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We're living longer and so should our superannuation

On 28 November 2012, I delivered the keynote presentation at the Association of Superannuation Funds of Australia (ASFA) conference in Sydney.  My presentation focused on the future of superannuation and the retirement system in Australia. This article examines why it might make good sense for the government to be the key provider of a national annuity scheme, to cater for what is now a growing gap in our retirement incomes system as a result of people living longer.

But first, let’s look at where scale superannuation came from.

Our retirement income system is built on three pillars:

  • the means and asset tested age pension
  • compulsory superannuation
  • tax-assisted voluntary superannuation.

The big leap forward came with occupational superannuation which morphed into compulsory superannuation with the introduction of the Superannuation Guarantee Charge (SGC) in 1991 and its extension to universality in 1992. That change was a defining one for Australia because few democracies can encourage their workforce to save at least 9% of their wages and even more on top of that voluntarily. But Australia did. And it was my Government that achieved this through the unlikely combination of:

  • a centralised wage fixing system
  • a formal government policy structure with the workforce (the Accord)
  • the Government granting a structural concession for cyclical prudence (wage restraint)
  • a supra-boost to productivity coming from a decade of macro and micro-economic policy reform with trend productivity doubling
  • affordability for the compulsory SGC paid by employers coming from a sharing of that productivity gain with their employees.

And since then a further 3% of compulsory savings has being approved by the current Government, which will take the compulsory portion up to 12% by July 2019.

This extraordinary combination of events now allows Australians, unlike most citizens of other countries of the world, to bridge the income gap from work, through and into retirement. But it is now clear that the current system does not provide enough because people are living longer now than when my Government created the scheme for them. We built something that took people from age 55 to 75, but these days, if you reach 60, you have a reasonable likelihood of getting to 85. And the numbers continue to change materially with every decade that passes.

So, we have two groups in retirement – a 60 to 80 group and an 80 to 100 group. The 60 to 80 group is all about retirement living and lifestyle, which I think the current superannuation system adequately caters for. But the 80 to 100 (which is technically, the period of life beyond the previous life expectancy) is more about maintenance and disability and less about lifestyle.

I don’t believe the current system caters for this. The policy promise of a good retirement cannot be fulfilled with such longevity, and so, the promise has to change.

At the ASFA Conference, I talked about two possible approaches to this problem:

  • People keeping some of their superannuation lump sum, which they generally receive at age 60, until later. This would be achieved by a portion being compulsorily set aside in a deferred annuity – a pre-payment which kicks back in at say 80 or 85 years. This would mean that the compound earnings on say 20-25% of the lump sum would accumulate between say the ages of 60 and 80, to be available on a deferred basis from 80. In essence, a significant proportion of the lump sum would be ‘preserved’ or ‘set aside’ for the much later years, including the years of longevity if there are such years. If there are not, the residual value of the deferred annuity would go to the person’s estate.

  • An alternative would be for a further 3% of wages (taking us from 12% to 15% in all) to be devoted to health – maintenance, income support and aged care.

While I think the second alternative has the primary merit, I want to examine here the first alternative, but with a twist: the government as the annuity provider.

While I believe that private enterprise has been the appropriate outlet to provide for products and services for our country’s compulsory superannuation system (and I have never been in favour of government mega-funds of the European variety), I do think deferred annuity structures are a different kettle of fish. So why do I think there is merit in the government providing a compulsory deferred annuities scheme?


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There are a number of reasons:

  • Only governments can bear and pool risk across generations, and as the government also provides the default option, the age pension, it picks itself as the most likely, effective and reliable longevity insurer. Covering oneself for later life and longevity risk is pretty much a classic insurance task, but there is a case for an appropriate government agency to operate such a longevity fund. One thing is clear … the longevity cohort, the high aged, requires absolute certainty as they have no room or ability to protect themselves.

  • While private enterprises are capable of providing deferred annuity products, they inevitably have to build into their pricing a profit margin as well as a ‘regulatory margin’ (the need to have a certain amount of assets supporting future promises to clients). As the government does not require either, it is able to offer significantly better deferred annuity rates.

  • The problem with later age, longevity and aged care is that capital markets have difficulty in managing that sort of risk. Private providers of deferred annuities find it problematic to adequately manage asset/liability mismatch meaning more ‘regulatory capital’ is required, with consequential lower returns to the end annuitants.

  • Albeit somewhat theoretical at this stage, I think the current ‘Simple Super’ changes underway in our superannuation system as a result of the Cooper Review provide the foundation for the government to play a competent role in the administration of a national and compulsory deferred annuity system. Standardised and systematic data protocols are well advanced and will soon be live, delivering an easy transfer of superannuation data between private enterprise and government.

  • With superannuation account consolidation (also an outworking of the Cooper Review) soon to be a reality, the government (via the ATO) is in the best position to know an individual’s total superannuation account balance at age 60 and hence the amount required to be compulsorily set aside for a deferred annuity to kick in at a later date.

