Professor John Piggott

With the election of the Coalition Government, incoming Treasurer Joe Hockey is being asked to firm up plans for his “Son of Wallis” root-and-branch review of the Australian financial system.

Certainly a big picture review of the financial system is a step worth considering. Such a review should look beyond banks to the broader interaction of the banking and other financial sectors, including especially superannuation.

As the first of Australia’s baby boomers turn 65 and start to retire, the challenges presented by population ageing will crystallise. There is still much to be done to address these challenges.

Australia is fortunate to have a very sound and sustainable superannuation system. Comprising three pillars – means-tested pension, compulsory savings and voluntary savings – it is, from a government expenditure perspective, one of the most sustainable retirement income systems in the world. Commonwealth expenditure on pensions is projected to increase from 2.7% of GDP in 2010 to 3.9% of GDP, compared with an OECD average of 8.4% in 2010 and 11.4% in 2050.

But the retirement income system in Australia is a bridge part built. Part of its sustainability is due to the system’s focus on protecting those on low incomes through the Age Pension. The role of superannuation should be to replace earnings for people across the income distribution.

But the remarkable success in accumulating super assets has not been matched by structures that will allow super to fund retirement effectively and allow for income streams that are to provide income beyond the basic pension.

Total estimated superannuation assets reached $1.62 trillion in the June 2013 quarter, an increase of 15.5% over the previous 12 months. Some of that increase has been due to solid returns, but much of it is related to contributions exceeding benefit payments. It indicates that the system is still maturing.

As more baby-boomers retire and the population ages during the next couple of decades, asset withdrawal will become a greater part of the picture. This is this part of the bridge that Australia still needs to build.

The financial products that will allow superannuation benefits to provide steady income streams, such as those featuring life-time or deferred longevity insurance, are lacking. For innovative longevity insurance products to flourish, governance and regulatory support for this market must be carefully developed to be in tune with products that will support consumer needs.

While the previous government’s Cooper Review made policy strides in making the accumulation phase more efficient and implementing an accumulation default, there has been little thinking about products and defaults for the stage when funds need to provide income.

As longevity in later life – that is, our life expectancy from 50 – continues to rise, the continued sustainability of our retirement income system depends on a closer examination of the draw-down phase.

Should Australia follow the example of Singapore, where mandated savings at a certain level translate to a certain level of mandated annuity? Or, perhaps we should look to Chile, where annuitisation is voluntary but well supported, and permits a combination of a deferred life annuity and programmed withdrawal.

This arrangement, suggested by a group of us in Australia more than 10 years ago, can help negotiate the balance between flexibility and security at the time of retirement.

Is the Age Pension sufficient in providing income insurance for all people all of the time? And if not, then what should be the product options? And how can policy help to bring them to market?

The next stage of Australia’s superannuation success story should be about how it provides actual retirement income though a thriving financial retirement products market. A financial sector review that answers questions and addresses concerns about the draw-down phase of super could be a significant part of that story.

John Piggott is a Scientia Professor at the Australian School of Business and  Director of  the ARC Centre of Excellence in Population Ageing Research. A version of this post appeared in The Australian Financial Review.

Peter Swan

Our latest research suggests independent directors have increased the pay of CEOs – regardless of how well they have performed –  and in so doing cut back on shareholders’ wealth.

There has been a major issue since 2003 with the relative ignorance of ‘independent’ directors, which has been combined with their lack of incentive to monitor their own pay, which has led to rocketing pay and no incentive to perform. This has been fatal for Australian company performance.

In 2003, the Australian Securities Exchange (ASX) required all listed firms to either adopt a majority of independent board members without links to management and substantial shareholders, or if they didn’t, explain why not.

Independent directors by definition have either no prior experience with the firm, or at least no recent experience. Moreover, many are professional directors with no specific knowledge or background in the industry and their part-time nature means that acquisition of such information is difficult and is never likely to be comparable to that of full-time executives. Quite simply, they are not as good, and shareholders suffer as a result.

