The objective of Flow’s goals-based investment approach is to provide an income in retirement that allows members to maintain their standard of living for life (or at least, endeavour to provide the best possible income given the level of contributions received and the period of time they contribute for before they retire).
Individual income goals: The Flow app will target an individual income goal per member based on the time they are expected to spend in the Fund(s) and in relation to their earnings before retirement.
Keeping pace with inflation: We target an income that increases each year. The increases should be linked to inflation which importantly, allows members to maintain their standard of living. The increase targeted will be driven by the nature of the annuity availability.
Payable for life: We target an income that will be payable over the expected lifetime of each member.
Most DC Funds will purport to target income for members in retirement. However, this is done without explicitly targeting an income stream (or annuity) but rather with a focus on maximizing members’ accumulated savings at retirement (with the hope that this is sufficient to provide the desired income. The app uses a framework that is different in that it explicitly targets an income stream (or annuity). Furthermore, the framework will be catered to the various types of annuities offer to members in the Fund at retirement.
Recognizing that there are different annuity options available, the framework is entirely flexible and can accommodate any type of annuity.
The Fund comprises a diverse set of members who differ by age, gender, accumulated savings, and time spent in the Fund(s). The heterogeneity of the membership across age group and even within an age group supports the need for a personalised approach. We are able to provide an analysis of this heterogeneity with access to appropriate Fund Data.
Our framework centres around using actuarial valuation techniques to create an individual balance sheet for each member. We do this by comparing their assets and their liabilities. This allows members to assess if they are on track to meet their income targets. This considers the cost of providing the targeted income against members’ savings within the Fund (their accumulated savings and future expected contributions). In doing so, member specifics (such as their life expectancy and gender) as well as market factors (such as inflation, market performance and interest rates) are considered.
These assumptions are market consistent (i.e. they are based on prevailing market conditions) and will be consistent with that used by the Fund Actuary in performing a valuation of the defined-benefit obligations.The Funds income target will be achievable and realistic. This needs to factor in:
Contribution rates across the Fund,
Time members are expected to spend in the Fund (and the average Normal Retirement Age)
Based on specific member information, it is possible to determine an appropriate income target. It is also possible for members to identify their own targets. Members’ targets within the Fund need to reflect their specific circumstances in the Fund. For example, it should reflect a member’s expected time in the Fund (taking account of when they joined and when they are expected to retire), and importantly a member’s contribution rate.
Assuming a current level of contributions and a given Expected Retirement Age, it is possible to identify a target of pensionable salary for each year of service expected in the Fund. we can therefore personalise each member’s target based on their expected service with the Fund.
The benefit of this approach is that the income target is explicit and tailored to the Fund’s specifics (contribution rates and retirement age) and further tailored for each member (based on the time expected in the Fund). This contrasts with traditional approaches which tend to have a “soft” or implicit 70%-75% target for all members. This 70-75% target is a widely accepted standard across the industry and often does not relate to the Fund’s specifics (contribution levels and retirement ages) and therefore might be inappropriate. Even if appropriate based on Fund specifics, it may still be inappropriate for members who spend only a few years in a Fund, or those that spend their entire working lifetime in a Fund (and have more than 40 years’ service).
We create an individual balance sheet for each member comparing their assets (savings) and liabilities (the cost of their targeted income). We consider their savings in the Fund (both accumulated savings and the value of their future expected contributions) to their targeted income in the Fund.
Our calculations take account of each member’s unique circumstances (i.e. we consider their targeted income in the Fund, their retirement age, their life expectancy, their accumulated savings, and their contribution rate) and market factors (such as inflation, market performance and interest rates).
Our calculations are updated with the latest member information (available from the Fund) and market information. This means that any changes to contribution rates, salaries, cost of purchasing an income and market performance are incorporated to provide members an up-to-date assessment of their retirement readiness.
Importantly, we perform these calculations on a market consistent actuarial valuation basis. This means that our calculations are based on the actual market information (not long-term assumptions that are out-of-sync with market inputs). Our calculations are therefore aligned with inputs used by annuity providers and importantly, means that the income communicated to members aligns with what they can buy in the market. This is consistent with generally accepted accounting principles and rules.
We create a balance sheet for each member taking their unique circumstances in the Fund into account. We use these individual balance sheets to assess whether members are on track to achieve their targeted income in the Fund.
Members that are on track have assets that are greater or equal to the value needed to provide for their targeted income. We refer to these members as having a “funding level” of 100% or more.
Members currently receive information that focuses on the value of their Fund Credit (accumulated savings) in the Fund. Whilst this is useful information, members do not know how much income this pot of money is likely to convert into at retirement and are therefore unable to evaluate whether that income will be enough for them to retire comfortably.
This is not a problem specific to South Africa and members in Defined Contribution arrangements across the globe are faced with a similar challenge (albeit to a lesser extent as a portion of their retirement provided for by Defined Benefit or social security arrangements). Professor Robert C. Merton (a Nobel Laurate involved in the development of our goals-based solution) published an article in the Harvard Business Review arguing that the retirement industry is facing a crisis as the vast majority of members retire on inadequate incomes (owing somewhat to the lack of meaningful information provided). A copy of the article can be found at https://hbr.org/2014/07/the-crisis-in-retirement-planning.
Flow provides members with more meaningful information about how much income they are on track for. This is broken down into how much income they can expect from accumulated savings in the Fund and future contributions in the Fund.
Flow helps members focus on the right metrics. We provide information about how members’ expected retirement incomes have changed over the year. This helps focus members’ attention on those aspects of the retirement journey that are within their control (such as contributions) and those aspects outside their control (such as market effects i.e. inflation, interest rates, investment performance). Importantly, communicating these aspects shifts member’s focus from investment performance in absolute terms (such as negative performance) and relative terms (compared to a market benchmark) to the metrics that really matter to them i.e. what income they are on track and how this changed over the reporting period.
Flow provides members with more meaningful information to help them improve their outcomes. There are only three ways to improve a member’s retirement outcome – members need to save more (i.e. increase contributions), save for longer (i.e. delay retirement) and/or change their investment strategy (by investing more aggressively).
We give members information on corrective (implementable) actions they can take to boost their retirement income. Not only are members given information about what actions they can take (such as saving more of delaying their retirement), we help members quantify the trade-offs between such actions by providing information about the potential benefit compared to the sacrifice being considered.