After a two-year delay the much-anticipated Retirement Income Covenant (RIC) is now on track to launch next July in a move destined to reshape the Australian superannuation fund universe.

First mooted in a May 2018 Treasury paper, the RIC was originally slated to go live in 2020 with new obligations for super funds intended to shift the market trajectory from accumulation phase to retirement income mode.

In the 2018 report preamble, Treasury noted: “The covenant will codify the requirements and obligations for superannuation trustees to consider the retirement income needs of their members, expanding individuals’ choice of retirement income products and improving standards of living in retirement.”

With a firm start date in place for the regime, super funds will need to start planning for the practical implications of the RIC, which will require most to develop new product suites either in-house or in collaboration with third-party specialist firms.

Dr Deborah Ralston, a member on the government’s 2019 Retirement Income Review (RIR) panel, told industry publication Money Management last December that the RIC would inevitably create more decumulation product choices for super fund members.

“I can see in a decade how superannuation funds will have a portfolio of products sitting on their platforms for retirees to help them through that phase of life,” Ralston says in the article.

Decumulation pressure demands more supply

The Covenant, and indeed the later RIR, simply added regulatory urgency for the super fund industry to address the underlying demographic reality of an aging population.

In fact, the inexorable shift from an accumulation-focused membership to one weighted to decumulation has long been a topic on the super talk-fest circuit.

But the rapidly rising number of super-funded retirees in recent years has moved the issue beyond theoretical debates into a pressing need for action.

For example, a 2019 Association of Superannuation Funds Australia (ASFA) study highlighted the growing importance of super in the post-65 population.

“Around 1.6 million out of 3.8 million Australians aged 65 and over have superannuation,” the ASFA report says. “This figure is up from around 1.3 million Australians just two years before. Superannuation now forms a significant and growing part of the retirement income of many Australians.”

The ASFA paper also cited official government data showing that the proportion of Australian households relying on superannuation as their main source of income increased from about 4 per cent in the 2007/8 financial year to 6 per cent a decade later.

Australian Bureau of Statistics forecasts the number of those aged 65 and over is set to grow from about 4.1 million in 2020 to over 6.3 million two decades later.

Mind-altering products: design rethink needed for retirement income solutions

As super assumes a much larger role in sustaining Australians through retirement, the demand for products that offer some level of income certainty should naturally ramp up regardless of the regulatory impetus, according to Fintan Thornton, Allianz Retire+ head of institutional solutions.

However, Thornton said the looming RIC regime will fast-forward the product development schedule for super funds that have to-date been content with creating investment solutions aimed primarily at members in accumulation phase.

He said while account-based pensions have featured as the main investment vehicle for retirees, the new RIC rules will require a different mindset from super fund product teams.

“Members are essentially taking on all investment risks themselves with account-based pensions,” Thornton said. “But the retirement income options envisaged under the Covenant transfer much of that risk management back to the fund product developers.

“To create viable, sustainable retirement income solutions, most super funds will need to take a vastly different angle on product design and likely build up new sector-specific expertise in development and implementation teams or work with reputable partners.”

Most importantly, Thornton said the new breed of retirement income products will have to account for a number of well-known risks unique to the decumulation phase.

Event management: getting the sequence right

While the focus on ‘longevity risk’ is well in frame, ‘Sequencing risk’ has emerged in recent times as another of the thorniest problems facing product designers in the retirement income space.

The now well-studied phenomenon refers to the ‘danger zone’ in the years immediately prior to and after retirement when member savings generally peak but, therefore, remain most vulnerable to market volatility.

“Most super fund members have a substantial allocation to risk assets both in the lead-up to retirement and for several years post the event,” Thornton said. “And most new retirees, facing 20 to 30 years without paid income actually need to retain a decent exposure to growth investments to fund their retirements, particularly in a constrained yield environment”.

“But a market crash in, say, the first year of retirement could easily wipe out a large chunk of those savings. And with less time to recover, many members could see their retirement dreams substantially downgraded along with fading income expectations.”

While most retirees don’t articulate it in the industry terminology, they no doubt experience sequencing risk as a hidden, unquantifiable fear, he said.

“Possibly, some retirees are being overly conservative with their investment strategy or perhaps taking on more risk than they know,” Thornton said. “A well-designed retirement income product, though, can help get the balance right by including some protection against sequencing risk, as well as an innovative longevity buffer, giving retirees comfort they will be able to sustain their lifestyles even amid falling share markets.”

Super funds will have to incorporate factors such as sequencing risk into products built to meet RIC guidelines.

“Some super funds may just choose to provide off-the-shelf retirement products with an annuity flavour,” Thornton said. “Others will probably create their own set of retirement income solutions to comply with the RIC. Whatever route they go down, however, super funds will have to assess the specific risks facing their members and select products accordingly. There will likely be no silver bullet in this but a combination of well-considered investment building blocks that deliver an income strategy for each stage of retirement.”

And with the RIC lift-off now in sight, the countdown for super funds has well-and-truly begun.

Partner with Allianz Retire+

As Australia approaches a major demographic shift, trustees are faced with the ultimate investment challenge – meeting the demand for sustainable, consistent income streams, while preparing and protecting their members from a complex web of investment risk.

Allianz Retire+ creates bespoke retirement income solutions to help trustees offer secure retirement incomes to their members. To learn more about partnering with Allianz Retire+ visit allianzretireplus.com.au