The changing face of retirementNicolette Rubinsztein

General Manager Retirement & Advocacy

Disclaimer

Adviser use only

Adviser use only This document is general advice only and has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6th November 2014. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State or any member of the Commonwealth Bank of Australia group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information.  Colonial First State is the issuer of the FirstChoice range of superannuation and retirement products from the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557. Colonial First State also issues interests in investment products made available under FirstChoice Investments and FirstChoice Wholesale Investments, other than FirstRate Saver, FirstRate Term Deposits and FirstRate Investment Deposits which are products of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 (Avanteos) (trading as Custom Solutions) is the issuer of the FirstWrap superannuation and retirement products from the Avanteos Superannuation Trust ABN 38 876 896 681. Avanteos also issues interests and operates investments under FirstWrap.  Colonial First State and Avanteos are wholly owned subsidiaries of the Bank. The Bank and its subsidiaries do not guarantee the performance of FirstChoice products or FirstWrap products or the repayment of capital from any investments. Colonial First State and Avanteos are the operators and administrators of investment platforms (the CFS Platforms).  Any annuity products accessible via the CFS Platforms will be issued by the relevant annuity provider (for example Challenger Life Company Limited ABN 44 072 486 938, Challenger Retirement and Investment Services Limited ABN 80 115 534 453, and The Colonial Mutual Life Assurance Society ABN 12 004 021 809 (trading as CommInsure)), and are not issued by Colonial First State or Avanteos. This document provides information for the adviser only and is not to be handed on to any investor. It does not take into account any person’s individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) available from the product issuer before making any recommendations. Clients should read the PDS before making an investment decision and consider talking to a financial adviser.

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Outline – The changing face of retirement

1. The post-retirement market backdrop

2. Key conclusions from Ernst & Young modelling

3. What is a potential financial planning response?

4. How is CFS responding?

Nicolette

Steve

The post-retirement market backdrop

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More than 85% of retirement FUM is being invested in income streams

Source: Rice Warner 2014

15

85

Assets (%)

Pension rollover

Lump sums

54

46

Investors (%)

Lump sums

Pension rollover

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With those taking lump sums having lower balances and generally spending the lump sums sensibly

Source: Australian Bureau of Statistics 2012, Retirement and Retirement Intentions. Excludes those that “Don’t know”.

Mort

gage/

renovati

ons

Invest

ed e

lsew

...

Rein

vest

ed in r

...

Paid

off

debts

Bought/

paid

off

a c

ar

Paid

for

a h

oliday

Ass

iste

d f

am

ily

Purc

hase

d a

nnuit

y

0%

5%

10%

15%

20%

25%

30%

35%

29%

20%

15%

12%11%

8%

3%

1%

Reason for taking a full or partial lump sum

45% of lump sums are less

than $50k

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Nearly half of this post-retirement FUM is in SMSFs and a third in retail products

Source: Rice Warner 2013

Not for profit

SMSFs

Retail

$159b (32%)

$85b (17%)

$249b (51%)

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In the retail segment there are a variety of products on offer

Source: ASFA Review of Retirement Income Stream Regulation 2014

Longevity risk protection

Investment risk protection

Inflation risk protection

Provide lump sums Death benefit

Life annuities High High High / Low Low Low

Life pensions High High High Low Low

Account-based pensions Low

Low / Medium

Low / Medium /

HighHigh High

Variable annuities Medium Medium Medium Medium High

Fixed term annuities Low High Low Low Medium

Hybrid productsMedium /

HighMedium

Medium / Low

Medium / High

Medium / High

Deferred lifetime annuities High High Medium Low Low

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But account based pensions are by far the most popular

Source: Plan for Life June 2014, Rice Warner 2014

Allocated pensions Term annuities Lifetime annuities Variable annuities (estimated)

0

20

40

60

80

100

120

140

160 153.2

7.3 3.2 2.6

Retail post retirement market FUM ($bn)

Significant success in the US (~$2 trillion), but limited success in

Australia

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Due to the flexibility and exposure to Australian equity returns

Source: Credit Suisse Global Investment Returns Yearbook 2014

Neth

erl

ands

Unit

ed K

ingdom

USA

Aust

ralia

Canada

Germ

any

France

New

Zeala

nd

Sw

itze

rland

Spain

Japan

Italy

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%6.0% 6.0%

5.8%5.5%

5.1% 5.1% 5.0% 5.0% 4.9%

4.4% 4.3%

0.6%

Annualised real equity returns over 50 years (1964-2013)

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But…

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There are growing concerns about longevity risk

Source: Mercers 2014

Age to which percentage of retiring white collar workers likely to live to:

50% 35% 5%

Men 88 91 99

Women 91 93 Beyond 100

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And customers remain significantly risk averse …

Source: Strativity Group Research

After reaching a ‘tipping point’, pre-retirees become highly engaged investors and their focus becomes acutely defensive:

“My main concern was maintaining my super. I didn't need it to grow much, just not go backwards”

“More than anything I wanted to ensure that my husband and I had financial security and safety for our money…nothing too risky!”

