Andrew Boal - Rice Warner Actuaries

Andrew Boal: Yeah, it's a really good question, a really good topic to be talking about. I think we're all well aware of the short-term challenges that we're facing here in Australia at the moment after COVID-19. But the... Despite those short-term challenges, there's still a lot of long-term challenges we've got to face due to the demographic change and the gradual aging of our population. If I can start. Let's step this in with a little bit about what the gradual aging of our population means, and then later on we can talk a bit about what we can do about it. If you go back a little while, the Charter of Budget Honesty was set back in 1998, and it brought about a number of innovations to fiscal reporting. And one of those major innovations was the introduction of the inter-generational report. Which was to look at the long-term sustainability of government policies over 40 years following the release of the report, and looking at the, in particular, the implications of demographic change on the financial situation of the economy. And way back in 2007, the second inter-generational report or, what became known as, IGR 2, was released and it provided a whole lot of detailed information about population, participation, and productivity.

And since its release, several policies have been already introduced for stopping the impact of demographic change and the gradual aging of our population on the society. Those have included the encouragement of skilled migrants, who are on average younger than the resident population, and to also encourage older Australians to continue working for longer. In part, to increase the first two Ps, population and participation. But at the same time, over the last 50 years or so, the life expectancy of an average 65-year-old in Australia has increased from about 13 years to 20 years for a man, and from about 16 years to 22 years for a woman. And it's still increasing. And while more of us are living longer, the cost of the Age Pension, the cost of healthcare and the cost of Aged Care, they're all going up at a rapid rate. While improvements in life expectancy have increased the number of expected healthy years of life, on average, more than half of a person's life is still expected to be living with a disability after the age of 65. This is a really important issue for us to all think about.

Indeed, life expectancy with a profound or severe disability... Oh sorry, without that, without a profound or just severe disability, is only about 16 or 17 years for both men and women. So that's really up until their early 80s. And after their early 80s, a lot of people will then be living with a disability in the latter parts of their retirement. So what's going to happen with that population over the next 30, 40 years? In particular, an area of focus is in the population that's over age 85. It's projected to grow from about 500,000 in 2015, to about two million by 2055. This is particularly concerning given that 30% of Australians over the age of 85 have dementia. Which is the single biggest cause of disability in Australia for those over age 65, and it also accounts for more than half of all residents in residential Aged Care. So, what impact will this significant increase in our elderly population have on the country's finances? First of all, we got to think about health. On average, the healthcare costs of a person over age 85 is about five times higher than those that are under age 35.

So this substantial shift in the increasing of population over the age of 85 is expected to drive up our healthcare costs. Indeed, if you go back to IGR 4, released in March 2015, healthcare costs were projected to grow from 4.2% of GDP up to 5.5% of GDP by 2055. And in fact, only eight years earlier, in IGR 2, it was expected to grow to 7.3% of GDP. But that reduction that we've projected is mainly due to some policy changes that have been implemented, such as changes to the Pharmaceutical Benefits Scheme to curb that expected cost increase. At the same time, the cost of Aged Care is expected to double over the next 40 years, from about 0.8% of GDP now to about 2%. There's a really material increase to government expenditure in these areas. Funnily enough, on the other hand, the cost of the Age Pension's actually projected to decrease over the next 40 years, from about 2.9% down to 2.7%.

Previously in IGR 2, this was set to increase to 4.4% of GDP by 2047. So this is a massive turn-around. And it's mainly due to some policy decisions that have been made, such as increasing the Age Pension eligibility age, combined with higher projected superannuation balances, that includes the SG going from 9% up to 12%, and also some tighter means testing rules. So as you can see, changes in government policy have already had a significant impact on the projected future cost of some of our important social benefits. But clearly, we've still got some major issues in front of us, particularly around health and Aged Care. So where to from here? We've already got one of the best retirement systems in the world for accumulating savings, we all know that. However, the compulsory contribution level didn't reach 9% until 2002. So it's still relatively immature for many older workers. And like many countries, we continue to struggle with how to design an efficient retirement spending system.

We've recently had the retirement income review, which was specifically tasked with identifying effects that will help improve our understanding of how the retirement income system in Australia operates, and the outcomes that it's currently delivering for Australians. In this context, the panel looked at four things. The first three we've talked a lot about over the years, and they're adequacy, equity, and sustainability, which is why I find the fourth one so interesting. The fourth one was cohesion. How do the various parts of the system work together to produce retirement outcomes that are adequate, fair and affordable?

