Opening ASFA 2012 former Prime Minister Paul Keating has called on the Federal Government to address longevity risk by increasing superannuation contributions by a further three per cent, or alternatively establishing a government pooled insurance fund.
In a thought-provoking speech, short on the political rhetoric for which he is known, Keating articulated the reasons why Government intervention was needed to provide "the high aged" with certainty because "they have no room or ability to protect themselves".
"Currently we have a system which, due to longer life expectancy, has privately managed superannuation for the first half of retirement, say 60 to 80 – let's call it Superannuation Phase 1 – with the Government, more or less, picking up the second half, 80 to 100 – let's call it Superannuation Phase 2," says Keating. "Because people are living longer, if you get to 60 you have a reasonable likelihood of getting to 85. 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. The 80 to 100 group is more about maintenance and disability and less about lifestyle."
According to Keating "the policy promise of superannuation is understood by people as about having a good retirement. But adequacy with longevity means that promise cannot be fulfilled, so the promise has to change. We want a system which provides people with retirement incomes but the few people who are buying annuities are buying them for something like 20 years. Not for life. If you retire at 60, where the sums in accumulation are tax free, and live into your 90s, a 20-year annuity probably leaves you reliant on the Age Pension for your last decade or two. The Age Pension, in effect, becomes the longevity insurer; to not put too fine a point on it – the Government becomes the insurer."
Keating believes that the Federal Government needs to address the second phase of retirement. One option is to require superannuants to keep some of their lump sum for later years of retirement.
This could mean that: "A portion of the lump sum, when it becomes available, 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 to 25 per cent of the lump sum would accumulate between say the ages of 60 and 80, to be available on a deferred basis from 80."
If a person died before being able to access this 'set aside lump sum' Keating proposes that the residual value would go to an individual's estate.
Given Keating's view that Australia missed an opportunity by not moving to 15 per cent SG and that 12 per cent, while an improvement on nine per cent, is still inadequate, he is proposing moving to 15 per cent, albeit with a new model from that which he proposed when in Government, with the additional three per cent dedicated to health – maintenance, income support and aged care.
"Instead of 15 per cent wage equivalent going simply to retirement accumulations managed by the private funds management industry, I am suggesting that an alternative may be 12 per cent (under the SG) being managed privately, and three per cent collected under a modified SG being managed within a Government longevity insurance fund," says Keating.
While Keating regards allocating an additional three per cent to superannuation funds as one option, his preferred model is a Government-administered, universal social insurance scheme with a fully funded, carefully constructed product.
"Covering oneself for later life and longevity risk is pretty much a classic insurance task. Life companies do it all the time. But as the Government provides the default instrument, the pension, and is in a superior position to pool risk, there is arguably a case for the appropriate agency to operate such a longevity fund – being the Government.
"People will know that I have always preferred individual vesting as distinct from government mega-funds of the European variety. And I still do. If it's vested in your name, you own it. The problem with later age, longevity and aged care is that capital markets have problems managing that sort of risk. Only governments can bear risk across generations as well as pool risk and, as government also provides the pension, it picks itself out as the most likely, effective and reliable longevity insurer."
While looking forward, Keating also reflected on the current challenges the superannuation industry is facing, identifying superannuation taxation concessions as an area where leadership was required.
"While the Government and the Treasury would see an increase in permissible voluntary contributions as a cost to the Budget in revenue otherwise forgone – such increases, in essence, would provide the Government with certainty in the out years by de-risking its future funding obligations – obligations in exchange for reduced tax revenue today."
Reflecting on rates of return, Keating questioned whether given the system stands at over 100 per cent GDP and will mature nearer to 200 per cent of GDP whether in aggregate double digit returns were possible in the future.
"If compound annual returns reflected nominal GDP plus, say, one per cent, the system would be doing well. Indeed, the Treasury forecast of system assets growing from $1.4 trillion today to $8.6 trillion in 2040 represents a compound annual growth rate of around 6.7 per cent, probably a little better than nominal GDP."
Keating is concerned that superannuation funds have adopted higher risk profile in portfolios, one of the contributing factors that has encouraged growth of SMSFs.
Says Keating: "Average returns for APRA-regulated funds averaged 3.8 per cent over the 10 years to 2011 – notwithstanding volatility from the unprecedented growth in equities and investment markets between 2002 and 2008 – juxtaposed against the impact of the GFC. Over the same period the average cash rate was 5.2 per cent and the average GDP growth 3.1 per cent. These results indicate that significant risk was taken by superannuation managers to secure returns in-line with the relatively risk-free government cash rate."
Keating is critical that investment risks are taken on by investment managers who had limited direct exposure to losses that were ultimately borne by superannuation beneficiaries.
"I am certain expectations as to returns are inflated and those expectations lead to incentives to drive higher fees for managers – but at much higher risks – as was the case between 2002 and 2011."
Keating is also concerned about the rise of SMSFs.
"Notwithstanding the costs of setting up an SMSF, you need something like $600,000 of assets to make the decision to self-manage, a better relative fee proposition, to management by larger managed funds. The issue gets back to investment skills – how many SMSF investors are competent in matters of asset allocation and general investment savvy? This becomes a real issue for the SMSF system and its deliverability as it occupies an increasingly higher proportion of overall system assets."
Reflecting on the role that superannuation plays in the Australian economy, Keating says that superannuation massively underwrites capital formation in Australia.
The legacy of former Prime Minister Paul Keating in building Australia's superannuation was appropriately recognised on the 50th anniversary of the establishment of ASFA. What Keating left all Conference delegates with was a clear need of the urgency to continue to advocate for reforms to superannuation to ensure that issues like longevity risk are addressed for the benefit of all Australians.
First published in ASFA 2012 National Conference and Super Expo Newsletter, Issue One, 28 November 2012