"I wanted a solution that would just protect my money”

“What I really wanted was to place my money with the safest bet I could. It was not the most successful but it definitely was the safest”

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We have a comparatively low investment in annuities

Source: Public Pensions Institute, Briefing Paper 66: Freedom and Choice in Pensions

Switzerland UK Chile Denmark Ireland Australia USA0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

80%

75%

70%

50%

30%

5%2%

Estimated annuitisation by country

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And income security is low for Australian retirees compared to other countries

Source: Global Age Watch Index 2014 – Income Security Sub-Index

Australia

New Zealand

Italy

United States

Germany

United Kingdom

Canada

France

Norway

0 10 20 30 40 50 60 70 80 90 100

52

77

78

79

81

83

83

88

89

Income Security Index measuring pension coverage, poverty and income replacement for population 65+ (%)

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As a result, despite the strong levels of voluntary investment in income streams, the Australian post retirement market is considered to be underdeveloped

The Inquiry has made the following observations about Australia’s retirement income system:

- The retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees

Financial Services Inquiry Interim Report, July 2014

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There is global change underfoot

OECD Roadmap for the Good Design of Defined

Contribution Pension Plans

“For the payout phase, encourage annuitization as a protection against longevity risk”

“A combination of programmed withdrawals with a deferred life annuity (e.g. starting payments at the age of 85) that offers protection against inflation could be seen as an appropriate default”

Recent US changes to support deferred annuities

The Department of Labor provided relief allowing investors to invest a portion of 401(k) savings into a deferred annuity commencing after age 70.5

Recent UK changes to compulsory annuitisation

In 2011, the requirement to annuitise private pensions by age 75 was removed

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As well as changes in the Australian market

“The Government is considering the possibility of extending to DLAs the same concessional tax treatment that applies to investment earnings on assets supporting superannuation income streams, to facilitate their provision and help people insure against longevity risk”

Treasury Discussion Paper on Retirement Income Stream Regulation

July 2014

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And advisers are showing more interest in annuities

Source: Investment Trends Retirement Income Report 2013

Key conclusions from Ernst & Young modelling

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What is the optimal retirement solution?

Post-retirement needs are very different from accumulation, and there’s a trade-off between them:

• Income (level, inflation-protection, security)

• Longevity (interaction with social security)

• Inheritance (assets, death benefits)

Any post-retirement model needs to be able to handle a range of client/environmental scenarios (e.g. risk aversion, economic conditions)

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EY built a stochastic model to evaluate the different product options in retirement

• Compares life annuity, allocated pension, variable annuity and combinations of products• Pricing, customer and market inputs are fully flexible• Draw down strategy takes into account age pension• Pension is means tested and indexed annually• Draw down strategy is modelled together with market returns• Key assumptions in appendix

67 72 77 82 87 92 97$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$0

$50,000

$100,000

$150,000

$200,000

$250,000

Allocated Pension($380k bal, $55k pa target income)

Current Assets (LHS) Current Income (RHS) Age Pension (RHS)Target Income (RHS) Total Income (RHS)

Age

Curr

ent

Assets

Am

ount (p

er a

nnum

)

Adviser use only

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Comparing products – income assessment

Where applicable, allocation between Allocated pension and Deferred annuity is 75%/25%. Deferred annuity has a 12 year deferral period. Hypothetical scenario only based on a balanced portfolio and mid-range market conditions. See appendix for investment assumptions. Past performance is no indication of future performance.

Adviser use only

10 years less than life expectancy

life expectancy 10 years plus life expectancy

AP: Allocated PensionLA: Lifetime AnnuityDA: Deferred AnnuityVA: Variable Annuity

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Comparing products – NPV assessment

Where applicable, allocation between Allocated pension and Deferred annuity is 75%/25%. Deferred annuity has a 12 year deferral period. Hypothetical scenario only based on a balanced portfolio and mid-range market conditions. See appendix for investment assumptions. Past performance is no indication of future performance.

