A Super system that is not productive

Wednesday, June 27th, 2018

The Productivity Commission (PC) recently released a draft report into Australia’s $2.6 trillion superannuation system.

The report contains some alarming and largely ignored issues that we believe not only call into serious question the long-term outlook and viability of superannuation in Australia but also shine a light on the duties of trustees of large superannuation funds – particularly the not-for-profit sector.

 

So, what is the Productivity Commission?

The Productivity Commission
The Productivity Commission is the Australian Government’s independent research and advisory body on a range of economic, social and environmental issues affecting the welfare of Australians. Its role expressed most simply, is to help governments make better policies, in the long-term interest of the Australian community.

The Commission’s independence is underpinned by an Act of Parliament. Its processes and outputs are open to public scrutiny and are driven by concern for the well-being of the community.

Further information on the Productivity Commission can be obtained from the Commission’s website (www.pc.gov.au).

 

The following is our take on the Report. The views expressed are not necessarily its conclusions, but ours.

 

  1. Retirees will be worse/no better off

The first issue is the adequacy of retirement savings. The PC is seemingly forecasting that Australian retirees in the future may, in fact, be worse off than they are now. After 30 years of national superannuation embedded in employment contracts, today over 70% of retirees each year still claim or are entitled to a full or part Commonwealth pension.

The PC provided graphical forecasts based on a 21-year-old entering the workforce with an opening salary of $50,000. If they move to the average wage and stay in the system for around 46 years until retirement at 67-68 years old, they will end up with about $1.2 million in super in 2064 – and that assumes they have somehow secured the best performing fund returns in every year for 46 years!


Source. Productivity Commission Superannuation Report

 

If they are in and out of the system (for example, a married female) they may end up with slightly less at about $1,000,000. As the PC noted – it is a bit of a lottery – more so in the default fund system.


Source. Productivity Commission Superannuation Report

 

Whilst $1 million to $1.2 million sounds like an impressive bounty, it will be nowhere near enough to retire on. If we simply compare it with the alternatives or benchmarks – the Commonwealth age pension and the average wage – we can see the problem in acute terms.

If we index the current full age pension for an individual of around $25,000 at 2.5% and 3% p.a., we can calculate that in 46 years’ time the Commonwealth aged pension will be between $78,000 and $97,000 per annum. Therefore $1 million of retirement savings in 2064 will represent just 12 times the pension rate – not much different to what we are currently witnessing.

Today the average person retires with about $200,000, or 8 times the pension. Therefore, the PC report is suggesting that after 50 years of implementation,  Australia’s national superannuation system will not dramatically improve the retirement outcome for the average Australian. Not even the fortuitous fluking of selecting the best performing fund every year of an average person’s working life will change this outcome.


Source. Roy Morgan Research

 

To understand the issue more clearly, we compare the forecast Commonwealth pension as a ratio of the average super balance and payouts on retirement. In 2064, an average pension fund should be paying about 4% p.a. pension or $40,000 p.a. which will be less than half of the forecast Commonwealth pension rate (see above). Further, the same 4% payout ($40,000 p.a.) will be less than 15% of the average wage forecast at between $250,000 (compounding at 2.5%) and $311,000 (compounding at 3%) in 2064. Today the Commonwealth pension is about 30% of the average wage.

Based on the above analysis, a financial advisor (assuming they still exist) in 2064 may well recommend that an average millionaire retiree disperse his pension fund and revert to the Commonwealth pension. Nothing much will change.

Australia’s superannuation system is large and will likely continue to balloon for decades. Today’s massive industry funds and aggrandising advertising may well be creating false hope for Australians entering retirement for many years to come.

The PC needs to consider the long-term viability of superannuation. Whilst some of its other observations are pertinent (see below), it has not addressed the real issue.

 


Source. Bloomberg, The Australian

 

  1. Shocking wastage

The PC noted that superannuation returns are being eroded by poor industry practices. The report highlighted the shocking wastage in the system caused by multiple accounts and the unnecessary payment of insurance premiums.

It is a remarkable observation that one-third of all the 30 million super accounts in Australia are multiple accounts – i.e. where an Australian holds more than one super account.