As I mentioned before, our retirement saving system is still relatively immature for many older workers. According to Treasury, about 65% of superannuation account balances at retirement are currently less than $250,000. However, the percentage for low-belt retirees is set to reduce from 65% down to 35% over the next 20 years, and that's a good thing. During the same period, the proportion of well-off retirees at the top end, those people that have more than $750,000 in Super when they retire, that's going to increase a little bit for about 10% of the population to 15%.

The big change, and the important change, is the percentage of the people retiring in the middle, those that have between $250,000 and $750,000. And that's going to double from about 25% of retirees now to about 50% of retirees in 20 years' time. This middle group in particular will need to draw down and spend their savings efficiently if they're going to have the kind of retirement that they aspire to, especially in their healthier years of their retirement. Also, for this middle group, retirement is going to be complex. They're likely to be eligible for a part Age Pension for most of their retirement, and the income and assets means tests are complex, depending on whether or not you're a homeowner, and whether you have a partner or are single. Of course, it's also worth noting that about 70% of people entering retirement are headed there as part of a couple, yet for most people, their Superfund doesn't know that, nor do they know anything at all about their partner's superannuation. So these are key issues that we're going to have to fix.

In addition, retirement's got a lot of uncertainty that people have to worry about. We could still do a lot more to help retirees and their families to manage this uncertainty. Aside from the costs of health and Aged Care, retirees have to manage four big risks on superannuation and savings. The first one is how to manage income risk. How are they going to spend their money safely each year, taking into account their variable spending needs as well as inflation? The second is liquidity risk. What happens when an unexpected expense comes up, like minor repairs to the house or replacing the fridge? The third is investment risk. This is the one that gets a lot of conversation. It's both to ensure that they continue to invest aggressively enough to earn enough investment income to last a longer life, but also to take into account the impact of short-term market volatility, including sequencing risk and switching risk. And finally, the one that's least understood is longevity risk, especially the systemic risk about the whole population living longer, but also the individual risks that a retiree has themselves. They don't know how long they're going to live themselves, and how do they spend their money safely?

So to help these people, we need to do two things in particular. The first, we need suitable retirement income products to help them manage these risks. And the second is we need affordable access to information, guidance and advice to help them navigate all this complexity. To meet their retirement aspirations, this middle group can ill afford to leave a large portion of their savings as bequests to their children or their estate if they happen to live a long life. They would therefore benefit from a well-designed retirement income product that would help them to draw down and spend more of their retirement savings sooner, safely and with confidence. And this is where a CIPR comes in, a Comprehensive Income Product for Retirement. An important development for CIPRs was the introduction of new means testing rules that took effect last year on 1 July 2019, with only 60% of the purchase price for qualified longevity protection products counting now as an asset for the Age Pension means tests.

I recall meeting with Treasury and government representatives back in about 2010 to promote this little change, and it's taken and it's taken about nine years for it to actually happen. It seems we might be heading down a similar path with CIPRs. Treasury released a consultation paperback in 2016, and everything was pushed back a couple of years into 2018. This week in the federal budget, it was announced that the covenant was going to be deferred for two more years until 1 July 2022, and we still don't have a starting date now for when CIPRs will actually commence, presumably because we're going to have further consultation that can now be informed by the findings of the Retirement Income Review when that's released.

So while CIPRs may one day be well placed to help many retirees manage their spending in retirement more efficiently, there's still another major concern for Australia's aging population, and that's how they're going to fund and manage Aged Care. This uncertainty is yet another reason why many retirees continue to spend their retirement savings frugally, and in many cases leave unnecessarily large bequests to their estates. Now, Aged Care is a catch-all phrase that includes in-home care options as well as residential Aged Care that includes a combination of daily living services and some elements of healthcare as well.

And residential Aged Care is one of the most significant financial decisions that retirees will make. The contract options are really complex, and they've got to make decisions about daily accommodation payments versus refundable accommodation deposits. It's all is really difficult. And all this happens at a vulnerable time when their physical and mental health is deteriorating. And it's also a very emotional decision, I've been through it myself with my parents, as it involves admitting that you can no longer live independently. You're moving away from the safety and security of your home that you've lived in for a long time with so many fond memories, to a new residence that simply just doesn't feel like home. And because it generally involves the sale of the family home, it's typically an irreversible decision. You can't go back once you've done it.

From the community descriptive... Yeah, go for it.

Shelley Wettenhall: We come across this a lot, Andrew, in talking to retirees, particularly when they're looking at making those really big decisions about perhaps moving into Aged Care, and it is a very big time of stress for them. Any hints on how they may be able to make that transition a bit easier and make those decisions a bit easier?

