The dynamics of the Australian superannuation system
Australian superannuation is a highly dynamic industry, as this review of 2013-2033 shows. For many retirees, institutional funds, whether industry or retail funds, have not been able to compete with the attraction of SMSFs.
The Australian superannuation system is the fourth largest in the world and is a source of pride for government and those working in the financial services industry. It provides the country with an enormous pool of investible funds that offer the potential to generate wealth and prosperity for our ageing population.
The Australian system, for all the praise bestowed on it, is as yet still to achieve its founding and most important objective: to deliver an adequate income in retirement to average Australians. Some of this shortcoming is explained by the youth of the system. Many Australians now approaching retirement have only received super for a limited portion of their working lives. The system is still maturing.
Nevertheless, our projections suggest that we are still a long way from achieving this central goal. Current policy settings, including the projected increase in the Superannuation Guarantee contribution to 12%, will not of themselves deliver the level of lifestyle to the majority of those retiring over the next 20 years that we, as a nation, are aiming to achieve.
The industry post GFC to 2013
The superannuation system, as measured by a pool of assets, looks healthy. You would be forgiven for imagining that the effects of the Global Financial Crisis (GFC) have been left far behind. The $1.1 trillion held in the immediate aftermath of the GFC has increased to $1.6 trillion, and funds are posting good annual returns. Yet, a closer examination of the last five years paints a much more complicated picture, and suggests that the Australian superannuation system has been under more pressure than many commentators think. Over this period:
benefit payments out of the superannuation system have increased materially
contributions into the system have reduced
growth of post-retirement assets in the system has been less than predicted.
It has been a tough time for self-funded retirees and for those older Australians who have lost their jobs. Low interest rates may be popular politically, but they strike directly at the living standards of retirees, forcing those people to dip into their retirement savings to a greater extent than they had previously intended in order to make ends meet. When this occurs at a time when those savings themselves suffered negative returns, the effect can be particularly damaging.
The last five years show how much pressure the Australian superannuation system has been under.
Growth will likely continue over the next 20 years
The continuing growth of superannuation assets is underpinned by compulsory contributions, and the prospect of the return of more ‘normal’ investment returns. In our calculations we have assumed that this also leads to a reduction in payments out of the system as retirees take the benefit of tax concessions and are able to draw down their account balances more gradually as they rely more on investment income.
Our projections show the pool of assets growing to $7.6 trillion by 2033, or in real terms from less than 100% to approximately 180% of GDP over the next 20 years. The government has stated its intention to defer the increase in the Superannuation Guarantee by two years. This will reduce assets by only 1% over the next 20 years.
Assets in the accumulation phase
This is where the bulk of assets are, and where we see the most public and fierce competition for members. We expect the competition to intensify even further as funds release their MySuper offerings and campaign for default status under the Fair Work provisions that have been put in place over the past few months, assuming indeed that superannuation default status remains an industrial issue.
The rate of growth is more than sufficient for all industry participants to grow, even if some lose market share.
Industry funds would appear to be in the box seat. As matters stand they dominate default fund status under modern awards and we expect them to become the single largest pre-retirement segment sometime around 2023. Personal retail products will also grow, reflecting the strength, brand and distribution networks of the banks.
We will learn much over the next year or so. The Stronger Super and FOFA reforms have dramatically changed the competitive landscape. At first blush these changes might be thought to favour industry funds. However it is not that simple.
Many retail funds have been burdened by significant embedded advisor fees that have allowed the industry funds to compete as the low cost option. Suddenly, this is no longer the case. Costs of MySuper and choice products will likely bunch much closer together and foster competition on other dimensions – performance, insurance, services, and brand.
The battle for individual customers is something that the banks and life insurers are long experienced at. In contrast, the industry funds are on a steep learning curve.
The post-retirement challenge
The growth in post-retirement assets is likely to be slower than in the past. The last five years shows that post retirement assets can be quickly drawn down during periods of economic adversity.
One thing is clear. Those Australians with substantial super at retirement are overwhelmingly voting to put their money into their own Self-Managed Superannuation Funds (SMSF). And they often establish their SMSF when they leave employment by transferring their benefit out of their corporate, industry or retail fund.
Institutional funds, whether they are industry or retail funds, have not yet been able to compete with the attraction of SMSFs. We anticipate that this will become the real battleground over the next decade. In fact the battle has started with some of the largest industry players introducing the ability for fund members to invest directly in shares and fixed term assets, as well as an increased emphasis on after-tax returns, and the introduction of new investment options targeting the income needs of retirees. It is a battle worth winning.