Adviser use only

10 years less than life expectancy life expectancy 10 years plus life

expectancy

AP: Allocated PensionLA: Lifetime AnnuityDA: Deferred AnnuityVA: Variable Annuity

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Key CFS conclusions from E&Y modelling

• The optimal solution must be tailored at the client level by the adviser

• The modelling supports three product conclusions:

• Allocated pensions perform well for clients living up to life expectancy

• On pure financial metrics alone, variable annuities do not provide attractive outcomes

• Combinations of an allocated pension and a life or deferred annuity can often provide superior outcomes to an allocated pension alone(i.e. support for partial annuitisation)

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Early academic research from University of Sydney and UTS supports partial annuitisation for balances over $200,000

Source: Choices over life annuities: optimal decisions for Australian Retirees, University of Sydney and University of Technology Sydney

Adviser use only

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Other academic research by David Bell has similar conclusions

Source: St Davids Road Advisory, David Bell 2013

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As reflected in this Cuffelinks article…

Why academics like lifetime annuitiesBy David Bell on September 18, 2013

“It remains a mystery in academic circles why people do not purchase life annuities. Financial models suggest life annuities are beneficial to rational decision-making individuals, yet in Australia the number of life policies purchased remains small”

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Mercer issued a paper ‘Partial annuitisation – Retirement Income Portfolio Guidelines’ commissioned by Challenger

Source: Mercers

Adviser use only

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Zenith has created model portfolios with a 20% allocation to a lifetime annuity, replacing part of the fixed interest allocation

Source: Zenith

Adviser use only

What is a potential financial planning response?

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Three potential financial planning strategies that include annuities

1. Layering

2. Deferred annuity

3. Aged care

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One financial planning strategy is based on “layering” of income

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Age pension ($20K p.a)

Income from allocated pension for life expectancy ($21k p.a) Deferred annuity

($10k p.a)

67 75 79

Super balance

Age

Am

ou

nt

($)

Another financial planning strategy is where a customer combines an allocated pension with a small investment in a deferred annuity

$41k per annum(ASFA

comfortable level of

retirement)

Invest$65k in a deferred

annuity or pay an annual

premium

Use allocated pension to fund income for life

expectancy. May incorporate investment protection

Reduction in income as

enter passive

retirement

A $10k per annum deferred annuity payable

from age 79 would cost $65K

at age 67

$379k

Retirement lump sum of $379k

Source: CFS/Comminsure

Adviser use only

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There is also a financial planning strategy focussed on aged care

• Lifetime annuity providing fixed payments

• Beneficially treated for Social Security and Aged Care purposes

• Generally no assessable income for aged care fees and Age Pension income test

• Depleting asset value for Age Pension asset test

• Commutation value: 100% of purchase price on:

• Death in first 10 years

• Voluntary commutation at year 10 window

How is CFS responding?

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The CFS product response – our ‘adviser toolkit’ strategy

Platform

• CommInsure and Challenger annuities on FirstChoice and FirstWrap (P)• A cost effective equity investment protection solution (P)• Enhanced reporting for advisers (√)• Client statement enhancements focusing on income in retirement (P)• CGT and transaction cost refund on super to pension transfers (√)

Investments

• Platform investment menu options suitable for retirement• Long term TDs (√)• Income and tax aware strategies (√P)

• Objectives-based multi-asset investment capability• GAM CPI+ fund (√)• Schroders Real Return (√)

Annuities• CommInsure reviewing annuities offering (P)• Dedicated BDM support and new adviser materials (P)

(P) Proposed(√) already in place

Any questions?

Appendix:Ernst & Young model investment assumptions

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Investment market assumptions for Ernst & Young modelling

Asset class assumptions

Mean return Volatility

CPI 2.5% 1.15%

Avg Weekly Earnings 3.5% 0.91%

Cash 5.0% 0.55%

Fixed Income 5.5% 5.00%

Aus Equity 8.5% 17.00%

Listed Property 8.2% 17.92%

Intl Equity 8.5% 17.00%

Direct Property 8.2% 12.00%

Correlations CPI AWE CashFixed

IncomeAus Equity

Listed Property

Intl EquityDirect

Property

CPI 100% 16% 29% 0% 0% 0% 0% 0%

AWE 16% 100% 0% 0% 0% 0% 0% 0%

Cash 29% 0% 100% 20% 0% 0% 0% 10%

Fixed Income

0% 0% 20% 100% 10% 10% 10% 10%

Aus Equity 0% 0% 0% 10% 100% 80% 75% 10%

Listed Property

0% 0% 0% 10% 80% 100% 60% 10%

Intl Equity 0% 0% 0% 10% 75% 60% 100% 10%

Direct Property

0% 0% 10% 10% 10% 10% 10% 100%

Adviser use only