The compulsory superannuation guarantee system was introduced in 1992 and since then it has become the second-largest asset for the majority of Australian workers. As of the end of the December 2014 quarter, superannuation assets totaled AUD 1.64 trillion. In late 2014, Australia was voted as having the world’s second-best retirement income system behind Denmark. In addition, the sector has become a major source of funding to the rest of the economy, including infrastructure projects, banks and non-financial corporates.

Q: Despite all this positive information, are there any downsides in your view?

A: The downside is that our superannuation is still a fairly immature system. It is over 20 years old, but the majority of people are not retiring on enough money. Women in particular require more – on average, they are retiring on around AUD 100,000, while the average for men is AUD 200,000. Because it is a maturing system and a defined contribution system, the real impact of it in changing the lives of retirees is still some way off as it requires time to accumulate over people’s working life. But certainly, for the majority of Australians, it will make their retirement today and in the future much better.

Q: ASFA’s research points out that since the introduction of compulsory superannuation the environment has changed dramatically. Can you outline those changes for us?

A: As it has grown and changed, one of the major impacts on the superannuation system and industry is that governments have and probably will continue in the future to tinker with the system. While any superannuation and retirement income system must be adjusted as demographics evolve and the system matures, not all changes to the system have been made in the name of good public policy. In previous years, we have seen the money in the system being used to deliver on short-term government needs. In our view, raiding the superannuation pool is not the way to fix a government budget. Although we understand the system needs to be adjusted over time and tax concessions need to be modified, we are concerned by constant tinkering with it, which can affect the community’s confidence in the system.

Q: The Financial System Inquiry and Mercer have been critical of the lack of policy stability over the past decade, which they believe adds to costs and reduces long-term confidence and trust in the system[1]. In addition, ASFA’s own research suggests the current regulatory framework “severely limits the scope for innovation and new products”[2]. How do you think the system is being affected?

A: When the superannuation system was designed it was all about accumulation, and the system has done a good job in allowing people to accumulate money for retirement. But there is a big gap and, as the Financial System Inquiry found, the system should be about providing income streams for retirement. This is a compulsory system that is funded by all taxpayers; it is about providing dignity in terms of income in retirement.

Under the current rules, there are seven major regulatory impediments around the development of income stream products. As we all know, as people retire they have very different wealth situations so they need a great deal of choice and a great deal of advice when it comes to how they create an income stream that is best for them. ASFA issued a document recently called ‘The future of Australia’s super: a new framework for a better system’, which details a set of principles that should guide superannuation policy decisions and outlines a policy framework to help the system deliver on its objectives. It comprises a series of recommendations, including that as a minimum we need six tiers of income streams as we manage everything from longevity risks to those income streams that will fit snuggly with the social security and the pension system.

The retirement income system should be about income streams, with greater flexibility to create a variety of income streams, including those that offer some protection against longevity risk but are also flexible enough to allow controlled access to commutations and limited lump-sum death benefits.

Q: One point that your research makes is that there is a prevailing culture of lump sum retirement payments vs. the income streams that you mentioned. How do you shift that mindset?

A: Certainly the Australian system does create that lump sum mindset. But what our most recent research shows is that the majority of retirees today are now taking a drawdown income stream. Five times as many people are taking an income stream as taking a lump sum. What is happening is those that are retiring on smaller lump sums (under AUD 100,000) are more likely to take it as a lump sum to pay down debt or go on a holiday. However, the vast majority of people are looking for an income stream to supplement their pension. So what we are not delivering for those people is a variety of income stream options that they can choose from.

Q: Former Federal Treasurer, Peter Costello has been critical of the sector for its lack of engagement in post-accumulation or retirement management. What’s your response to that?

A: I interviewed Peter recently and I’m always surprised that a lot of politicians, former politicians and certainly experts across the industry make statements without fully understanding the latest data. The questions of how to invest post-accumulation or in retirement is quite a new conversation and what our latest research is showing, as we all know, is that people are living longer in retirement. So the general propensity to move to cash and bonds just before retirement is not necessarily in retirees’ best interests if they are looking at a long retirement period. Funds and providers are now looking to deliver diversified portfolios that will provide steady income streams over the longer term and that are also cost-effective and sustainable throughout people’s retirement.

