Superannuation: Retirees poorly served by system, says Centre of Excellence in Population Ageing Research

Superannuation: Retirees poorly served by system, says Centre of Excellence in Population Ageing Research

April 13, 2014 – 11:57PM

Peter Martin

So poorly are retirees served by the super system that Australia’s leading longevity research organisation is suggesting the government step in and offer policies of its own through Australia Post.

The Centre of Excellence in Population Ageing Research is the government’s preferred researcher on ageing and superannuation, funded by the Australian Research Council.

In a submission to the financial system inquiry to be published on Monday, the Centre says Australia is one of the few countries in the developed world to have outsourced its retirement income system to the private sector.

But it says the private sector funds either can’t or won’t bear the risk of working out how long their customers will live, so pass it back to them via inadequate products.

Instead of being offered a fortnightly payment for the rest of their lives most retirees are offered a lump sum or an amount which they can draw down over time. Without knowing how long the sum will last they are unable to plan and often outlive it and end up on the pension.

Many are encouraged to spend it or pour it into their houses in order to get the pension straight away.

“The most common reported use of lump sum spending is paying off home, home improvements and buying a new home,” said Centre director John Piggott. “When the lump-sum runs out, people revert to the pension system or try to re-enter the workforce.”

Professor Piggott said Australia’s finance industry was dominated by four large banks and one major wealth management group. They charge high prices and stifle competition. If a competitor gets successful they take it over.

Financial advisers find it more rewarding to continually advise on the management of lump sums than to suggest the alternative of buying longevity insurance.

Longevity insurance is a one-off purchase of the right to a guaranteed income until death. It is priced according to the risk of death, with the insurer rather than the customer bearing the risk of getting it wrong.

The submission recommends the creation of a new national agency to sweep away barriers to longevity insurance, overseeing the work of the Prudential Regulation Authority, the Securities and Investments Commission, the Department of Social Security and the Tax Office.

If needed the government could create the underlying financial instruments that would make the market work.

If the superannuation industry remained unenthusiastic the government itself could offer longevity insurance, selling guaranteed lifetime incomes through Centrelink or Australia Post in competition with the super funds.”

“It runs the risk of being forced to further subsidise retirement income if it doesn’t,” Professor Piggott said.

He also wants super funds to change the way they describe account balances. Instead of describing “amounts accumulated” their statements should describe expected “income streams” presented by age of retirement. Current regulations prevent the funds from forecasting income streams.

“Research suggests that presenting superannuation information in a ‘consumption’ frame is far more likely to move people in taking retirement benefit products with longevity protection features,” Professor Piggott said. “People have trouble converting lump sums to income streams as well as finding it difficult to work out how long they might live.”

The Centre’s submission echos that of the Treasury which said Australia’s super system was one of the world’s most expensive and was more focused on amassing contributions than managing payouts.

The financial system inquiry will report in November.

 

Is your superannuation under supervision?

April 14, 2014

Clancy Yeates

It’s often said we pay a lot for superannuation. But how much? Well, research firm Rainmaker estimates Australians paid $18.6 billion in fees for their retirement savings to be managed last financial year.

That is equivalent to $1075 for every adult in the country, including those who don’t even have super.

It’s the same amount that was paid out last year by Medicare, which provides free or subsidised healthcare services to the entire population. And just like Medicare costs, super fees are likely to swell, with the total super pool tipped to triple over the next two decades.

Funnily enough, business groups don’t complain about this cost burden as they warn about growth in government spending on social services. That’s hardly surprising – super is a significant source of corporate profits.

But thankfully, the issue should come under serious scrutiny in the financial system inquiry being led by former Commonwealth Bank boss David Murray.

As submissions from the Reserve Bank and Treasury highlight, ours is one of the most expensive private pension schemes in the world.

The RBA cites Organisation for Economic Co-operation and Development figures on pension funds’ operating expenses as a share of total assets. In the RBA’s graph, Australia’s cost ratio was third-highest among OECD countries, behind Spain and Mexico.

So, why do Australians pay so much for the management of their retirement savings? In part, the RBA reckons it’s a result of some distinctive features of our system.

Generally, the Australian ”defined contribution” approach, whereby many privately managed funds compete for your business, is more expensive than models overseas, which typically have fewer funds.

The extent to which our funds favour ”active management” – paying investment managers handsomely to try to beat the market – also drives up their cost.

Our preference for investing in ”growth” assets such as shares and infrastructure also tends to come with heftier management fees.

All these factors raise costs. But perhaps the most interesting dynamic is the failure of competition to drive down fees. With such a vast choice of funds, and the growing popularity of self-managed super, you might expect there to be strong downward pressure on fees. But it hasn’t worked out that way to any great extent.

Rainmaker says average fees have drifted down from 1.31 per cent to 1.23 per cent since 2007, but this hasn’t been caused by funds actually lowering their prices. Rather, the average fee rate has been dragged down because more people are moving their money to lower-cost self-managed or not-for-profit funds.

How come funds haven’t had to cut their prices?

A likely reason is that most people are just not that interested in their super. It’s complicated, can quickly become overwhelming, and may not affect us for decades. As a result, 50-70 per cent of workers leave their money in the ”default” fund chosen by their employer.

This disengagement, and the fact that 9.25 per cent of all wages go into super, has allowed super funds to pay less attention to fees than do other industries.

The previous government acted to deal with some of these issues. Default contributions from this year must go into no-frills, low-cost MySuper funds. We won’t know the results of MySuper for a while, but it will undoubtedly help.

However, there are some issues MySuper will not resolve.

The RBA says a remaining issue is the very fee structure itself, whereby members pay a percentage of all assets under management to their fund, and a string of asset consultants, fund managers and others take a cut along the way.

In this great fee bonanza, the RBA says ”normal competitive forces don’t apply” in pushing down costs, because most people who take the default option don’t seek out information about fees.

Funds don’t have a strong incentive to lower their fees because the actual decision maker in most cases – the employers – do not pay the fees anyway. Instead of competing on cost, investment managers and their many hangers-on compete by promising better returns.

It’s hard to know what we might do to change this.

”Clipping the ticket” is a deeply embedded part of the wealth management sector. Targeting the rapid growth in super is part of every bank’s strategy, and it makes good business sense for them to do so. But is it in members’ interests?

Rainmaker’s head of research, Alex Dunnin, says that to make serious further inroads into super fees would require slashing adviser and distribution costs by dismantling ”parts of the wealth sector’s reliance on superannuation as their revenue driver”.

That would mean taking on the might of the big banks and the wealth industry. Judging by the government plan to water down the Future of Financial Advice laws, this is supremely unlikely.

We can only hope that the Murray inquiry gives serious thought to how to lower the cost of super.

After all, this is an industry in the privileged position of receiving 9.25¢ in every $1 of wages. Any government, whatever its political stripe, should be making sure the industry operates as efficiently as possible.