Source. Productivity Commission Superannuation Report

 

The costs of multiple accounts are significant. Australians pay $690 million in extra administration fees each year due to multiple accounts and on an individual basis, multiple accounts could mean that an average person retires with 6% or $51,000 less than they could have.


Source. Productivity Commission Superannuation Report

 

Insurance costs also devastate super savings. The PC estimates the industry siphons off $1.9 billion in excess insurance premiums per annum. Combined, insurance and excess administration fees are costing Australians $2.6 billion p.a. of their super. Those are extraordinary numbers. The wastage is staggering.


Source. Productivity Commission Superannuation Report

 

The observations by the PC expose a problem for superannuation trustees – more so for not-for-profit trustees.

What have trustees, who have a fiduciary duty to their members, been doing to stop wastage and ensure adequate returns?

On this issue, the PC noted:

“The suitability of insurance in super relies on trustees balancing insurance cover for members against the erosion of member balances at retirement… While insurance in super is good value for many members, it is not for all members. Premiums come out of members’ accounts, meaning higher balances at retirement are forgone. The effects on retirement balances are worse for members on low incomes, especially those with intermittent labour force attachment who continue to have premiums deducted from their accounts while not contributing to their super. The retirement balance erosion for these members could reach 14 per cent ($85 000) and well over a quarter for some disadvantaged members with duplicate insurance policies ($125 000).

Some insurance policies are unnecessary for members. An estimated 17 per cent of members have duplicate policies across multiple super accounts — which can erode their retirement balances by over $50 000. And some members are being defaulted into insurance products they are ineligible to claim on (‘zombie’ policies). The chief and costly culprit for such ‘zombie policies’ is income protection, which can typically be claimed against only one policy and only when members are working. A typical fulltime worker can expect insurance to erode their retirement balance by 7 per cent ($60 000) if they have income protection cover, compared to just 4 per cent ($35 000) if they only have life and disability cover.”

The above consequence is inconsistent with the fiduciary duties that govern the activities of trustees of large superannuation funds. The job of trustees (no matter how much they are paid) is to look after their members. They can’t sit there and blindly say they weren’t aware of this. The entire industry is aware of this. But the trustees have done nothing to alleviate the problem.

 

  1. Fund consolidation isn’t the answer

One common answer to alleviating high costs is to encourage fund ‘consolidation’. The PC talks about merging or aggregating retail and industry funds where smaller super funds combine with large funds.

Today there are 40 industry funds managing about $600 billion in super. There are also 123 retail funds with about $600 billion in assets. In passing, we note over $700 billion in SMSFs (595,000 funds).

The argument is that members will enjoy ‘economies of scale’ in the merged funds – their fixed administration costs will be spread across more members, pushing down individual member costs. But the PC has completely overlooked ‘dis-economies of scale’ of investment which will push down investment returns and outcomes as funds become too large.

Today our superannuation funds ($2.6 trillion) are larger than the economy’s GDP (which is approaching $1.8 trillion) and our stock market (which has $1.9 trillion in market capitalisation). Superannuation assets are growing at a faster rate than both the economy and the equity market. Therefore, the ongoing ability to invest capital in Australian growth assets (equities, property, etc) will become increasingly difficult.

We are seeing the commencement of the dis-economies problem as large industry funds allocate to private equity, engage in privatisations and move more aggressively into offshore markets (dominated by perversely low yields in fixed income and bond markets). They will also be competing with other massive pension funds from other countries which are also looking for scarce yields – wherever they are available. We observe that recently Australia’s Future Fund ($140 billion) has downgraded its investment return target and now expects about 6.5% per annum. (Since inception in May 2006, the average annual return of the Future Fund has been 7.7%.)

Our view is this.  As large super funds continue to compound at current rates and grow to excessive sizes, there will be one sure result – returns will decline. The dis-economies of scale are immense, more so when funds grow at well above domestic GDP. Rather than driving mergers of super funds, the PC should be considering caps that limit the size of funds when dis-economies clearly set in. Rather than amalgamating smaller funds, they should be encouraged to perform better. Indeed, they will eventually have a competitive advantage when dis-economies affect their peers.