Q: Recent debate has centered on longevity and the fact that current modeling may be under-estimating the length of retirement periods by up to a decade. What measures can be taken to prepare for this?

A: There are a couple of measures. The first is that people will have to put more away. That’s why we’ve been strongly advocating that we move to the 12% superannuation guarantee as soon as possible. The deferral in the increase significantly decreases the effectiveness of the system in getting people off the full age pension.

The second is to open up the post-retirement market so that longevity risks can be a firm part of income stream products. At the moment, the way that products are defined in terms of what is regarded as an income stream for pension purposes and tax rulings reflect two extremes – a life pension or annuity, or an account-based pension or annuity. Managing longevity risks is really outside the remit of those products. What we need to start creating are hybrid products where you have a regular income stream, you can manage your longevity risks, and you can access some of the capital. But also for many people, income streams should be reversionary so they can reconvert that income stream into a lump sum if they have to move into aged care.

To develop a flexible product like that on a cost-effective basis today is extremely difficult. This is why we’ve been advocating for changes around legislation and tax rulings and even in the role of regulators in the development and approval of post-retirement products.

Q: According to Australian Prudential Regulation Authority (APRA) statistics, the number of superannuation funds has decreased, is primarily due to mergers. However, the most significant growth in the sector has been in self-managed funds. What challenges do you think this trend brings?

A: It’s very important to look at the overall picture when thinking about self-managed funds and pooled vehicles. Over 90% of Australians are in pooled vehicles, with less than 3% in self-managed funds. Over 31% of the money across the system is in self-managed funds, most of which is in drawdown. So the challenge for superannuation and the industry has been what does it mean for the overall pool? We have a large pool of superannuation money – while it’s not Australia’s sovereign wealth fund, it is a ballast for the economy. It’s very important for that pool to invest for the long-term growth of the economy and the long-term benefits of Australians. We need to ensure that the superannuation system and the pool do their jobs, both for individuals’ retirement and the Australian economy.

Q: What is your view on superannuation fees?

A: There has been criticism about the industry in terms of the amount of fees. Now there are some reasons that fees are significant. If you do an international comparison, the Australian system is very good value. But what people fail to understand is that one of the huge benefits of the system, but also one of the big costs, is insurance. The superannuation system provides over 80% of insurance for death, total & permanent disability (TPD) and income replacement across the Australian community. That alone saves the Australian government AUD 400 million in social security benefits. Another reason for these fees in that a lot of the industry legislation has been drafted quickly, with short implementation times, which has increased costs. We believe that we need to see resolution in these areas in order for costs to be pared back.

Q: What does the future look like for the sector?

A: The superannuation sector has a very strong future because the need to provide income in retirement is understood by the general community. There is no doubt that there will be continued pressure on the sector to reduce its costs to take advantage of that scale. Some of the areas in which the sector is opaque, particularly in terms of fees, will need to be resolved. The need to look at the public good in terms of how funds are invested, including in some areas like fossil fuels, will be a very active discussion over the next few years. But the biggest opportunities for individuals and the community are in the real provision of a wide variety of income stream choices. That will also allow greater investment in income-producing assets like infrastructure and more investment in areas of innovation, which will drive economic growth in Australia and economic growth is what is needed in order to sustain the lifestyle people have today.

———–

[1] Financial System Inquiry, Interim Report (2014): http://fsi.gov.au/publications/interim-report/04-superannuation/stability-of-superannuation-policy-settings/

[2] ASFA, ‘Changes to regulatory settings for financial products dealing with longevity’, October 2013

Disclaimer: This material is issued by Nikko AM Limited ABN 99 003 376 252, AFSL 237563 (Nikko AM Australia). The information contained in this material is of a general nature only and does not constitute personal advice, nor does it constitute an offer of any financial product. It is for the use of researchers, licensed financial advisers and their authorised representatives, and does not take into account the objectives, financial situation or needs of any individual. The information in this material has been prepared from what is considered to be reliable information, but the accuracy and integrity of the information is not guaranteed. Figures, charts, opinions and other data, including statistics, in this material are current as at the date of publication, unless stated otherwise. The graphs, figures, etc., contained in this material include either past or backdated data, and make no promise of future investment returns, etc. Past performance is not an indicator of future performance. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided.

The post Pauline Vamos – Flexible income stream products are the future of the superannuation industry appeared first on AdviserVoice.