Australia’s super funds need to be able to make more concrete promises about the income members are going to get in retirement. That they can’t represents a major shortcoming for an otherwise world-class retirement income system, writes Jeremy Cooper.
When they retire, most people want something like a ‘retirement pay cheque’ for the rest of their lives. Yet this is precisely what super funds currently can’t offer them. Funds can’t make that sort of promise because they don’t have the capital to back it if things don’t turn out as expected.
So rather than a lifetime retirement pay cheque, the mainstream retirement income product is an account-based ‘income stream’. While these products are flexible and have other advantages, they leave retirees exposed to the risk of running out of money. This is a structural problem for super and it’s a big shortcoming for an otherwise world-class retirement income system.
With super, there is no promised monetary outcome. A retiree might expect to get around $3, in today’s dollars, in retirement for every $1 of deferred wages contributed. But it could be $2 or $4. Three dollars is just an estimate based on the lower growth environment we now inhabit. What’s more, no super fund promises that outcome or keeps a capital buffer to ensure that it happens. Unless they are very close to retirement, most super fund members have only a vague idea of the income they will be able to spend in retirement.
At the heart of this issue is that in our ‘defined contribution’ super system, risk is borne by the individual, rather than the institution. For the individual, super funds are riskier than bank deposits; super’s premise being that members will be rewarded for taking the extra risk by the compounding of higher average investment returns. Over extended periods, this assumption is correct on average, but it is not universally correct. There can still be poor member outcomes because of the risks involved.
This difference is so much more important once you retire because it can directly affect your quality of life. In retirement, you must manage how long your money is going to last. You are self-insuring this ‘longevity risk’, as well as the risk of the market falling and inflation eating away your savings. Those exposures are currently the retiree’s problem, not their super fund’s.
Super is undoubtedly an Australian success story. It builds up retirement savings and is demonstrably more efficient than it was a decade ago. Australia’s super funds have helped 14.8 million Australians build $2.5 trillion in retirement savings. This contributes to better retirement outcomes. But, once in retirement, when the job of super switches to providing a retirement pay cheque, should there be such a big gap between the safety of the banking promise and what super offers? In super, there is limited intermediation; members are exposed to raw combinations of market-linked assets despite risk management tools such as diversification and other measures. What’s missing are capital buffers and pooling mechanisms able to take some risk away from retirees, while still leaving them with some liquidity and exposure to growth assets.
The super industry needs to engage with the need for a more capital-intensive retirement phase – recognising that this is the key to delivering security for retirees who have spending needs above the safety-net age pension. The government’s MyRetirement reforms, recommended by the Murray Inquiry, call for this, but the industry is dragging its feet. It likes the risk settings the way they are.
The completely ‘self-insured’ approach to retirement income should rightfully only be the province of retirees with substantial retirement savings. Those with very modest savings are protected by the safety-net age pension. Everyone in the middle is exposed to the risk that their hard-earned super savings won’t do what they were intended to do – provide them with a reliable income for their increasingly long lives. These are the very retirees who need the super system to shoulder some of their retirement risks.
Holding either member capital, shareholder capital or third-party capital to back retirement promises will be a substantial change for an industry that has favoured flexibility and low capital intensity over risk management. Funds management has been highly effective in building up the retirement savings pool, but most retirees are not well-resourced enough to self-insure their retirement risks. They are living too long to do so for a start. Super was designed to cater for a retirement from about age 55 to 75. Today’s workers are looking at a retirement spanning from age 65-70 to 90-100. The game has changed and the industry must adapt to this new reality.
Jeremy Cooper is chairman of retirement income at Challenger, a partner of the CSRI. This article was originally published in The Australian Financial Review on January 29, 2018.