 

  1. Industry fund governance hypocrisy

Australia’s super system has serious governance issues. The report recommends 30% of industry fund trustees should be independent. But why just 30%? Why not have most directors as independent as required for large listed companies?

The following interview with the Chairman of Industry Super- the Honourable Peter Collins – showed a remarkable display of ambivalence about the need for independence – to paraphrase Mr Collins, “Banks have had independent directors and look at the result.”

Source. ABC
Full video here – http://www.abc.net.au/

As you can see in the interview above, industry funds seem to believe there should be one set of rules for themselves and another set of rules for others.

Yet it is industry funds themselves who are pushing for independent directors on public company boards. Almost the entire AMP board was wiped out by industry funds, which wanted more independent directors. When it comes to governance, industry funds need to be told to improve their practices and focus on their members’ retirement outcomes.

 

What have trustees been doing?

The trustees of not-for-profit superannuation boards, which is what industry funds are, have one overarching duty, and that is the duty to their members. (Public company directors have duties to all stakeholders of the company, including the company’s staff, shareholders, creditors, etc). Yet those trustees have for many years not addressed the issue of multiple funds and the taking of insurance premiums in and outside default super funds. The PC notes these issues have been in existence for many years. It is amazing that a self-governing industry standard to stop the leakage on insurance premiums has not been adopted across the industry. We wonder why trustees have delayed?

The elephant in the room

The underlying issues that the PC report inadvertently highlights calls into question the entire super system. At some point, the community and the Government must settle on a workable, efficient and outcomes-based retirement policy. Our society needs to determine if individually funded super accounts, in whatever form, will achieve the outcome that most people are secure in their retirement.

The evidence is growing that Australia needs a national pension scheme, not a national savings scheme presented as a superannuation scheme. There should be a national pension scheme where everyone contributes, and everyone has the right to a safety net pension. Then, if individuals can, they should be encouraged on a reasonable basis and with reasonable limits, to create a personal pension fund.

International pension fund schemes do not excessively push the average individual into self-funded schemes. They acknowledge that there are more “average” wage earners than not. Average workers should not be exposed to “a lottery type system” where they may get lucky or they may lose out in retirement.

A national pension scheme would be based upon a system where everyone contributes, and pensions are paid on a cash-flow basis adjusted for present reality, and not some distant hope that somehow it all works out.

The finite capital contribution system – which is the Australian super system today – is not going to work (if you believe the PC’s forecasts). This will be a long-term problem for Australia’s future and there needs to be an urgent rethink. That may be a controversial conclusion. But what everyone is claiming is supposed to be a great super system … when you look at it more closely, is actually a pretty rotten system.

*A person with Super Cap limit of $4.98 million would pay 5% or $250,000 pension. This will be equivalent to the average weekly wage in 2064. Clearly a $1.0m retiree in 2064 will be hopelessly underfunded.

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8 Responses to “A Super system that is not productive”

  1. Franz Fahnle says:

    Yes, yes and yes, we need a pension system and not a savings system. As a young man, I paid into a life insurance which promised me to be a rich man at age 65. Once I had reached that age, it gave me one nice weekend with my wife. Who are those people who are able to predict inflation, deflation, interest rates, fraud, misadventure etc. etc, 40 years ahead? European countries are running pension systems very successfully for nearly 200 years. Why do we reinvent the wheel, only to create a millionaires factory for a few shameless individuals ?

  2. Karen says:

    Brilliantly written. Thank you

  3. Peter Stefan says:

    Although interesting findings which will lead to better governance (if you are watching someone’s performance, performance improves), we need to be very careful when advocating a government retirement fund. Just ask the Greeks who put their pension savings with the government fund!
    Maybe the govt can be in super but it must be with competition with the private sector.

  4. Robert N says:

    I am a bit confused by this article. There is no specified author and to me this article ends prematurely with a statement that is essentially scrap it and do something else! Further there appears to a bias against Industry Funds even though these funds (with all their supposed deficiencies) still outperform Retail funds.

    Let us face it, many of the problems outlined by the PC and reiterated by this article are due to indifference by the members of superannuation funds to one of their most valuable assets. Is the answer to this indifference to take control of the industry and essentially create what appears to be a system with some aspects of the (probably soon to be bankrupt) American Social Security system?