Andrew Boal: Well, there's a couple of things there, really. One is about trying to make these financial decisions earlier. So before the mental health and physical health are deteriorating and just becoming an urgent decision, or, and this happened with my own family, as soon as Mum and Dad were unable to live independently we had to make all these decisions on the run in a very short period of time. So we currently don't have the forethought and the planning, and because it's so complex, to spend the time when we don't really think it's going to happen for many years to come. So it's that... It's like most things from a behavioural science perspective, we hope that it's a long way into the future and therefore we don't have to worry about it today. So we've got to find ways to bring that forward so we can make a decision quicker.

Josh Funder: Andrew, I wanted to ask you about the Retirement Income Review.

Andrew Boal: Yes.

Josh Funder: It led the world in its terms of reference in setting out three pillars of a retirement funding system quite differently. The first, of course, is the government pension, the second is compulsory savings, in Australia, we have a leading superannuation system, but for baby boomers, it's been an inadequate time in that system to accumulate adequate retirement funding. And the third was voluntary saving including homeownership. And for Australians, they're the wealthiest retirees in the world, but predominantly that wealth has been saved conscientiously in home equity.

Josh Funder:  Now, the home's really pivotal here, because people want to stay at home as long as they can, even when they're needing home care or even when they start to have the early onset of dementia, for 30% of people. The home is also absolutely pivotal for retirement outcomes in terms of maintaining community connectiveness and a vibrant context for retirement. As you've mentioned, it affects the assets test for the pension, what you've got in and out of your home. And then finally, of course, it's the largest part of savings that people should be able to draw on. Where do you see the CIPR or the transition over time, to make sure that that third pillar can support retirement housing, lifestyle, but also funding in Australia?

Andrew Boal: Yeah, so I think it's that particular, that middle group that I talked about. I mean, the wealthy I'm less concerned about, but in the middle, I think to receive the retirement that they really aspire to, they need access to as much of their savings as they can, which includes part of the equity that they have in their own home. But the big problem that they have is, "I'm not sure if I'll need all of that to get into an Aged Care facility if something happens to my physical health or mental health." And so they are really, really conservative about wanting to access the part of their home equity to spend on things other than Aged Care, just in case. And so if we can find a methodology to bring forth some of that decision-making, even in allowing for forward thinking about purchasing access to Aged Care and other in-home care needs, before you need it. A bit like insurance. So we have an insurance policy that says, "Don't worry about that anymore, that'll be taken care of. You've paid for that, but everything you got left you can now spend safely on living in retirement." And if we can use other forms of vehicles like an annuity, or deferred life annuities, to help them even further bring forward some of their spending to the earlier parts of their retirement when they're healthy, even better.

Josh Funder: I wanted to ask one final question, Andrew. You mention the Intergenerational Report, and retirees are already taking that into their own hands, and actually this is an area where that forward thinking is absolutely widespread. The bank of Mum and Dad is Australia's fifth biggest bank. Transfers from baby boomers and people in retirement to their children, often for first time buyers deposit, to their grandchildren, really often focused on educational expenses and meeting those needs, and getting those lifetime skills, and the value of those skills as high as they can; it is a huge thing that is under recognised in our policy thinking. But often the bank of Mum and Dad is at the expense of retirement funding, and the last 10 or 15 years of retirement are depleted in the available resources because people have chosen the bank of Mum and Dad. So, how can we make sure people can think ahead to the back end of their retirement and the outer years, and at the same time really support their families in a range of ways that are responsible, but also meet their real big desire to be the bank of Mum and Dad?

Andrew Boal: Yeah, it's a great question 'cause I think, and it's a similar situation to what I was describing before about having that confidence to spend earlier in retirement, to actually have the confidence to spend some of that even earlier again to help children and others. So at the end of the day, if you know that that latter part of life is taken care of... At the moment we're seeing that most retirees are dying with at least 30% of their superannuation still left. Wouldn't that money have been better spent on themselves, or even in what you're just talking about, helping their children get into their first home and do other things at the time their children need it. A couple things have changed with the aging population, is that going back many, many years ago, if somebody retired at age 65, they might only live seven or eight years. And because they had children at a young age, their children were already in their mid-40s. Now we're having people live until 90. Their children are going to be 70 by the time they die, and do they need any money? Why can't we find a way to give them the confidence to give that money to their children when they've got their own debts and they can actually make it useful? And so once again it's the same solution, is to have some insurance mechanisms in place to provide the confidence that they can use the rest of their money safely.

Josh Funder: Andrew Boal, we are out of time, but warm thanks for your contribution to the 2020 Third Pillar Forum. Thank you very much.

Andrew Boal: My pleasure, good to see you.

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