Post-retirement solutions

While individuals, asset managers and governments across the developed world have long focused on retirement planning – i.e. saving and investing for the golden years – surprisingly little attention has been paid to decumulation planning. 

As life expectancy lengthens and expected retirement spans extend, the importance of planning how to deploy accrued savings to support retirement has never been more acute.

Digging into decumulation

In the video below, Lesley-Ann Morgan, our Global Head of Defined Contribution and Retirement, provides insight on the challenges facing retirees across the world, and for Hong Kong in particular. She addresses the balancing act between the needs and wants of those facing retirement and explores investment approaches for those retiring in Hong Kong.

Schroders’ undertook a study of how retirement saving are utilised in markets across the world. We found that no market – including Hong Kong – has yet solved the puzzle of the most appropriate post-retirement investment solution.

A common thread across these markets is the conflicting objectives savers face and the fact that most participants have not contributed enough to their defined contribution pension plans.

Lengthening life spans complicate retirement planning

With elderly populations growing and individuals living longer than ever in Hong Kong and across the developed world (see Figure 1), there is growing awareness that most individuals are not saving enough to meet their needs in what is likely to be a longer-than-expected retirement.

Figure 1. Life expectancy has steadily risen, with Asia leading the globe

Source: United Nations, Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision, custom data acquired via website.

Asia leads global growth in post-retirement populations

As healthcare improves and life expectancy continues to rise, old-age dependency ratios1 are rising across the globe.

  • Asia’s old-age dependency ratio of 11.1 was slightly better than the global average of 12.6 in 2015.
  • This is expected to change by 2050, when the region’s ratio is forecast to reach 28.4, eclipsing the global average of 25.6.
  • Hong Kong’s situation is particularly acute, with its old-age dependency ratio estimated to more than triple from 20.6 in 2015 to 64.6 in 2050 (see Figure 2).
  • This will leave Asia home to an aggregate old-age population that exceeds that of the rest of the world combined (see Figure 3).

These point to a pressing need for governments, financial institutions and individuals to prioritise post-retirement planning.

Figure 2. Hong Kong tops Asia and global old-age dependency

*Old-age dependency ratio = ratio of population aged 65+ per 100 population 15-64
Source: United Nations, Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision, custom data acquired via website.

Figure 3. Asia’s old-age population to exceed the rest of the world’s by 2050

Source: United Nations, Department of Economic and Social Affairs, Population Division (2015). World Population Prospects: The 2015 Revision, DVD Edition.

Retirement planning considerations and risks change over time

When thinking about post-retirement planning, we find four key “known unknowns” that individuals need to take into consideration:

  1. How long will I live?
  2. How much will things cost in the future?
  3. How much income will my investments generate?
  4. What goods and services will I consume?

And the answers to these questions are moving targets. As Figure 4 illustrate, the risks they represent are not static but actually shift over time. For example:

  • Returns – The value of a defined contribution pension will likely be largest in the years immediately preceding and following retirement, making it most susceptible to market volatility at this time.
  • Inflation – Inflation, which has ranged from about -2% to about 8% in Hong Kong over the past 10 years2, is of more concern in the early years of retirement – when a retiree faces decades of inflation and a shrinking asset base – than it is 20 years into retirement.
  • Longevity – Longevity risk, the risk of outliving one’s sources of income, increases with age as it is more likely that an 89 year old will reach the age of 90 than it is for a 65 year old.

Figure 4. The significance of retirement risks change over time

Source: Schroders. For illustration only. February 2015.

With two centuries of experience, US$520.6 billion in assets under management and 4,100 investment professionals worldwide, Schroders is a truly global investment partner. This includes more than 45 years in Hong Kong, where we understand that employers are concerned about their employee’s post-retirement welfare.

There is growing recognition that simply relying on a cash lump sum in retirement will not meet retirement funding needs. We see an opportunity for employers and pension scheme sponsors to work with an investment partner, like ourselves, to implement well designed investment solutions that address their employees’ key risks in retirement and help to deliver income security in the face of uncertainties such as longevity risk, inflation and the unpredictability of returns.

1 Old-age dependency ratio = ratio of population aged 65+ per 100 population 15-64
2 Bloomberg, accesses 5 June 2017. Monthly year-on-year inflation for the 10-year period troughed at -1.6% for 31 August 2009 and peaked at 7.9% on 31 July 2011.

