Navigating the Retirement Risk Zone A Consumer Perspective December 2013 Hazel Bateman School of Risk and Actuarial Studies How well do consumers navigate the Retirement Risk Zone Context Individuals face increased risks and responsibilities for retirement saving investment and ID: 602658
Download Presentation The PPT/PDF document "Australian School of Business" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
Australian School of Business
Navigating the Retirement Risk Zone: A Consumer Perspective
December 2013
Hazel Bateman
School of Risk and Actuarial StudiesSlide2
How well do consumers navigate the Retirement Risk Zone?Slide3
Context
Individuals face increased risks and responsibilities for retirement saving, investment and
decumulation
decisions
Participation
Superannuation fund/Pension
provider
Contribution rate
Asset allocation
Retirement date
Retirement benefit type
Financial advice/advisorSlide4
4
What do Australians do?
Participation decision: MANDATORY
(for employees, 90-95% coverage)
Superannuation fund:
< 3% (?) choose super fund (remainder
DEFAULT fund
).
Contribution rate:
around 2/3 contribute no more than minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT
at min SG, 9.25%).
Asset allocation:
Around 43% assets in
DEFAULT
investment option, about 2/3 industry fund
assets in
DEFAULT
option
(? 60% members ?).
Retirement
date:
Choice
NO DEFAULT
Benefit choice:
NO
product
DEFAULT.
About 50% (assets) lump sum/50% (assets) account-based pension,
several hundred life annuities sold annually.Slide5
5
What do Australians do?
Participation decision:
MANDATORY
(for employees, 90-95% coverage)
Superannuation fund:
< 3% (?) choose super fund (remainder
DEFAULT
fund
).
Contribution rate:
around 2/3 contribute no more than minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT
at min SG, 9.25%).
Asset allocation:
Around 43% assets in
DEFAULT
investment option, about 2/3 industry fund
assets in
DEFAULT
option
(? 60% members ?).
Retirement
date:
Choice
NO DEFAULT
Benefit choice:
NO
product
DEFAULT.
About 50% (assets) lump sum/50% (assets) account-based pension,
several hundred life annuities sold annually.Slide6
6
What do Australians do?
Participation decision:
MANDATORY
(for employees, 90-95% coverage)
Superannuation fund:
< 3% (?) choose super fund (remainder
DEFAULT
fund
).
Contribution rate:
around 2/3 contribute no more than minimum superannuation guarantee (ABS, 2009) (remainder
DEFAULT
at min SG, 9.25%).
Asset allocation:
Around 43% assets in
DEFAULT
investment option, about 2/3 industry fund
assets in
DEFAULT
option
(? 60% members ?).
Retirement
date:
Choice
NO DEFAULT
Benefit choice:
NO
product
DEFAULT.
About 50% (assets) lump sum/50% (assets) account-based pension,
several hundred life annuities sold annually.Slide7
7
For consumers in the retirement risk zone, retirement benefit/
decumulation
decisions are difficult
Involve complex financial products
Interaction with publicly provided benefits
Cannot navigate by ‘default’
High stakes (largest non-housing asset)
Once in a lifetime decision
no opportunity to learn from experience (decision made once and generally i
rreversible)
Mass market DC is new
little opportunity for
social learning (
ie
, to learn from older generations)Slide8
We should not be surprised – this is what Behavioural Economists have been telling us…Bounded rationality – certain types of problem are too complex for individuals to solve on their own
Bounded self control
– individuals lack the willpower to execute their plans
Bounded self interest
– while individuals do seek to maximize their personal utility, they are more co-operative and altruistic than predicted by economic theory
Swayed by behavioural factors – loss aversion , inertia, procrastination, framing, confusion, status quo bias, heuristics(Thaler and Mullainathan, 2000)Slide9
Lessons from the academic literature?5 year ARC Discovery Grant (2010-2014): The Paradox of Choice: Unravelling Complex Superannuation Decisions
Hazel
Bateman (Risk and Actuarial,
UNSW)
Christine
Eckert (Marketing, CenSoC, UTS)Fedor Iskhakov (CEPAR, UNSW)Jordan Louviere (CenSoC, UTS)Stephen Satchell (Cambridge UK)Susan Thorp (Finance, UTS)+ Julie Agnew (Finance and Economics, College of William and Mary, USA)Investigated the ability of ordinary people to make complex retirement savings/investment/decumulation decisionsSlide10
Evidence of incomplete and unrealistic plans Retirement planning.Slide11
Survey of financial knowledge, plans and valuesFielded in May 2011Online panel provided by Pureprofile 920 peopleAges 50-74
