits; and
(iv) o lder adults show marked decline in “numeracy”, i.e. the mathematical skills needed to deal with everyday life
and information, and in understanding simple measures of risk; and
(c) t rustees are seen as best-placed to ensure optimal retirement outcomes because they understand the risk profile of the
overall fund membership (and of specific sub-groups of the membership) and therefore can identify an appropriate level
of risk for the "average" default member, and hence design an appropriate default strategy that aims to deal with risk
at increasing ages.32 The Cooper Review considered that the best way to promote the interests of super fund members
in retirement was to ensure trustee accountability. It considered that trustees are best placed to understand the
particular demographics of their funds' membership bases, to communicate with those members about the risks and
options involved, and to mobilise service providers to deliver the most appropriate retirement products.33
2.10
ccordingly, default option design is extremely important. Defaults need to encourage retirees toward optimal retirement
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income decisions and superannuation fund trustees are seen as being "on the hook" for default design that leads to suboptimal retirement outcomes.
2.11
B efore we investigate this issue further from a trustee perspective, however, it is useful to pause at this point and remind
ourselves of the current duties the SIS Act imposes on trustees in relation to investment strategy and the new duties that
will soon be imposed on trustees through the Superannuation Legislation Amendment (Trustee Obligations and Prudential
Standards) Bill 2012 (currently awaiting Royal Assent) (TOPS Bill).
3.
TRUSTEE DUTIES SPECIFICALLY IN RELATION TO INVESTMENT STRATEGY
Section 52(2)(f) covenants
3.1
C urrently, s 52(2)(f) of the SIS Act effectively34 requires superannuation trustees to formulate and give effect to an
investment strategy that has regard to the whole of the circumstances of the fund. Circumstances that must be considered
include (without limitation):
(a) t he risk involved in making, holding and realising, and the likely return from, the fund's investments having regard to its
objectives and its expected cash flow requirements;
(b) t he composition of the fund's investments as a whole, including the extent to which the investments are diverse or
involve the entity in being exposed to risks from inadequate diversification;
32
33
34
30
31
National Bureau of Economic Research, above n 28, 17.
Agarwal. S., Driscoll, J, Gabaix, X., and Laibson, D., above n 20.
Towers Watson, above n 6, 7.
Commonwealth of Australia, above n 2, 209.
By deeming the governing rules of a superannuation entity to include a covenant by the trustee of the entity to this effect.
(c) the liquidity of the fund's investments having regard to its expected cash flow requirements; and
(d) the fund's ability to discharge its existing and prospective liabilities.
Additional duties under the TOPS Bill
3.2
The TOPS Bill elaborates on trustees' duties in relation to investment strategies. In particular, trustees must:
(a) h ave regard to valuation information, expected tax consequences and costs in formulating, reviewing regularly and
giving effect to an investment strategy for the whole of the fund, and for each investment option (our emphasis);35
(b) exercise due diligence in developing, offering and reviewing regularly each investment option;36 and
(c) ensure the investment options offered allow adequate diversification.37
As under the current law, these specified items are not exhaustive. Trustees must formulate, review regularly and give effect
to investment strategies taking into account all relevant considerations, not just those specified.
3.3
In addition, the TOPS Bill seeks to implement an extremely important change for directors of corporate trustees (Trustee
Directors).
3.4
C urrently, to access the defence to an action for loss or damage in relation to an investment (provided by s 55(5) of the SIS
Act), a trustee must show that the investment was made in accordance with the investment strategy formulated under the s
52(2)(f) covenant as set out in paragraph 3.1 above.
3.5
When the TOPS Bill becomes law, s 55(5) will be amended so that a trustee must comply with all relevant covenants and
MySuper obligations in order to be able to access the defence to an action for loss or damage in relation to the making of an
investment. Therefore, a trustee's investment decision could be challenged on the basis that it was not in the best interests
of beneficiaries and the trustee will not have a defence for investment loss unless it can establish that it complied with all of
the covenants and MySuper obligation. Duties with respect to MySuper Products
3.6
In relation to a MySuper product only, trustees (MySuper Trustees) must also:
(a) p romote the financial interests of MySuper beneficiaries, and in particular returns to those beneficiaries (after the
deduction of fees, costs and taxes);
(b) d etermine annually that there is sufficient scale in the MySuper product (in terms of assets and beneficiaries) so as
to not disadvantage the financial interests of beneficiaries relative to the financial interests of beneficiaries in other
MySuper products;
(c) include in the investment strategy the details of the trustee's determination of scale as described above; and
Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012 (Cth) (currently awaiting Royal Assent), s 52(6)(a).
Ibid s 52(6)(b).
37
Ibid s 52(6)(c).
35
36
(d) include in their investment strategy an investment return target (over a rolling 10 year period) for the MySuper assets
and level of risk appropriate to those assets.
