Introduction
I am very pleased to have the opportunity to open this important conference, discussing issues and new research into Australia's superannuation system. Thanks to Professor John Piggott and Dr Hazel Batemen for inviting me to speak with you today.
Superannuation is now a pervasive and important part of Australian society, with 91 per cent of employees covered, and with superannuation making up the largest component of the financial assets of households. Twenty years ago superannuation researchers may have been seen as paddling in a small backwater, affecting relatively few ordinary Australians. Today, however, they are swimming strongly in the midst of mainstream issues affecting almost all Australians.
Our superannuation system is based on strong foundations, is growing rapidly, both in size and importance for Australia's financial markets, and is being developed sensibly through attention to areas like choice, disclosure and the development of a saving culture. As the system matures over coming decades, ordinary Australians will be well served by markedly improved retirement incomes. This is not to say the system cannot be improved – of course it can. But, as I said we are building on a strong foundation.
Strong Foundations
As we all know, the Australian retirement income system has developed gradually over the past century and comprises three elements:
- the public age pension and service pension;
- compulsory superannuation guarantee contributions; and
- voluntary savings, such as additional superannuation contributions, housing and investments in shares and financial securities.
Age and service pensions currently cost about $17 billion a year. This is equivalent to approximately 3 per cent of Australia's Gross Domestic Product (GDP). Australia has been able to better control its pension costs than many other countries, mainly because the age pension is subject to a means test and is paid at a flat rate which is not tied to an individual's earnings history. Further, the total cost of Age and Service Pensions is projected by the Retirement and Income Modelling Unit of Treasury (RIM) to only increase by a little over one to one and a half percentage points of GDP over the next 40 years as Australia's population ages significantly.
Overall, our three pillar design and cost-effective age pension combine to give Australia one of the most sustainable retirement incomes systems in the world – and a system that is very well regarded internationally. In particular, the World Bank regards Australia's system as a model for other countries without an established retirement income system, recognising its comprehensive coverage, long term sustainability and cost effectiveness.
The other key aspect of the superannuation system is the Government's strong and effective framework of economic management:
- This is demonstrated through its strategies of returning the Commonwealth Budget to surplus and of reducing public debt, overall contributing to an exceptionally strong economy:
- Through the year to March 2000, Australia's GDP growth was 4.3 per cent.
- The March 2000 quarter was the 12th consecutive quarter of through-the-year growth at or above 4 per cent.
- And the already strong framework of economic management is being further developed through the massive overhaul of the tax system
- Which has improved individual incentives to save but left superannuation as a good tax preferred saving vehicle (as I will demonstrate later).
Rapidly Growing
Turning to the future, Superannuation is one of Australia's great growth industries.
Asset growth continues to exceed informed expectations, and is faster than asset growth in most OECD countries.
- The system's aggregate assets are now $439 billion, around double the level of 5 years ago, exceeding the levels and rate of growth projected by the Retirement and Income Modelling Unit of Treasury (RIM).
- Both as a proportion of assets to GDP and in terms of growth, this places Australia up near the top of the OECD rankings.
- In 1990 superannuation assets represented 33 per cent of that year's GDP; they now represent over 65 per cent.
The recent investment returns of superannuation funds have been very strong, reflecting in part Australia's sustained period of economic growth.
Over the last five years, returns for superannuation funds have averaged almost 10 per cent real (above inflation), which is over double the long term earnings rates.
However, it is also important to recognise that much of recent growth also represents contributions. Member contributions are at much higher levels than indicated by trend projections and are continuing to grow strongly – in fact member contribution flows have doubled over the past three years.
Australian Prudential Regulation Authority analysis shows that most of this growth in member contributions represents genuine additions to system assets and is not churning or 'recycling'.
This suggests that the strong growth of member contributions largely represents the voluntary injection of savings into a strong and secure superannuation system and reflects member confidence in the system.
Employer contributions are also growing significantly. In the year to December 1999, employer contributions grew by 11 per cent, and this is after removing over $8 billion dollars in abnormal public sector contributions in June 1999, mainly for the funding of previously unfunded schemes.