    Such massive changes cannot be dealt with in such simple terms as: completely change it as it “is actually a pretty rotten system”, a statement with which I do NOT agree.

    Bob

  5. John Tonkin says:

    Surely any super system should be just part of a savings/investment strategy for retirement. Individuals must take responsibility for themselves and their future and be educated to do so.

  6. Trevor Ridgway says:

    I TOTALLY DISAGREE with “your conclusion”
    ” A national pension scheme would be based upon a system where everyone contributes, and pensions are paid on a cash-flow basis adjusted for present reality………”
    ABSOLUTE RUBBISH : 1. Not everybody is ABLE to contribute !
    2. There is EVIDENCE that the last people we should TRUST with our money is the GOVERNMENT. A “National Welfare Fund ” was put in place by Ben Chifley PM in 1946.
    By 1951 under Menzies PM it was being ‘absorbed into general revenue’ and SPENT and
    by 1985 it had ALL been transferred to the Consolidated Revenue Account…althought the
    TAX LEVY remains in place even today ! ( That is theft by any description ! )
    3. SUPERANNUATION is made up of the EMPLOYEE’S FOREGONE WAGES and is simply a
    scheme which COMPELS EMPLOYERS TO WITHHOLD WAGES and remit them to some
    fund. It is nothing more than FORCED SAVINGS with NO access until old age or illness or
    divorce intervenes ! THIS is something any individual COULD DO on their own and they DO NOT NEED some “commission” or government bureaucrat RUNNING the show !
    There is EVERY INDICATION that THE BUREAUCRACY is AGAIN attempting to PURLOIN
    the Superannuation Savings ! A$2 TRILLION…..how tempting is that !??
    4.No ! It is NOT A ROTTEN SCHEME. The “ROTTERS” are those who continually alter the
    rules relating to the scheme. If left alone and intact IT IS A GREAT SCHEME but it could
    be better if EVERYONE had their own SMSF ( Self Managed Super Fund ) and the education
    and assistance to RUN IT PROPERLY.
    “a pension paid on a cash-flow basis adjusted for present reality….”
    SO……..IF THE GOVERNMENT IS BROKE…….LIKE NOW………YOU GET NOTHING ?
    You get “to do your bit for the Nation” YET AGAIN ! Like sending YOUR SONS TO DIE
    IN SOME OVERSEAS WAR that we should never have been embroiled in !!???
    I don’t think THAT THAT will “cut it ” anymore !
    I would APPRECIATE your REPLY to my comments. Regards , Trevor.

    • John Abernethy says:

      Hi Trevor,

      My reply to your comments – which I thank you for – are as follows.

      What you and many others fail to understand is that we have a poorly structured and funded national pension scheme already.

      The Commonwealth pension is currently claimed to some extent by over 70% of retirees. The percentage rises as people age from initial retirement to a mature pension stage.

      So I just don’t understand your comments ( and those of others) that we cannot trust a government pension scheme. We have one.

      The problem with the current scheme is that it sits beside a national savings scheme that does not have clear objectives and is therefore not reviewed.

      What is success for a national superannuation scheme? Answer that question and review the PC findings and observations.

      Regards
      John Abernethy

  7. Danny Hannan says:

    Currently Superannuation is a vehicle for the wealthy to avoid paying tax, not a retirement scheme for the masses. The problem is that super pension phase income is not taxable, even though those funds were accumulated with a substantial tax discount. Lower income people receive only a small tax discount on their super if any at all.
    To make the superannuation system a Fair Retirement Scheme for all:
    1. Make compulsory contributions to super up to an amount, e.g. 15% of statistically modal annual income a tax free threshold for super contributions. (removes bracket creep)
    2. Raise compulsory contributions to 15% of income but offset by using 50% of any income increase to be contributed to super.
    3. Contributions over that tax-free amount receive a discount, e.g. 15%, off the marginal tax rate for that individual.
    4. Pension phase earnings have a tax-free threshold for a couple of e.g. the minimum full time annual earnings, after which normal tax rates apply.
    5. Remove the limits on after tax contributions to super but introduce a minimum deemed earning rate for super accounts over e.g. $1 million.

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