Our latest study compared the performance of 969 Australian companies from 2003 to 2011. 561 changed their board structure following the introduction of the ASX’s rule change.

Arguably, the most important and controversial corporate governance issue is board composition. Independent directors free of personal associations with senior executives and major shareholders should be more dispassionate and less biased, especially when evaluating existing business practices.

However, change in the rules in favour of independent directors effectively meant they were far less experienced – and they also set pay. It is noticeable that Australian companies that instituted boards with a majority of ‘independent’ directors in response to a 2003 change in the Australian Securities Exchange’s listing rules have lost almost $70 billion in value compared with other listed companies.

The ASX’s rule change is the most costly and disastrous regulatory change ever implemented in Australia by a private regulator.

Pursuit of private interests seems particularly likely for independent directors as, almost by definition, they have small or negligible shareholding or ‘skin in the game’ that diminishes any intrinsic incentive to monitor that the independent director may possess.

Peter Swan AM FASSA is a Professor of Finance in the School of Banking & Finance at the Australian School of Business. The analysis will be presented at the Chulalongkorn Accounting and Finance Symposium in Thailand in November 2013.

Associate Professor John Evans

Australians accept that during their working life, some earn more than others, but will they accept that the compulsory Superannuation Guarantee Levy system could deliver very different post retirement incomes to those who had similar pre-retirement incomes?

The Australian retirement system, consisting of the Age Pension, the SGL system and personal savings has one serious flaw that will only start to emerge once the system has matured in 2020.

Almost all analysis done on the retirement system uses “on average” assumptions as to periods of contribution, investment returns, costs and period of retirement and usually concludes the system is “adequate”. But this analysis fails to consider that over a typical working life of 40 years, a lot can vary. In particular, all SGL contributions go into some type of investment vehicle where the member’s accumulated retirement benefit is a function of investment markets, and these include significant “shocks” from time to time, such as the recent GFC.

The consequence of investing SGL contributions in market linked securities, regardless of the capabilities of the fund managers is that workers are going to have very different retirement incomes depending on how “lucky” they were in not being subjected to market shocks during their working life. Research with colleagues shows that even without any market shocks, the typical worker could end up with a replacement ratio (the ratio of post retirement income to pre-retirement net income) ranging from around 45% to almost 300%. With even a modest number of market shocks, this range could extend down to almost 35%, and that includes the Age Pension.

This range of post retirement standards of living is highly likely to be unacceptable to retirees who have been forced to defer part of their income to retirement savings and will not only create unanticipated demands for the Age Pension, but possibly social unrest.

The solution to this issue already exists and was a fundamental part of the industry fund philosophy when first established. The solution is to go back to the concept of the SGL contributions being invested in a common pool, but to credit the member account with an interest rate, much the same as occurs with bank deposits on a regular basis. The interest rates would reflect the underlying earnings of investments of the pool, but would be smoothed by creating reserves to balance the good times with the poor times. This is not a new concept and has been practised in investment related insurance contracts for many years. It is of course not perfect and if mismanaged can create problems, and failures as it did with Equitable Life in the UK. But if properly managed, it can create much smoother returns to members of retirement funds and reduce the effect of market shocks and the impact of market volatility. One of the reasons that industry funds abandoned this concept was that they were expanding very rapidly, and $100 of reserves at the beginning of a year had considerably less impact in smoothing returns during the year when assets doubled to $200, but the industry funds are now much more mature and this issue can be managed.

The interest rate concept would create more significant financial risk for the Boards of the superannuation funds, and greater financial skills would be required than is currently needed, but the result should be less volatile retirement benefits for members who are already pooling their contributions and are expecting some level of retirement income that may evaporate close to retirement. The regulation of superannuation funds would also need greater attention but the regulator already has similar issues with the few remaining defined benefit funds.

A return to a more stable distribution of the investment returns is socially desirable to avoid the results of the current system – without it many people will find they reach retirement without much of the money they thought they’d have.

John Evans is an Associate Professor and Head of Risk & Actuarial Studies at the Australian School of Business.