Contrary to some claims, employer contributions to superannuation are growing faster than wages. Over the three years ending December 1999, wages grew by 17 per cent and employer contributions grew by 24 per cent.
Sustained voluntary contributions to superannuation reflect confidence in the system and also an appreciation of the tax incentives involved.
Dr George Rothman of the Retirement and Income Modelling Unit of Treasury is presenting a paper at this Colloquium which clearly demonstrates the continuing tax advantages of superannuation. After accounting for the major reductions in income and capital gains taxes introduced under the Government's major taxation reforms, compulsory employer contributions remain tax advantaged over a working life for all taxpayers.
Projections of Growth in Superannuation
As I have already noted, in December 1999, superannuation system assets totalled $439 billion. Looking ahead, and bearing in mind the continuing relative benefit of investing in super, the Retirement and Income Modelling Unit (RIM) projects assets to reach around $700 billion by June 2005 and one trillion ( that is $1000 billion) by June 2010.
The ratio of assets to GDP is projected to move from its current level of 65 per cent to reach 90 per cent by 2010 and to exceed 100 per cent of GDP by 2017.
A high rate of continued growth is projected notwithstanding the increased payouts to baby boomers as they retire.
RIM uses long term fund earnings rates for its long term projections, that is, the historical rates are averages over a 25 to 30 year time frame. If the higher earnings rates from the past five years were used, the RIM projections would be higher.
Developing the System
1. A More Competitive Superannuation System
The Government has a number of key initiatives to promote competition in the superannuation system. More competition should improve returns on money invested in the system and also better meet differing individual needs.
CLERP 6 financial system legislation
One of these initiatives is the Financial Services Reform Bill which is part of the Corporate Law Economic Reform Program (CLERP).
The draft Bill, released for public consultation in February this year, puts into effect proposals contained in the Government's 1999 consultation paper and will implement a number of recommendations of the Financial System Inquiry.
A world class regulatory framework for the financial services industry is being established which will facilitate innovation and promote business, while at the same time ensuring adequate levels of consumer protection and market integrity.
Key aspects of the Bill are:
- uniform regulation of all financial products, including superannuation;
- a single licensing framework for financial service providers;
- minimum standards of conduct for financial service providers dealing with retail clients; and
- harmonised disclosure obligations for all financial products provided to retail clients.
The draft Bill reflects the outcome of extensive consultation with key stakeholders and members of the industry. To date over 100 submissions have been received on the draft Bill. These will be taken on board in finalising the Bill prior to its introduction to Parliament.
Introduction of Choice
The Government is firmly committed to providing choice of superannuation funds. Choice was an election commitment of the Government in the 1996 Election campaign and the commitment was confirmed in the 1997 Budget.
Choice of funds will deliver substantial benefits to Australians, through increased competition and efficiency in the superannuation industry.
I have heard representatives of the superannuation industry complain that people don't take enough interest in their super and that the Government should do something about it.
My experience is that people often don't take much interest in events over which they feel they have little or no control. The Government's choice of fund policy will encourage Australians to take more interest in their superannuation by giving them more control.
Given the sound tax advantaged system we have, greater interest may well lead to greater personal contributions.
Regrettably, the necessary legislation has been delayed in the Senate. However, negotiations with the Democrats are continuing.
Choice of fund will be accompanied by enhanced disclosure requirements in line with the new CLERP 6 framework I have just outlined.
Choice will also be accompanied by a strong education campaign expected to use a range of media, including television.
The education and disclosure arrangements will improve the ability of individuals to choose funds that provide the services they want, such as insurance and investment choice and to compare costs between funds.
Introduction of Portability
Another important government initiative is to provide a legislative framework for portability of superannuation benefits. While many funds do provide portability, some do not. This has contributed to the large number of small superannuation balances and lost accounts.
In fact, there are now more superannuation accounts in Australia than there are Australians.
This is expensive for consumers and inefficient for the superannuation industry.
Providing legislative support for portability will be good for consumers and good for the superannuation system.
It is clear that choice and portability complement each other. Work is progressing on the full details of the Government's portability policy. Consideration will be given to the start date for portability, including the possibility of choice and portability having a common start date.
