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Retirement system begging for reform

Much attention has been drawn recently to the high cost of the Australian superannuation system compared with pension systems overseas. The industry response has been that our defined contribution superannuation system, with its high exposure to risk assets and included features such as insurance and financial planning, is built for high performance and can’t be compared with ‘no frills’ defined benefits systems overseas.

Missing from the debate however has been proper consideration of outcomes – what do we get from this so-called ‘high performance’ superannuation system? I argue that performance of Australia’s costly ‘bespoke’ superannuation scheme should ultimately be judged on its ability to deliver sustainable and higher living standards in retirement.

Critique of current assessment

The 2014 Melbourne Mercer Global Pension Index (MMGPI) released recently compares the retirement income systems of 25 countries on the basis of adequacy, sustainability and integrity. According to the MMGPI, Australia is ranked first in terms of retirement income adequacy and third in terms of sustainability. Overall, Australia’s retirement saving system was “ranked second best in the world beating the Netherlands for the first time in five years and falling just short of Denmark”.

What is remarkable about the MMGPI ranking is that it stands in marked contrast to other global aged living standard rankings. In particular, the UN/World Bank’s Global AgeWatch Index ranks Australia 57th in the world for income security for the aged. The OECD ranks Australia 32nd out of 33 for aged poverty and last for net replacement rates (the ratio of post-retirement income to pre-retirement income). This raises the question of how can the highly positive results of the MMGPI be reconciled against the negative assessment of the United Nations, OECD and World Bank. The answer lies in the way the MMGPI is measured.

First, the MMGPI adequacy index relies heavily on a projected measure of net replacement rates for the median income earner 40 years from now rather than actual replacement rates. That means these projections are based on the hypothetical assumption that the current design of the pension and superannuation systems has been in operation for the full working life of the retired population which is of course not the case for current retirees. The methodology provides an unrealistic picture of the adequacy of retirement incomes in Australia today given that it will be many years before all retirees have been through the superannuation system. Evidence on actual (rather than projected) replacement rates presents a totally different picture. According to OECD estimates, Australia’s replacement rate (retirement income as a proportion of median earnings) is the lowest among 34 OECD countries and it was even lower for retirees over 75 years of age.

Second, the MMGPI excludes a measure of poverty as a key indicator of income adequacy. A common poverty measure is the proportion of the population with incomes below 50% of median income (Burnett, Davis et al 2014). Using this well-established measure, the OECD estimates that Australia has one of the highest aged poverty rates in the OECD region (35% compared with an OECD average of 12.8%), second only to Korea (47%). While the living standards of the aged across the world are generally lower than those of the broader population, this disparity is greater in Australia than in almost all OECD countries. This is a perverse finding for such an expensive system.

Third, the MMGPI includes 25 countries at various stages of economic development while the OECD analysis includes 33 advanced economies all at comparable levels of economic development.

Superior assessment of adequacy

While the MMGPI provides a technical and assumption-driven assessment of the design of various retirement income systems and how well they are likely to perform in the long term, it is much less useful as a tool for the more important task of evaluating actual retirement outcomes. An alternative global index, the Global Sustainable Retirement Income (GSRI) Index, has been developed by the author to enable a comparative assessment of living standards in retirement. This index, covering a broad range of indicators for sustainability and adequacy, incorporates actual rather than hypothetical replacement rates and aged poverty rates in its calculation. For an explanation of the methodology click on the link at the end of this article.

Using this index, the pension system performances of 33 OECD countries were evaluated with scores assigned to each country on the basis of their performance against each indicator. According to this index, Australia ranks 25th in terms of adequacy and second in terms of sustainability. Overall, Australia comes in at a modest 13th place in contrast to second position based on MMGPI.

The low level of income adequacy for Australian retirees compared with their counterparts overseas cannot be explained away by higher rates of home ownership. Many other OECD countries have similar or even higher rates of home ownership. While publicly-provided services are estimated to enhance elderly incomes for Australian retirees by 35%, this rate is lower than the OECD average benefit of 40%. Taking into account in-kind benefits of housing and publicly-provided services does not change the overall conclusion that retirees in Australia are less well off than their OECD counterparts.

Even if the comparison is restricted to OECD countries with high-financially sustainable pension systems, Australia’s retirement system performance is still left wanting. Three fiscally sustainable pension systems stand out as having significantly higher living standards for the aged – Canada, Denmark and the Netherlands – with both Canada and the Netherlands achieving these outcomes despite more significant demographic pressures than Australia.

Policy implications

The relatively low level of income adequacy provided by the Australian retirement system raises fundamental questions. Given the significant level of national resources devoted to retirement in Australia, including superannuation fund assets equal to GDP and public expenditures on superannuation tax concessions and pension payments, should Australians be content with the low level of financial security offered by the retirement income system?

Given the mounting budget pressures associated with the projected growth of superannuation tax concessions and expenditures on aged care resulting from population aging, can we afford to be complacent about the inefficiencies and poor value for money of the retirement income system?

The policy debate is ill-served by glib references to Australia’s ‘world class pension system’ and calls for increasing the flow of compulsory contributions into the superannuation system. Such statements contribute to a sense of complacency about the effectiveness of the system that is not supported by the evidence. Rather than arguing for increasing the contribution rate, we should be asking ourselves how can we deliver better retirement outcomes with the national resources already committed to the retirement system.

Increasing the adequacy of retirement incomes without consideration of budgetary consequences is clearly not an option. The priority is therefore to identify reforms that would improve the level of retirement income adequacy without compromising, and indeed improving, fiscal sustainability. There is no silver bullet. A multi-pronged approach addressing the lack of integration between the public pension and superannuation systems, competition and governance is needed. While such reforms are complex and may take time to deliver outcomes, a good place to start is to address the undeveloped post retirement system given its very direct relationship with retirement outcomes. These issues are exercising the minds of both the Murray Inquiry and Treasury’s Review of Retirement Income Regulation, which are running concurrently.


Patricia Pascuzzo is Principal of Superannuation Policy and Research, and was formerly a Treasury Official and co-author of the Financial System Inquiry 1997. Her most recent report, An International Comparison of Pension Systems Performance in Delivering Adequate Retirement Incomes (2014)”, was commissioned by Challenger Limited, and forms part of that institution's second submission to the current Financial System Inquiry.


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