Retirement adequacy: the big issue
The central role of superannuation is to help Australians maintain an adequate and comfortable standard of living in retirement. We know that as of 2013 most retiring Australians do not have nearly enough super. Currently 81% are still forced to, at least partially, rely on the government aged pension to supplement their income.
And there are forces at work that will make it tougher for the super system to deliver this fundamental objective.
The population is ageing.
The number of Australians over the age of 65 will increase by 75% over the next 20 years (from 3.3 million in 2012 to 5.8 million in 2032), and at a much faster rate than the working population. The implication for government is clear. There will be proportionately fewer working Australians available to fund those in retirement.
Australians are living longer. Since World War II the average time in retirement has increased by almost 50% as we see the results of medical advances. Even so, this still understates the financial impact of the issue. As an increasing number of Australians live into advanced old age we see dramatic increases in the cost of aged and palliative care.
The big issue for government is what should be done?
It is trite to suggest that we can address adequacy by increasing superannuation contributions.
The reality is that those most likely to have insufficient superannuation are those least able to divert current income into savings. We provide examples using averages that suggest an additional contribution of the order of 5% to 7.5% of salary would be needed to allow the typical current 30 year old to retire comfortably on their super.
It is not going to happen. We see only some evidence to suggest a widespread capacity for Australians to make sustained voluntary super contributions, and certainly nowhere near the amount required
Allow/encourage Australians to work longer
The Federal Government has already moved to increase the pension age to 67. Recent changes also allow Australians to continue to have contributions paid into super at older ages. Other countries are moving in the same direction, and it makes sense.
There is a doubly positive impact on the person’s standard of living in retirement. The extra time spent in the workforce increases the superannuation that the person accumulates. At the same time the period spent in retirement is reduced by the extra time working.
We have performed calculations assuming that Australians work an extra two and five years. At an individual level the impact is clear. There is a materially greater ability to live at a more comfortable standard to an older age. For the system as a whole we see the accumulation of a substantially greater pool of assets. If retirement is deferred by two years there is an extra $400 billion in the system in 2033, and if deferred by five years the pool of assets increases by a full $1 trillion from $7.6 trillion to $8.6 trillion.
The long-standing weakness in the Australian superannuation system is that individual Australians accumulate a lump sum balance in their superannuation account throughout their working lifetime with the aim of using that lump sum to deliver an income during their retirement.
The system breaks down on a number of fronts:
1. Some draw directly on their super to pay off debts and/or to maximise their ability to draw on social security
2. Some die before their super is exhausted but on their death any remaining balance is moved out of the system
3. Some outlive their superannuation and ultimately are forced to rely on social security.
Lifetime pensions address these inefficiencies by pooling longevity risk. Un-needed assets held in respect of those who die at younger ages are made available to support continuing income payments to those who live to advanced age.
We are not the first to point out the benefits of pensions vis-à-vis lump sums. We also understand that it is an enormous challenge for our politicians. The conventional wisdom is that Australians are devoted to their lump sums and will not countenance any government that even thinks of changing things. Nevertheless, the impact of not pooling longevity risk is hugely underestimated.
Calculations we have undertaken suggest that if Australia moved to a genuine lifetime annuity or pension system then, other things being equal, we would reduce the amount of assets needed to fund adequate retirement benefits by about 15%.
Let us be clear. The fixation on maintaining lump sums in retirement means that one dollar in six is effectively wasted even if we accumulated precisely enough to provide an adequate income over average life expectancy for each individual Australian.
This is a substantial amount in a system that is already $1.6 trillion. It is an enormous amount in a system that is expected to grow to well over $7 trillion in the next 20 years. We know that a move away from lump sums in retirement must occur and needs to be addressed sooner rather than later. Our political leaders need to enact legislation to enable this to happen irrespective of potential short-term ramifications.
Our 2013 report into the Dynamics of the Australian Superannuation System confirms much of the inherent strength of the system. Certainly, growth in the body of assets, underpinned by the compulsory Superannuation Guarantee contribution, is certain. Our calculations show assets increasing to a total of about 180% of our national GDP over the next 20 years.
This is a huge sum of money. Competition for a slice of the industry is intensifying. The major protagonists are the largest industry funds and the wealth management arms of the banks and the life offices. In the past, the battle between these segments has resembled class warfare and been dominated by cost vs. advice vs. service.
Our belief is that the Stronger Super reforms will change the competitive landscape with much greater emphasis in the future being on product design, transactional efficiency of back office operations, and the ability to simply and cost-effectively engage with individual members, as well as the use of brand, distribution, and consumer marketing to win and retain customers.
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