Retirees have good reason to be wary of rising inflation. It can quickly destroy the value of a lifetime’s savings and with it, their quality of life.
But that doesn’t mean inflation is an appropriate benchmark for super funds attempting to meet their members’ retirement needs.
Where retirees actually spend their money is only partially reflected in the components of the official Consumer Price Inflation (CPI) index. Yet more than half (59%) of all of balanced pension funds rank their performance against CPI, according to researcher SuperRatings.
Source: Australian Bureau of Statistics
CPI jumped 0.5% in the March 2017 quarter due to rising fuel and health costs and residential property prices, pushing annualised CPI 2.1% higher on a seasonally adjusted basis. Unfortunately, the CPI is not adjusted for the actual expenditure of retirees.
Milliman’s Retirement Expenditure and Profiles (ESP) reveals by just how much. The ESP analyses the spending patterns of 300,000-plus retirees and shows not only where retirees are spending their money, but also how it changes over time and by location.
How retirees’ expenditure differs from CPI
The following diagram breaks down retiree spending across 11 categories and five age bands, using real-world data to determine actual retiree behaviour rather than relying on limited, qualitative surveys and assumptions.
Source: Milliman Retirement Expectations and Spending Profiles Q2 2017. See full report for a full breakdown and labels of each spending component.
For example, health takes up 12% of 65- to 69-year-olds’ total expenditure, quickly rising to 23% of expenditure by the time they reach age 80 to age 84. Rising health costs may have a larger impact on retirees than the CPI would suggest.
Just as the impact of health costs increases as retirees age, their expenditure on travel and transport almost halves between the 65- to 69-year-old band and the 80- to 84-year-old band.
Meanwhile, other components given greater weighting in the CPI, such as housing and education, tend to account for a much lower proportion of retirees’ expenditure. We know that the majority of older Australians own their own homes, quarantining them from rising property prices, which is also reflected in the ESP data.
However, an estimated 15% of older Australians currently rent their homes, making significantly higher demands on their cost of living (partly because the value of homes doesn’t affect Age Pension eligibility), according to the latest census data.
The proportion of older renters is expected to increase as soaring east coast property prices lock more people out of the residential property market. The proportion of all people renting in Australia increased from 27% to 31% over the six years to 2016, according to the latest census data.
This shows that no measure is static–identifying trends and planning for their impact is a key challenge for funds but one that is only possible to meet with quality data.
Using this information to build better benchmarks
Inflation is an important factor to consider in portfolio construction, but the Milliman Retirement ESP shows that CPI is far from an accurate measure for retirees.
Getting it right is particularly important given that retirees are drawing down their life savings: small changes in expenditure (and investment returns) can have a significantly larger impact than on those still accumulating.
More accurate information about members can be used to create new benchmarks that suit retirees’ actual needs.
Some funds may wish to retain an inflation-based benchmark but reweight the components to reflect the real-world spending patterns of their retirees. This could be changed depending on the age of the retiree or retirement income streams could be constructed to meet discretionary versus essential spend.
Some funds may take this a step further and, given that CPI is not an investable asset itself, may replace CPI-based benchmarks altogether. An absolute return benchmark may give some retirees greater certainty and better meet their needs if funds can base those targets on granular data about real expenditure.
In this way, funds can create a personalised retirement journey for members and truly improve their retirement lifestyles.
The full Milliman Retirement ESP report is published to subscribers each quarter. Contact Milliman senior consultant Jeff Gebler at firstname.lastname@example.org for more details.
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