Introduction of Retirement Savings Accounts
One measure already introduced which demonstrates the Government's commitment to provide greater choice and flexibility in the superannuation system is the Introduction of Retirement Savings Accounts (RSAs).
From 1 July 1997, banks, credit unions, building societies and life insurance companies have been permitted to offer retirement savings accounts which operate without a trust structure.
RSAs are a simple, low cost, low risk product which increase competition and choice in the superannuation industry, thereby putting downward pressure on fees and charges, and encouraging better standards of service.
2. A Saving Culture which handles Diversity
As well as being more competitive, we need a superannuation framework which is flexible, and allows for the diversity of situations and customer needs. The policies I have just been outlining such as choice and RSA's do have regard to the diverse needs of individuals and we have introduced other policies to accommodate different social and workforce circumstances.
Spouse Contributions
For example, in the past, many low-income women have not had access to their own superannuation plans. The Government therefore introduced a tax rebate to encourage individuals to make superannuation contributions on behalf of their low-income spouses. An 18 per cent rebate applies to contributions of up to $3000 per annum to the superannuation fund or retirement savings account of a low income spouse. (The maximum rebate is available where the low-income spouse's income does not exceed $10,800.)
Age Restrictions
The Government also considered that the previous age restrictions on superannuation contributions were unnecessarily restrictive and discriminated against individuals choosing to remain in the workforce for a few years beyond the normal retirement age.
In view of this, the Government increased the age at which individuals are allowed to contribute to a regulated superannuation fund from 65 to 70. Consistent with this, the exemption age for the Superannuation Guarantee arrangements has also been increased from 65 to 70 years of age.
Superannuation and Divorce
The Government gave an election commitment to examine the treatment of superannuation following the dissolution of marriage, with a view to increasing the options available to divorcing couples.
The Family Law Legislation Amendment (Superannuation) Bill 2000 was introduced into Parliament in April 2000. Under the legislation separating couples will be encouraged to settle their own affairs. Where parties are unable to agree, the court will be given the jurisdiction and power to order that the superannuation be divided.
The Bill is currently being considered by the Senate Select Committee on Superannuation and Financial Services before further consideration by Parliament.
These are useful developments of the System but collectively Australian Society needs to go somewhat further.
We need to promote a saving culture within which individuals care about their retirement savings, understand options available to them.
As part of this development there will be increased responsibility for superannuation funds to communicate clearly with members, and also to provide options such as investment choice that meet the preferences of members.
For its part, the Government needs to provide ongoing sound economic management and well constructed tax and social security systems which make long term investment attractive. The current government has concentrated a great deal of resources upon achieving just such an environment.
An obvious example is the new tax system now introduced for the long term benefit of all Australians.
The Ralph changes to capital gains taxation also give further incentive for households and individuals to invest and save.
Legislation has been passed which effectively halves the marginal tax rates for capital gains on assets held by individuals for a year or more. This change provides a greater incentive for individuals to invest in enterprises and to actively manage these investments. The taxation of capital gains made by superannuation funds has also been modified so that only two thirds of nominal capital gains are taxed.
Another example is the Government's promotion of a share-owning democracy. Ways for facilitating this include privatisations, such as that of Telstra, and promotion of share ownership.
And within this favourable environment, importantly, there is a big role for individuals and individual responsibility. Australians are taking more interest in retirement savings as a result of a number of factors, not the least of which is our sound superannuation system
A useful discussion paper titled 'Independence and Self Provision' has been published as part of the development of a 'National Strategy for an Ageing Australia'. This paper expands on personal work and investment long term strategies for enhancing retirement incomes.
By international standards, the Australian household balance sheet is in good shape with the ratio of household liabilities to assets at 17 per cent. This underlying strength is sometimes lost on those who concentrate on the narrowly defined household savings ratio.
Between June 1996 and June 1999, the financial assets of Australian households grew by $285 billion. Of this, $127 billion came from growth in superannuation and insurance assets and $85 billion from growth in shares and equities held by households.
The saving culture is developing.
3. Superannuation has a key role in Australia's Financial Markets and in the Economy:
Superannuation plays a vital role in Australia's Financial Markets. In December 1999 managed funds in Australia totalled $646 billion. Seventy per cent of funds come from superannuation sources.
