Just “Today’s Dollars” or “Real” Is Not Clear Enough
In this article, Colin Grenfell from the Institute’s Superannuation Projections and Disclosure (SPD) Subcommittee highlights the requirements of sections 5.3 and 5.4 of Professional Guidance 499.02 (PG 499.02) relating to disclosing deflators used in retirement benefit projections.
The Institute’s Professional Practice Guideline 499.02 applies:
“… to any Member advising a Client or other party in relation to Retirement Benefit Projections. Retirement Benefit Projections may be provided as illustrations or numerical indications depending on the purpose, audience, and the nature of the retirement benefit.”
and for the purposes of the Practice Guideline:
“’Retirement Benefit Projections’ means the presentation of any estimate of an amount that may be received by, or cash flows that may be paid to, an individual in the future to and through retirement. Presentations of the Projections may include illustrations or numerical indications.”
The latest edition of PG 499.02 was issued in September 2023. It applies in a wide range of circumstances and section 1.1.4 is particularly relevant. While not quoting that section in full, the section explains that the types of Retirement Benefit Projections include, but are not limited to, those that will be:
- issued to Plan members;
- provided on a website;
- provided to the press and then used to advise or inform the general public;
- provided to trustees of the Plan members (to assist strategic decision making);
- provided in a document, or as the output of any form of computer software (including websites and online digital calculators);
- used for modelling and designing retirement income strategies including innovative retirement income streams under the requirements of the retirement income covenant;
- used to support aggregate fund reporting for the purpose of APRA SPS 515, SPG 515 and SPG 516; and
- used to support business cases to fulfil Best Financial Interests Duty.
Defining the basis of “today’s dollars” or “real”
We have noticed that some Retirement Benefit Projections provided through online calculators or consumer education materials tend to state “today’s dollars” or “in real terms” without explaining what these words mean.
Sections 5.3 and 5.4 of PG 499.02 aim to guide members to provide sufficient and appropriate information to enable the end-user to understand the projected benefits:
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“5.3 Preferred practice is that sufficient information is provided to allow the end-user of a Projection to relate the benefits shown to his or her current income and balance. A projected income may be presented: (a) in real terms; and/or (b) as a percentage or multiple of projected salary. A projected balance or capital value may be presented: (a) in real terms; and (b) in nominal terms. The following is one example of how to present the projected balance in both real and nominal terms and projected income in real terms in one statement: “Your balance is projected to be $x at age 67 in future dollars, which is equivalent to a balance of $y in today’s dollars after taking account of the impact of wage inflation. This can be converted into a retirement income stream of $z per annum in today’s dollars.” 5.4 Preferred terminology in presenting the projected results is: (a) “today’s dollars” or “in real terms” refers to projected amounts which have been deflated to the projection date using a price or wage-based deflator. It is important that this is defined to explain the basis of deflation. (b) “future dollars” or “in nominal terms” refers to projected amounts with no adjustments. (c) The following is an example of a possible explanation of “today’s dollars” when presenting the projected results deflated by a wage-based deflator: “Today’s dollars” converts your projected future retirement assets or income into a current value. It takes the “future dollars” amount and discounts (or deflates) it back to today at the assumed rate of wage inflation. Wages, salaries and community living standards tend to grow faster than prices over the long-term and converting to “today’s dollars” is intended to allow you to better assess whether your retirement assets or income will be enough to maintain your current standard of living in the future.” The most important aspect is that the terminology is clear and consistent with respect to the basis for deflation (i.e. whether it is nominal, wage-based or price-based).” |
The highlighted sections show that just using the terms “today’s dollars” or “in real terms” is not adequate unless they clearly explain, either within the current text or accompanying notes, whether the basis of deflation is:
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wage-based;
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price-based; or
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wage-based until retirement then price-based after retirement.
The following three examples are extracts from three 2024 retirement projections. The extract wording from Example 1 is clear and quite reasonable, but the wordings from the other two examples are not adequate.
Example 1 explains that values in the “accumulation phase” are discounted by a wage-based rate and that values in the “retirement phase” are discounted by a price-based rate. It then explains the meaning of the “accumulation phase” and the “retirement phase”.
In contrast, Example 2 only states that figures are in “today’s dollars” without any explanation of how today’s dollars were determined. Likewise, Example 3 also has no explanation of how today’s dollars (or real terms) were determined. Further, Example 3 states that various items are adjusted for, or change in line with, “inflation”, but offers no explanation as to what this means.
Significant difference using a wage-based vs price-based deflator
ASIC (Superannuation Calculators and Retirement Estimates) Instrument 2022/603 (ASIC Instrument 2022/603) and Regulatory Guide 276 Superannuation forecasts: Calculators and retirement estimates (RG 276) require default deflators to be based on wage inflation prior retirement and price inflation after retirement.
ASIC recently updated its rate of default long-term wage inflation rate from 4.0% to 3.7% p.a. while keeping the price inflation rate at 2.5% p.a. Despite the reduction in gap between price and wage inflation rate, the difference in the deflated value for a future dollar value of $1 million can be significant over longer-term periods:
Due to the significant difference caused by the choice of deflators, the Actuaries Institute’s Technical Paper: Good Practice Principles for Retirement Modelling (published in August 2023) listed “Deflator” as the first item in a list of ten key assumptions to be disclosed clearly in a standardised way (see Principle 10 for more details).
The SPD hopes that this article will encourage members to improve disclosure practice on deflators used in Retirement Benefit Projections.
The difference between price-based and wage-based inflation is significant. It is not adequate to just use terms such as “today’s dollars” or “real” or “inflation” unless the bases of these terms are clearly explained within the current text or within accompanying notes. With ASIC requiring default deflators to be based on wage inflation prior retirement and price inflation after retirement, there is a heightened need for clear communication.
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