Schroders believes addressing the post-retirement challenge requires a two-pronged approach:

  • On the one hand, governments, employers and asset managers must continue to support individuals during the asset accumulation phase of their lives to ensure they have sufficient savings at retirement.
  • On the other, there is a need for increased focus on the too-often-ignored decumulation phase of life, when retirement savings are being drawn down.

Crafting a decumulation strategy that works

In our study of decumulation strategies worldwide, including in Hong Kong, we found that every individual faces a balancing act between addressing the features they need and those that they want.

In searching for this balance, Schroders works with employers and sponsors to consider the tools plan participants have at their disposal, which comprise three key options:

  1. cash lump sum is the simplest option. It allows individuals to control their own funds, but also leaves them with all of the responsibility and risk associated with managing decumulation.
  2. Utilising individual accounts allows an individual to adjust income levels throughout the decumulation process. At the same time it offers the flexibility to choose underlying investments while also having the option to access the benefits of a lump sum and an annuity.
  3. Annuities provide a reliable income stream while an insurer manages the associated pooled risk. The income stream can be set at a flat level or rise over time and, similarly, can start immediately or in the future. Annuities can also deliver the peace of mind of including guaranteed spousal benefits.

Creating a tailored decumulation strategy

There is no single option that produces a suitable solution for everyone. Rather, any given post-retirement decumulation strategy is likely to utilise a combination of these options in order to meet the key needs of individual retirees in Hong Kong. Schroders believes there are four key areas where such a solution must deliver:

Default to a tailored decumulation plan

With so much uncertainty surrounding post-retirement planning and myriad options available, an ongoing debate in the asset management industry surrounds the potential for governments and employers to offer a “default decumulation strategy”.

While the simplicity of this approach is appealing, Schroders believes planning a decumulation strategy for any one individual is simply too complex for such a prescriptive approach to work as:

  • Everyone’s circumstances differ meaning a default strategy may not match a given individual’s needs.
  • Improved financial literacy and the availability of web-based resources empower individuals to make their own accumulation and decumulation choices.
  • Many individuals highly value choice.
  • It would be impossible to get all stakeholders across government, plan sponsors and asset managers to agree on one default plan.

In fact, our research and discussions with stakeholders suggests that an individually tailored post retirement plan is the only plan that should be considered “default”.

This does not mean leaving plan participants at sea amid a hundreds of potential decumulation plans. Rather, Schroders suggests providing retirement plan participants with a short-list of appropriate plans that have the potential to deliver longevity protection despite continued inflation and the potential for capital market volatility.

To explore the key considerations for decumulation planning further, please download our reports using the buttons below.

Live Long and Prosper   Putting your savings to work

Experts from Schroders discussed these challenges and solutions in an article for AsianInvestor. Lesley-Ann Morgan, Global Head of Defined Contribution and Retirement and Chris Durack, CEO of Hong Kong and Head of Institutional Asia Pacific shared their views and opinions on the topic.

What is an effective retirement scheme that addresses changing risks across post-retirement?

Hong Kong’s public annuity scheme is a step in the right direction for addressing post-retirement incomes because the plan forms the basis from which individuals could supplement with solutions that provide for lengthening life expectancies and inflation risks, says Schroders.

Based on the proposal to be launched by Hong Kong Mortgage Corporation (HKMC) in the middle of next year, elderlies aged 65 and above will be allowed to invest up to HK$1 million in exchange for a guaranteed monthly income until death.

While we welcome the plan, it may not be adequate, says Lesley-Ann Morgan, Global Head of Schroders’ Defined Contribution and Retirement. She explains that there are three key risks that people face in retirement: living longer than expected, experiencing higher inflation than expected and getting lower investment returns than expected. She believes that the scheme, which is capped at HK$1 million, cannot be expected to address all of these risks.