Even genders
60% had some post-school education
37% already retiredSlide12
Uneven planning and expectationsAround 30% still employed had not thought about the financial aspects of their retirement and a further 20% had just started to think about it
Only around 45% of those 50+ had tried to work out how much money they would need for retirement (2012 Financial Literacy survey)Slide13
Uneven planning and expectationsOptimistic lifestyle expectations of pre retirees (travel/leisure) vs post retirees (carers/return to work)
Fewer than one in five discussed retirement with friends and co-workers
Fewer than one in four had attended a retirement seminarSlide14
Estate planning is more common than financial or workplace planning60% of surveyed had made a will
70% had thought about leaving a financial or material bequestSlide15
Pessimism about length of retirement Typical respondent wasPessimistic about near-term survival (75-85)
Optimistic about survival at older ages (90 onwards)
Men
in their 50s
Underestimated lifetime by 6 years on average
Men in their 60sClose to improved life table expectationsWomen in their 50sUnderestimated lifetime by 7 years on averageWomen in their 60sUnderestimated lifetime by 5 years on averageSlide16
Evidence of poor financial literacy, system and product knowledge .Slide17
Survey fielded in June 2012 – Australian extension to Financial Literacy around the World (FLaT) studyOnline survey using PureProfile
Web Panel (600,000+ Australians)
1,024 respondents
Nationally representative
sample
Age ranges from 18 to 84742 respondents aged 25-65 and non-retired17Measuring financial literacy in AustraliaSlide18
(1) Interest rates: Suppose
you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow
?
More than $102
-Do not know
Exactly $102 -Refuse to answerLess than $102 (2) Inflation: Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?More than today -Do not knowExactly the same
-Refuse to answerLess than today
(
3)
Diversification:
Buying shares in a single company usually provides a safer return than buying units in a managed share fund.
True -Do not know
False
-Refuse to answer
18
3 Key Financial Literacy QuestionsSlide19
19Only 42% respondents answered 3 key questions correctlySlide20
The same survey indicated somewhat poor super knowledge
% incorrect/
do not know
What is the mandatory employer contribution under the SG
33%
Does superannuation receive tax concessions?38%If you have any superannuation you will not receive an Age Pension29%Do you know the minimum age at which you can access your superannuation account?48% Only 14% of those who said ‘yes’ were correctSlide21
Of concern: If your superannuation account is invested in a ‘balanced’ investment option, this means that it is invested exclusively in safe
assets such as
savings accounts, cash management accounts and term deposits
.Slide22
A related study revealed mixed awareness of products to provide income in retirement
Have you heard of this product?
Yes
Term deposit
98%
Unit trust45%Bonds67%Cash management trust63%Shares88%Reverse mortgage59%
Retirement savings account54%Lifetime annuity
37%
Allocated/account based pension
48%
Survey of 920 superannuation fund members, 50-75 years old, May 2012Slide23
In particular, retirement income products are not well understood
Lifetime annuity
Yes
Have you heard of
this product?
37%- Offers lifetime income?22%- Offers guaranteed income level?8%Allocated (account-based) PensionHave you heard of this product?48%- Offers choice of income subject to regulated minimum?
25%- Withdrawal of capital is possible?
20%
Survey of 920 superannuation fund members, 50-75 years old, May 2012.Slide24
Consumers are swayed by Behavioural factors.Slide25
Consumers making retirement benefit decisions likely influenced by
Mental accounting (narrow framing)
Loss aversion (
eg
, focus on impact of dying young)
Misleading heuristics (insurance is for bad events)Illusion of control (wealth vs income)
Hyperbolic discounting
Framing (consumption
vs
investment frame)
Complexity
=> Use defaults or other decision rulesSlide26
26
FRAMING: Brown et al (2008) Why don’t people insure late life consumption?
American Economic Review
Life annuity of $650 per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing 4% pa interest
72%
21%
Term annuity for 20 years paying $650 per month
77%
48%
Term annuity for 35 years paying $500 per month
76%
40%
Console bond paying $400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest
motiveSlide27
27
FRAMING: Brown et al (2008) Why don’t people insure late life consumption?