3.7
In relation to 3.6(a) and 3.6(d) respectively:
(a) T he duty in 3.6(a) raises an interesting dilemma for trustees with older members. Would the law require trustees
to seek to promote returns for beneficiaries, at the expense of managing risk appropriately? The Explanatory
Memorandum for the TOPS Bill (EM) states that the obligation to promote the financial interests of beneficiaries
necessarily includes consideration of the level of investment risk appropriate for these members, recognising that
different groups of members may have a different risk tolerance and there is a trade-off between return and investment
risk. This is a sensible approach and would be required by what we consider to be the primary obligation of this
proposed legislative clause, being the promotion of financial interests of beneficiaries, rather than simply maximising
returns.
(b) W
ith respect to 3.6(d), the EM states that in determining the risk appetite for the investment of its MySuper assets, a
trustee may consider members' age.38 In addition the EM states that a trustee's obligation to consider the investment
return target and level of risk for a MySuper product must be done in parallel, reflecting the inherent trade-off between
a target investment return and related investment risk.39
3.8
Considering the additional duties relating to MySuper products is currently beyond the scope of post-retirement issues,
because MySuper products are not required to include a post-retirement income stream. However, it is expected that the
Government will give consideration in the future to such an inclusion40 and, in our view, it is a prudent trustee that ensures
they will be in a position to meet their duties in relation to post-retirement products when this requirement arises.
Other duties that impact on investment strategy
3.9
It is also important to remember that the SIS Act and the general law impose41 general duties on trustees that may impact on
decision-making in relation to investment strategy. Trustees must:
(a) e xercise, in all matters affecting the superannuation fund, the same degree of care, skill and diligence as an ordinary
prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide;42
and
(b) ensure their duties and powers are exercised in the best interests of the beneficiaries.43
3.10
T he TOPS Bill alters the duty described in 3.9(a) above, so that trustees will be required to exercise the same degree of care,
skill and diligence as a prudent superannuation trustee would exercise. This is a higher standard than the current ordinary
prudent person test.44
E xplanatory Memorandum, Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012 (Cth) (currently awaiting Royal Assent)
15.
39
Ibid.
40
Wouter Klijn, Costello Flags Possibility Of My Pension (23 June 2011)
Investor Daily http://www.investordaily.com/cps/rde/xchg/id/style/11885.htm?rdeCOQ=SID-0A3D9633-AD6A42EB.
41
Again, SIS effectively imposes these duties by deeming the governing rules of a superannuation entity to include a covenant by the trustee of the entity to this
effect.
42
Superannuation Industry (Supervision) Act 1993 (Cth) s 52(2)(b).
43
Ibid s 52(2)(c).
44
We note that State and Territory trustee legislation currently imposes a professional trustee standard in relation to investments.
38
New duties on trustee directors
3.11
Importantly, the TOPS Bill also seeks to apply45 new duties to the directors of corporate trustees of registrable
superannuation entities.
3.12
C urrently, a director of a corporate trustee is required to exercise a reasonable degree of care and diligence (to the standard
of a reasonable person) for the purpose of ensuring that the corporate trustee carries out its covenants. However personal
duties (e.g. to act in the best interests of beneficiaries) do not apply to the directors of corporate trustees in their own right.
3.13
T he TOPS Bill imposes additional duties on each director of a registrable superannuation entity, which reflect the duties
imposed on the corporate trustee itself, including:
(a) t o exercise the same degree of care, skill and diligence as a prudent superannuation entity director would exercise in
relation to an entity where he or she is a director of the trustee of the entity and that trustee makes investments on
behalf of the entity's beneficiaries;
(b) t o perform the director's duties and exercise the director's powers as director of the corporate trustee in the best
interests of the beneficiaries; and
(c) t o exercise a reasonable degree of care and diligence to ensure that the corporate trustee carries out its duties under s
52 of the SIS Act.
3.14
F urther, each director of a MySuper Trustee must exercise a reasonable degree of care and diligence to ensure the corporate
trustee carries out the additional duties imposed on MySuper Trustees as outlined in paragraph 3.6 above.46
The degree of care and diligence required is that a superannuation entity director would exercise in the corporate trustee's
circumstances.47 A superannuation entity director is a person whose profession, business or employment is, or includes,
acting as a director of a corporate trustee of a superannuation entity and investing money on behalf of beneficiaries of the
superannuation entity.48
3.15
The overall effect of these changes is to hold directors of corporate trustees to a higher standard than currently.
3.16
person who suffers loss or damage because a director contravened these obligations may recover the amount of the loss
A
or damage by an action against the director, or any other person involved in the contravention, commenced within six years
after the day the cause of action arose.49 Importantly, the defence under s 55(5) (as amended and as discussed in paragraphs
3.4 and 3.5 above), applies to such an action for loss or damage.50
We note that State and Territory trustee legislation currently imposes a professional trustee standard in relation to investments.
