Board Report Guide: Well-Designed Life-Cycle MySuper Defaults

Now the Productivity Commission (PC) has confirmed that well-designed life-cycle products are better, MySuper trustee directors should be expecting a detailed board paper on this issue.

 What should directors expect to see in that report, how can they tell if their fund executives or consultants are on top of the issues involved and what does well-designed mean?

This guide summarises the main elements.

PC FINDING 4.3

Well-designed life-cycle products can produce benefits greater than or equivalent to single-strategy balanced products, while better addressing sequencing risk for members.

There are also good prospects for further personalisation of life-cycle products that will better match them to diverse member needs, which would require funds to collect and use more information on their members.

Some current MySuper life-cycle products shift members into lower-risk assets too early in their working lives, which will not be in the interests of most members.

The first sentence is clear that the twin elements of higher retirement outcomes and managed risk are ‘on offer’ with a well-designed product.

The second sentence makes it clear that personalisation is better and the third that funds should be taking into account younger members long investment horizons. 

1. This is a Finding – not a just a Recommendation. There is no further process or approval required. The status quo has changed.

It has been determined that:

• well-designed life-cycle products are better than single strategy balanced products (one-size-fits-all MySuper defaults), held by 70% of funds, and
• current age only life-cycle products (the other 30%) will not be in most member’s best interest,
• there are good prospects for further personalisation of life-cycle products.

The default product landscape has just evolved.

The PC noted that well-designed MySuper life-cycle products, can bring “ potentially significant gains” (35+% based on the 100,000 member accounts, holding $30 billion we have tested so far).

2. The Royal Commission has found trustees must act (on well-designed life-cycle defaults):

“the concept of acting in members’ best interests is not hard to understand”,

“a trustee must do the best they can for the benefit of their beneficiaries, and not merely avoid harming them”,

“a trustee cannot avoid its obligations by doing nothing”.

Trustee directors need to carefully assess and promptly respond to this issue in order to remain within the law and act in good faith. Not to do so would be ill considered, may breach insurance indemnity arrangements, risk policies and damage reputations.

The PC noted, “the short-run need to scrutinise and rationalise existing life-cycle products should not preclude the development of more innovative products.”

3. The new Outcomes Test Prudential Standard supports well-designed life-cycle defaults:

This PC Finding is supported by the new Outcomes Test Prudential Standard. According to APRA, the test represents a continuation of a shift in regulatory philosophy for the superannuation industry, from being substantially compliance-focused to the principles-based, outcomes oriented approach enabled by the new and enhanced prudential requirements. It commences on 1 January 2020.

The PC noted, “Smart life-cycle products have a strong in-principle justification

What are the Elements of a Well-Designed Life-cycle Product? 

4. There are a series of trade offs available for trustees between risk and return elements that produce better outcomes.

For example, this PC finding could equally have been stated as:

• by personalising MySuper Default products, some members will achieve higher retirement benefits, while for others the benefit will be lower sequencing risk.  
• By design both single strategy and age only life-cycling are inferior.

The PC has not attempted to ‘maximise’ the greater outcomes, but left that trade-off for trustees in their outcomes test assessment and framework to determine.

5. A Well-Designed Life-Cycle Product uses known personalisation factors to cohort.

The SIS Act life-cycle exception allows gains and losses from different classes of asset of the fund to be streamed to different sub-classes of the members of the fund who hold a MySuper product on the basis of the age of those members and other Prescribed Factors.

The Prescribed Factors are the member's account balance, contribution rate, current salary, gender, and the time remaining, in the opinion of the trustee, before the member could be expected to retire.These factors are known and already combined by most trustees (following an FSI recommendation) in a member’s projected retirement balance, which is now included on member statements. By using this projected retirement balance approach, remaining earnings to retirement (or human capital theory) information is also utilised.

These sub-classes, or cohorts, can then be used in a Well-Designed Life-Cycle Product.

Those cohorts can and should be the same as the cohorts used in the Outcomes Test. This then aligns “in the well-designed life-cycle product to ‘produce the options, benefits and facilities’ and to ensure the product is appropriate for those members”, as specifically just legislated in the new SIS Act S52 (10). That enables each cohort's return and sequencing risk profile to be known and documented.

The other PC mentioned characteristics, such as the likelihood of receiving an Age Pension, gig economy and maternity leave breaks can be built into the design now or in the future, in a continuous improvement process. This may, for example be in the setting by trustee of the cohorts (fund level) or the automatic calculation of the projected retirement balance (member level).

The PC noted ““Data and technology are opening up new opportunities to make super work better for members — across domains as diverse as product design (such as tailoring products to individual members), member engagement.”

 6. Well-Designed Life-Cycle Products are fund demographic specific and use a fund's own profile to improve member retirement benefits.

MySuper funds are skewed away from a ‘normal’ population curve:

• to have a greater proportion of younger members, who have lower average balances
• they lose circa 2/3rds of their members by age 55 (they have engaged and made an investment option selection), with those remaining or joining late having lower average balances.

In making an assessment of the design, there is a need to include the fund’s profile, assess the impact on average returns (fund level) and at the cohort (member) level.

For example, once it is recognised that 2/3rds of the MySuper members will not be in MySuper at age 55 (they have self engaged/selected an investment option), that can be included in the (fund level) assessment of this design and then compared to a single strategy approach. 

Equally and at the same time, an assessment of the 55 year olds, by their own (projected retirement balance) cohort means some can appropriately bear more sequencing risk, while others should bear less (member level).

This assessment, when tabulated, is not complex.

The PC noted “there is significant scope for more personalised MySuper products , extending the design currently used by QSuper.

‘Smart’ defaults could potentially be included in future best in show lists.

7. Well-Designed Life-Cycle Products use dynamic efficiency and compounding overtime to lift retirement outcomes.

By moving the bulk of younger members into higher growth options (i.e. equities compared to the balanced option) which is consistent with Age-Only based life-cycling, they receive on average circa 2.0% p.a real more.

Until they engage, that extra return compounds, and on average improves their retirement balance and cohort. If they, as 2/3rds of members over time do, engage and select an investment option, they on average have a higher transfer balance. Job of the MySuper trustee done well.

As retirement approaches, those remaining 1/3rd in MySuper, are in cohorts according to their own projected retirement balance (which by this stage is more reflective of the actual retirement outcome) and sequencing risk can be selectively managed down by the trustee. Job of the MySuper trustee also done well. 

In assessing or completing your fund’s board report, do not allow simplistic, ‘out of date methodologies’ that don’t include the above elements and funds demographics to be used.

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