American Economic Review
Life annuity of $650 per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing 4% pa interest
72%
21%
Term annuity for 20 years paying $650 per month
77%
48%
Term annuity for 35 years paying $500 per month
76%
40%
Console bond paying $400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest
motiveSlide28
28
FRAMING: Brown et al (2008) Why don’t people insure late life consumption?
American Economic Review
Life annuity of $650 per month OR
Consumption frame
(spend, payment)
(% prefer life annuity)
Investment frame
(account, earn, invest)
(% prefer life annuity)
Savings account bearing 4% pa interest
72%
21%
Term annuity for 20 years paying $650 per month
77%
48%
Term annuity for 35 years paying $500 per month
76%
40%
Console bond paying $400 forever
71%
27%
Benefits calculated to be actuarially equivalent.
Weak bequest
motiveSlide29
Discrete choice experiment of retirement benefit decisionsSeptember 2011 (repeated Sept 2012)Initial - online
web panel of
854
participants with a superannuation
account (ages 50-64, not retired)
Survey instrument included:TASK: Hypothetical allocation of ‘retirement accumulation’ between life annuity and investment accountLongevity expectations, health expectationsProduct knowledge/Financial literacyDemographics/personal information.Slide30
Income stream choice task
Annuity, guarantee
Investment account, flexibility,
risk of account depletion,
4 levels of risk of running out of fundsSlide31
Two-stage model of decision making: first understand the products then make the choicesWho is involved?
Test for who recalls the features of the products correctly:
People who understand the decision
People who are paying attention in ‘real time’
Who is risk aware?
Test for who chooses to reduce the chance of low income as the risk (of running out of funds) risesSlide32
Who understand the products and is ‘involved’ with the decision?
Numeracy
+
Basic financial
literacy
+Sophisticated financial literacy
+
Knowledge of existing retirement income product
attributes
+
Subjective understanding of finance
-
Planning
of financial aspects of retirement (Higher = more advanced planning)
+
Quality
of Life (Higher= better quality of life)
-
Subjective
survival expectations (Higher = more optimistic)
+
Gender (female = 0, male
= 1
)
F
Wealth sector ($50K, $125K, $250K, $1000K)
-
Intention
to retire before age 65
+Slide33
Risk-aware choices depend on understanding the products and ‘real time’ interest.
Dependent variable (irrational) = 1 if subject
decreased
annuity % when risk increased or did not move the slider at all
Numeracy
+Basic financial literacySophisticated
financial literacy
Knowledge of existing retirement income product
attributes
Subjective understanding of finance
Planning
of financial aspects of retirement (Higher = more advanced planning)
Quality
of Life (Higher= better quality of life)
Subjective
survival expectations (Higher = more optimistic)
Gender (female = 0, male
= 1
)
Wealth sector ($50K, $125K, $250K, $1000K)
Intention
to retire before age 65
Involvement score
+Slide34
34Benefit choices experiment: conclusions
People with higher financial capability pay more attention (more ‘involved’)
More numerate and more attentive people are better risk managers
Detailed
understanding of
specific products is critical to risk-perceptionRepeat experiment identified use of heuristics (decision rules)diversification (1/n) heuristic (50/50 allocation)default (stay with initial allocation) Extremes (100% annuity, 0% annuity)Slide35
35What have we learnt about navigating the retirement risk zone?
Incomplete plans, unrealistic expectations
Poor financial skills, system/product knowledge
Numeracy, financial competence and system/product knowledge enhances interest/involvement
‘Involvement’ and numerical ability facilitates risk awareness (and better decisions)
Role of decision heuristics (1/n diversification, defaults)Slide36
Navigating the retirement risk zone – is this the consumer perspective???Slide37
Thank youSlide38
Relevant papers
Papers
Economic rationality, risk presentation and retirement portfolio choice
(
CenSoc
and UNSW Working Paper) Financial competence, risk presentation and retirement portfolio preferences (Journal of Pension Economics and Finance, forthcoming).Financial competence and expectations formation: evidence from Australia (Economic Record 2012).Superannuation knowledge and plan behaviour JASSA, 2013. Work, money, lifestyle: Plans of Australian retirees JASSA, 2013.Financial literacy and retirement planning in Australia
(Numeracy, 2013). Involvement: A partial solution to the annuity puzzle (
CenSoC
and UNSW Working Paper)