Australian funds under management are far higher than for other countries in the region:
- Total discretionary funds under management for Singapore were around $US83 billion ($A126b) as at 30 June 1999 – less than one quarter of the size of the Australian market.
- Funds under management for Hong Kong were at $US121 billion ($A183b) as at 30 April 1999 - less than one third of the size of the Australian market .
The comparison with Singapore may surprise some people – don't they have superannuation contribution rates around 40 per cent? Yes – but this money is not privately managed and withdrawals can be made for housing and other purposes to the detriment of retirement savings.
Making sure that superannuation is used for retirement purposes has been a major theme of the Coalition Government.
On 1 July 1999 we introduced a preservation policy which prospectively preserves all contributions and earnings, except in limited circumstances.
Early access to preserved superannuation benefits is permitted in limited circumstances, such as 'severe financial hardship' and specified compassionate grounds. The preservation rules are designed to provide early access to superannuation where there is genuine need, but not simply to fund lifestyle expenditure.
This preservation policy is also estimated to increase superannuation fund assets by about $140 billion and to add point nine of one per cent of GDP to National Saving.
System Outcomes
1. Improved Retirement Incomes
Our superannuation system is very much about improving retirement incomes for ordinary Australians.
The average superannuation balance per person now is about $54,000, with a wide variation about this average depending on years of membership and level of contribution. By June 2005 this average balance is projected to increase to $67,000, by June 2010 to $80,000 and $106,000 in June 2020, all in today's dollar values. These estimates are based on quite conservative assumptions about fund earning rates.
Average age retirement payouts are also estimated to increase. Average age retirement payouts are currently around $62,000 per person rising to $77,000 in June 2005, $97,000 in June 2010 and $135,000 in June 2020. Again all these are in today's dollar values.
There will be wide variations around all these averages, but the strong improvement in benefits as the system matures is clear.
2. Adequacy
While there is debate on how adequacy should be defined, there is no doubt that our maturing system is expected to bring about considerable improvement in the adequacy of retirement incomes for older Australians.
Contrary to some claims being made, when the 9 per cent SG is fully implemented, the average person's financial independence in retirement will be more secure than at any time in Australia's history. An individual who earns Average Weekly Ordinary Time Earnings (AWOTE) throughout a 30 year period and receives the 9 per cent SG contributions only, will have a standard of living in retirement around 77 per cent higher than the aged pension alone. This constitutes a replacement rate of about 64 per cent of pre retirement expenditure, slightly in excess of the 60 per cent figure traditionally cited as a sensible target.
These RIM estimates include the age pension and tax in the calculations. I have been somewhat surprised to be attacked by industry fund figures who do not include the age pension and taxation in their calculation of replacement rates.
After forty years of SG accumulations on AWOTE earnings, a standard of living in retirement twice that from the age pension alone can be achieved. The corresponding replacement rate would be around 75 per cent.
Around seventy per cent of employees earn less than AWOTE. The potential replacement rates for such people are higher.
System Issues and Pressures
Most OECD countries are concerned about increasing pressures on the Budget over the long term as populations age. The Australian Age Pension is a integral and sustainable part of our overall system and, as noted earlier, its cost (as a percentage of GDP) is projected to rise only moderately over the long term.
Many take the view that as our population ages, future Health costs are likely to constitute a greater strain on Australian Government resources than the social security framework. Such issues are being addressed in developing a National Strategy for an Ageing Australia, work I alluded to earlier in my address.
In the shorter term, as you are all aware, there is pressure for a Review of Superannuation. The Treasurer has nominated Australia's saving and retirement income system as one of the Federal Government's next areas of review, but has said that this would not occur until tax reform has been fully bedded down. In the meantime, work on key system developments such as choice and superannuation and divorce continues.
Conclusions
I have argued today that superannuation is one of Australia's great growth industries. It will play an increasingly important role in the lives of all Australians, particularly as we move towards an older population.
Australia's superannuation system is based on strong foundations, is growing rapidly and is being developed sensibly through progress on policy issues such as choice of fund, disclosure and the development and encouragement of a savings culture.
Your work can contribute to ensuring that the foundations of the industry remain relevant and strong.