  • Through the experience of managing the Future Fund, the government now has a workable precedent for managing assets with a long term perspective, away from the day-to-day business of the government’s own balance sheet.

A government-administered, universal, compulsory deferred annuity scheme would be a fully-funded scheme, with the capital provided by the annuitant from a portion of their lump sum superannuation benefit. This would mean that if there was any shortfall in the actual assets set aside and the liability due to the annuitant, the government would fund the gap.  However, careful asset management with a long term horizon should ensure that any such shortfall should, over time, be insignificant.

I am still of the view that the compulsory superannuation component should increase further beyond the 12% level. People will recall that in the Budget of 1995, the Treasurer, Ralph Willis, announced that compulsory superannuation would rise from 9% to 15% over time. However, a change of government saw this initiative subsequently reversed, to the detriment of current retirement savings.

If the compulsory superannuation charge was increased from 12% to 15%, it would provide more options to adequately provide for the final phase in life, rather than relying on the age pension.

 

Next week, Paul Keating gives his views on Self Managed Super Funds.

Hon Paul Keating was Treasurer of Australia between 1983 and 1991 and Prime Minister between 1991 and 1996.

 

7 Comments
Bob Ruscoe
February 14, 2013

There is a huge outcry against "fiddling" with super again but there are areas which I believe need changing,
The purpose of super, as Keating outlines, is to provide for the retirement years of our life.
I suggest tax free lump sums from Super should be removed altogether or at least limited and that the Transition to Retirement ability should be discontinued.
Both were introduced by Costello I think, and not only reduce the chances of having sufficient retirement income, but heavily favour higher income retirees who, after all, are more able to provide for their retirement than the average worker.
The cost of lump sum tax concessions and Transition to Retirement Tax minimisation must be enormous and increasing.

Hans Schaffner
February 13, 2013

The patience of Mr. P. Keating is unbelievable. The political experience necessary to
achieve really only minor benefits is pathetic. Self interest would dictate a good style
of living in retirement and it seems to me the male population is note very interested.
As a migrant from Switzerland 46 years ago it was logical to pay premiums for
Superannuation (3% worker 6% employer at the time). The swiss government had
to make adjustment, because contributors fell due to lower birthrates, but most retirees have enough pension income to live a reasonable life. There is no seniors card available to obtain reduced prices in public transport etc. Some people took out
additional cover to the compulsory government scheme although as far as I am aware there is only additional pension scheme without the possibility of lump some
payments. My swiss pension increases with cost of living increases.
It seems to me quite fair and simple and the Nanny State argument unwarranted.

Rob Mews
February 13, 2013

Some of this article is corect in it's anaysis of the amount of money required for retirement income, but it fallls short of explaining that the overall value of investments in super are expressed in Australian dollars and some of the super savings are in cash and fixed interest. Little of people's super is held in commodities.The effect of this is exposure to inflation and variations in exchange rate. Taxation by governments is also a large factor which inceases exposure to risk as is wreckess federal government policies like so called "stimulus" at the expense of increased budget deficits which subtley take the value of cash savings away leaving by reducing purchasing power. I personally place little value on the Keating anaysis of anything since he misses critical facts or bets them just plain horibly wrong. I can quote factual examples of this i required.

Sven Larsen
February 11, 2013

yes that's exactly right "Gladys" - the vast majority not only can't but think very little about how long they're likely to live and all but the 99th percentile wouldn't save for themselves - that's exactly why compulsory super was introduced 20-odd years ago

it has been well-established that human nature favours near-term gratification and irrationally discounts the probability and magnitude of future events - especially the unpleasant ones like being very old and very poor

but as we will see over the next 20 years, the baby boomers are woefully under-prepared for living up to 30 years in retirement and many thousands will sit in their million dollar homes, dependent on receiving an age pension

Gladys Dowrite
February 11, 2013

Yuck... more government.

As a solution to (the presumed) problem that the majority can't work out how long they are likely to live and save for themselves?... not a logical place to start.

"Only governments can bear the pool risk across generations"... come on!

The Future Fund shows how government can manage long-term assets? ... not yet... but the current state of roads, schools, hospitals, electricity grids etc. does.

Nigel Renton
February 09, 2013

Worthy of discussion.
The government might provide "aged pension units" - a unit being a deferred real lifetime annuity with travel and medical concessions etc. equivalent to the aged pension. To address the government's asymmetric risk of providing the pension pillar, each individual's super fund is not permitted to invest in " risky assets" until it has purchased (say) two aged pension units.

Sonia Main
February 09, 2013

Another advantage of giving a fund manager money when the investor is aged 60, where the proceeds are not required for 20 years, is that a 'through the cycles' investment approach can be taken, knowing the money will not be withdrawn if short term performance is not good. We can take a step away from managers being paranoid about quarterly earnings and reporting and take a decent investment perspective, where trends take a while to play out but can be handsomely beneficial over the right time horizon.

 

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