Risks after retirement

Early in retirement, investment returns and inflation are the two principal concerns, she says. However, longevity risk, which starts out relatively small, due to the high probability of survival through the early years, will grow quickly as the individual ages -- reflecting the fact that longevity is self-fulfilling, i.e. the probability of reaching age 90 is much higher for an 89-year-old than for a 65-year old. “You need some longevity protection, but you don’t need it until later in life; maybe not until you get into your eighties,” says Morgan. This insight helps to focus the solution on the appropriate risk at each stage of retirement. According to Schroders, a successful post-retirement strategy should meet four primary ‘needs’ criteria. It should provide stable investment returns (net of costs), protect against longevity risk, safeguard against inflation and be flexible to adapt to changing requirements. However, these needs differ significantly from what individuals want from their post-retirement investments. Most retirees want predictable income so that they can budget, be able to leave some legacy assets to family members, they want enough to live on and for the solution to be simple, according to Schroders’ report “Investment perspective: Live Long & Prosper.”

The three components of a post-retirement plan

While there is some degree of conflict between the needs and wants, Schroders recommends a solution that provides a balance of these factors.

While considering an appropriate pension strategy, Schroders analysed three commonly used approaches to providing income in retirement and assessed how they fare against the four needs and wants of retirees, these three being: cash lump sum invested in an instant-access bank account (common in Hong Kong); individual investment accounts that provide non-guaranteed income; and fixed income annuities that provide longevity protection.

“Any of these components is unlikely, in isolation, to be suitable to meet the needs of retirees,” says Morgan. “An effective solution will be a combination of fixed annuity/longevity protection and an investment portfolio that returns growth above inflation. With lengthening life expectancies, we anticipate strategies that provide a growth and income account-based approach for the first 15-20 years after retirement with longevity protection engaging in later life,” she adds.

No market in the world has yet fully solved the puzzle of the most appropriate post-retirement strategy, says Morgan. “Many DC (Defined Contribution) members have not contributed enough, and they are living longer, which means they need to make assets in post-retirement work harder,” she says.

While annuity products are popular in Continental Europe, supported by regulation that has been put in place to provide guaranteed income for life, falling bond rates are putting a strain on such policies. “The challenge for such products is that the guarantees are difficult to provide and this put a question mark on how long they can continue,” says Morgan.

In some countries, reverse mortgage schemes, which allow people to borrow against the equity of their homes, remains unpopular. “It is very hard to make it work from an emotional and behavioural standpoint because people like the idea of being able to hand their property on to their family when they die.”

A suitable solution for Hong Kong

As Hong Kong considers the launch of its annuity scheme, Morgan advised combining the annuity with a growth solution. “The combined plan will tick more of the boxes. You get the flexibility, you get longevity protection, you get the return potential in excess of inflation and is reasonably simple,” says Morgan.

According to Schroders, the solution for Hong Kong should focus on maximising risk-controlled growth opportunities in the early stages before adjusting to protect against longevity risk, later on, fitting the pattern of risk sensitivities as the retiree ages.

A single default strategy won't work for everyone

Amid the uncertainty and a broad range of post-retirement options, some industry experts have argued for the creation of a post-retirement “default strategy” to help offer a better starting point for these decisions, says Morgan. However, Schroders does not advocate the approach of having a single default fund in post-retirement primarily because everyone’s circumstances and needs differ. “Rather like building regulations that ensure buildings are built on a set of robust principles, we favour an approach which seeks to establish a set of principles that are the necessary conditions for good quality retirement solutions,” it says in its report.

For example in a corporate plan, an individual could be given a short-list of suitable investment funds and a short-list of suitable longevity protection options from which to choose, suggested Schroders. The individual would also determine the proportion to allocate to the investment component and the remainder to the protection component. A minimum proportion could be imposed on each. If permitted and tax-efficient, a partial cash lump sum might also be taken at the point of retirement, it says.

Employers and pension scheme sponsors voicing out concerns

With lengthening life expectancies leading to increasing inflation and investment risks, plan sponsors could have a bigger role to play post-retirement to ensure that retirees make the right choices with regards to their investment choices during the “decumulation” phase. Currently plan sponsors have no legal responsibility to get involved in how their employees obtain an income when they retire. “In our dialogues with institutional clients, we see increasing concern that Hong Kong employees have access to adequate retirement benefits,” says Chris Durack, CEO of Hong Kong and Head of Institutional Asia Pacific. “There is growing recognition that simply relying on a cash lump sum in retirement will not meet retirement funding needs.

Instead, some employers and scheme sponsors are looking to implement well designed investment solutions that address their employees’ key risks in retirement and help to maximise their hard-earned life savings,” Durack adds. “In this regard, Schroder could help with providing the right solutions,” he says.

Important Information: This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Source: AsianInvestor June/July 2017