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Speech to the 2012 National Conference of Association of Superannuation Funds of Australia [speaking notes]

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Association of Superannuation Funds of Australia

PJ Keating Speaking notes

ASFA - 50th Anniversary Conference 28 November 2012

• Before we focus on the future of superannuation and the retirement system, it is worth focusing also on where scale superannuation came from

• It came from the sea change in the economy and society produced from the co-operative political model adopted and operated between 1983 and 1996

- Superannuation emerged from it like perspiration emerges from the pores of the skin

• And what was that framework?

- A more competitive outward looking economy with greatly enhanced levels of productivity

- A productivity environment enhanced by a comprehensive social wage

æ Access and equity in health with Medicare æ Access and equity in education æ The right for unions to bargain æ A set of minimum award rates æ Strong real wages growth and, of course, æ Superannuation

- And in the real economy,

æ Low inflation æ A productivity basis for improvements in living standards and, æ Superannuation as a form of distribution of those improved

living standards

• The co-operative model induced and produced a massive increment to real wealth

- Making superannuation not just affordable but: - Using the wealth to meet a growing economic problem - an ageing workforce - Realigning the mix between capital and labour through the labour

contribution to real capital growth

- Fostering joint union and employer control of a large proportion of superannuation savings - and through vesting to individuals keeping the accumulations out of the hands of government bureaucracy

- A policy of industrial co-operation and social justice, generated from a productive economy

- Not a scheme riven by defined benefits which cripples corporations - as we have seen in the US.

• Indeed, very few countries get to develop an adequate retirement income system

- Especially around contributions

- A system in which there is no ‘false promise’

- With benefits otherwise evaporating in corporate bankruptcies

• Australia has - and it has done it by morphing a limited superannuation system into a universal one

• And the base on which it is built is the Age Pension - an income and asset tested - anti-destitution payment: cast at a reasonable level of income - but which ceases when the recipient dies

• Our system is built on 3 pillars

- the means and asset tested Age Pension - Compulsory Superannuation - Tax assisted Voluntary Superannuation

• The big leap in the structure came with occupational superannuation which we had morph into compulsory superannuation with the introduction of the SGC in 1991 and its extension to universality in 1992

• That change was a defining one for Australia


- Few democracies can encourage their workforce to save at least 9% of the wages - let alone 12% - and even more - voluntarily on top of that. - But Australia did - It did it through the unlikely combination of

i. A then centralised wage fixing system ii. A formal government policy structure with the workforce - The Accord iii. The government granting a structural concession

for cyclical prudence? (wage restraint) iv. A supra-boost to productivity coming from a decade of macro and micro-economic policy reform with trend productivity doubling v. Affordability for the Compulsory SGC paid by

employers coming from a sharing of that productivity with their employees vi. In the ricochet of that 9% - a further 3% of compulsory savings being approved by the current


• That 12% of all wages and salaries representing a level of savings that marks out Australia from most countries in the world - Not simply in respect of the size of our savings pool but

- In its capacity to bridge the income gap from work, through and into retirement

• A set of circumstances - So propitious and - So unlikely - in most countries As ever to be replicated

• This is why the extra 3% points of wages to 12% needs to be consolidated

• It will not happen again - and in a compulsory sense, is otherwise unlikely to be improved without bipartisan agreement

• But is it enough?

• The answer: No!

• Why?


- Because people are living longer now - than they were when we created the scheme for them - We built something that took people from 55 to 75 - There is now a different profile as to when the money is


• Because people are living longer - if you get to 60 - you have a reasonable likelihood of getting to 85

So, we have two groups in retirement

æ A 60 to 80 group and

æ An 80 to 100 group

• The 60 to 80 group is all about retirement living and lifestyle

• The 80 to 100 group is more about maintenance and disability and less about lifestyle

• The policy promise of superannuation is understood by people as about having a good retirement

- But adequacy with longevity means that promise cannot be fulfilled

So, the promise has to change

• We want a system which provides people with retirement incomes


the few people who are buying annuities are buying them for something like 20 years. Not for life.

• If you retire at 60; where the sums in accumulation are tax free, and live into your 90s,

- A 20 year annuity probably leaves you reliant on the Age Pension for your last decade or two

- The Age Pension, in effect, becomes the longevity insurer; to not put too fine a point on it - the government becomes the insurer.