Again, SIS effectively imposes these duties by deeming the governing rules of a superannuation entity to include a covenant by the trustee of the entity to this
effect.
46
Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012 (Cth) (currently awaiting Royal Assent) s 29VO(1).
47
Ibid s 29VO(2).
48
Ibid s 29VO(3).
49
Ibid s 29VP.
50
Ibid s 55(7).
44
45
Comments in recent reviews
3.17
In the Cooper Review,51 the panel (Cooper Panel) noted that, while the factors outlined in current s 52(2)(f) of the SIS
Act can cover post-retirement concerns, the risk profile, tax treatment and liquidity needs of retirees are likely to be
different from those of members in the accumulation phase. It considered that the use of a single investment strategy for a
superannuation fund might not be appropriate once post-retirement assets become substantial.52 The Cooper Panel thought
it important to ensure that MySuper Trustees are responsible for devising an investment strategy not just for the fund as
a whole, but for the assets held on behalf of post-retirement members. Trustees would work out how to fulfil these new
specific duties in the circumstances of their fund's particular characteristics.53
3.18
The Government supported the recommendations of the Cooper Panel requiring a separate investment strategy for both
post-retirement members in MySuper products and other choice products that offered income streams.54 Unfortunately, the
TOPS Bill did not deal with this issue, but it is hoped that, in time, the Federal Government legislates in accordance with its
response to the Cooper Review.55
3.19
T he Henry Review56 stated that having a wider choice of retirement income stream products would be beneficial to retirees,
and that product innovation should be encouraged. It was also recommended that the Government remove the prescriptive
rules relating to income streams in the Superannuation Industry (Supervision) Regulations 1994 (Cth).57
Complying with legislative requirements
3.20
E ven though there is not yet a mandated requirement to have a separate investment strategy for post-retirement
members, the question arises as to whether a trustee could still fail to meet its current duties under SIS if it does not give
consideration to such an option. 3.21
It is possible that a retired member (or, importantly, a group of retired members in a class action) could argue that the failure
to have a separate investment strategy for retirees constitutes a failure to give effect to an investment strategy that has
regard to the whole of the circumstances of the fund.58 This could be difficult to establish, given that trustees could invoke
reasons why an identical strategy for post-retirees as for accumulation members could be appropriate. See for example the
reasons outlined in paragraph 2.2.
3.22
However, there is a possibility that such an argument could be successful, given the reasons identified above as to why
retirees face different issues to accumulation members (recognised by the Cooper Review and supported by Government). If
the argument were successful, we believe the trustee would not have available to it the defence under s 55(5) of the SIS Act
on the grounds that one of relevant circumstances of the fund was not considered. 3.23
Importantly, however, even where the trustee could establish that it had met its duties under s 52(2)(f) of the SIS Act, a
member, or group of members, could argue that the trustee had failed to meet its duty to:
53
54
55
56
57
58
51
52
Commonwealth of Australia, above n 2.
Commonwealth of Australia, above n 2, 209.
Ibid.
Commonwealth of Australia, Stronger Super, 2010, 46.
Ibid.
Commonwealth of Australia, Australia’s Future Tax System: Report to the Treasurer, December 2009 (Henry Review).
Ibid 85.
Superannuation Industry (Supervision) Act 1993 (Cth) s 52(2)(b) s 52(2)(f).
(a)
exercise the required degree of care, skill and diligence;
(b)
exercise its powers in the best interests of beneficiaries; and
(c)
treat different classes of members fairly (which is a general law duty).
3.24
Under current law, this would not impact a superannuation trustee, given the defence available to it under s 55(5) of the SIS Act. However, when the TOPS Bill becomes law, trustees will be required to comply with all relevant covenants and MySuper duties in order to be able to access the defence to an action for loss or damage in relation to the making of an investment. Therefore, if a trustee fails to meet just one of the various duties outlined in paragraphs 3.23(a), 3.23(b) and 3.23(c) above, the defence under s 55(5) falls away.
3.25
Also importantly, individual trustee directors will be subject to new duties (as set out in paragraphs 3.11 to 3.16 above), and would be directly and personally liable to fund members that have suffered investment loss where they have breached those duties.
Way forward
3.26
It is imperative that the Australian regulatory system supports the creation of innovative retirement financial products. While there may never be an ideal, or “one-size-fits-all”, product that will meet every retiree’s needs, it is important that regulatory settings allow something better than the current offering to be created. Finally, trustee directors must be “on their toes” in relation to the entire post-retirement space to ensure compliance with both current and future trustee and trustee director duties.
AUGUST 2012
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Jane Paskin
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Persons listed may not be admitted in all states and territories. This document is intended to provide general information. The contents do not constitute legal advice and should not be relied upon as such. © Clayton Utz 2012