• So currently, we have a system - which due to longer life expectancy - has


i. Privately managed superannuation for the first half of retirement, say 60 to 80 - Let’s call it Superannuation Phase 1

ii. With the government, more or less, picking up the second half - 80 to 100 - Let’s call it Superannuation Phase 2

• The default risk insurer being the government

• What should be done about this? - about Superannuation Phase 2?

There are two issues to deal with

i. People being able to better cater for themselves for the balance of their life expectancy (say up to 85 or 87)


ii. People being looked after in a period of longevity - technically, the period of life beyond the normal life expectancy

Two approaches come to mind.

1. Keeping some of the lump till later. A portion of the lump sum, when it becomes available, being compulsorily set aside in a deferred annuity - a pre-payment which kicks back in at say 80 or 85 years. This would mean that the compound earnings on say 20-25% of the lump sum would accumulate between say the ages of 60 and 80, to be available on a deferred basis from 80.

This would mean that a significant proportion of the lump sum would be ‘preserved’ or ‘set aside’ for the much later years - including the years of longevity, if there are such years. If there are not, the residual value of the deferred annuity would go to the estate.

An alternative to that - to the pension meeting all or most of the later life and longevity years - would be for a further 3% point of wages (15% in all) to be devoted to health - maintenance, income support and aged care.

This final compulsory 3 per cent of wages could come in two ways;

i. Through the labour market via the SG, as now, or


ii. Through a government-pooled insurance fund - a longevity fund devoted to income and health support for later life

This would take the form of a government administered, universal social insurance scheme - with a fully funded carefully constructed product.

Covering oneself for later life and longevity risk is pretty much, a classic insurance task. Life companies do it all the time.

But as the government provides the default instrument - the pension - and is in a superior position to pool risk - there is arguably a case for the appropriate agency to operate such a longevity fund - being the government.

People will know that I have always preferred individual vesting as distinct from government mega-funds of the European variety.

And I still do. If it’s vested in your name, you own it.

The problem with later age, longevity and aged care is that capital markets have problems managing that sort of risk.

Only governments can bear risk across generations as well as pool risk - and as government also provides the pension - it picks itself out as the most likely, effective and reliable longevity insurer.

One thing is clear. The longevity cohort - the high aged - requires certainty and they have no room or ability to protect themselves.

People should recall that in the Budget of 1995, the Treasurer, Ralph Willis, announced that compulsory superannuation would rise above the SGC at 9 per cent to 15 per cent in three, two percentage steps.

The tax cuts to be paid as savings were provided for in the forward estimates. These were removed in the first Costello Budget.

In effect, I am still proposing 15 per cent savings - but with the composition of that 15 per cent being potentially different.

Instead of 15 per cent wage equivalent going simply to retirement accumulations managed by the private funds management industry - I am suggesting that an alternative may be 12 per cent (under the SG) being managed privately, and 3 per cent collected under a modified SG being managed within a government longevity insurance fund.


Let me return the subject to current system and the Superannuation Guarantee.

Having largely set up the current system, let me say some things about it.

• The first thing I wish to say is that the SG was not introduced as a welfare measure - one principally to supplement the incomes of the low paid.

• The SG was principally designed for middle Australia - those earning $65,000 to $130,000 a year; 1 to 2 times AWOTE.

• This is not to say that those on 50% or 75% of AWOTE should not benefit equitably from the superannuation provisions. They should. But for middle Australia - the SG and salary sacrifice is the way forward

- At an SG of 12 per cent and broadly tax arrangements as now, someone on 1 times AWOTE to 2 times AWOTE + more generous salary sacrifice limits - should be able to secure a replacement rate in retirement income of around 70% over a 35 year working life.

• Under the system I set up people were encouraged to salary sacrifice in later life - when mortgages had been paid off and children had left the home - When they had discretionary income - Under that policy, people could salary sacrifice up to $100,000 a

year over 50 years of age - Howard and Costello junked the $100,000 a year for the over 50s in favour of $50,000 a year for everyone - regardless of age - For Budgetary reasons, the Gillard Government currently has that

limit at $25,000 a year.

I believe that sum is too low - certainly for those over 50 and I believe it should be increased. $25,000 is simply too little.

While the Government and the Treasury would see an increase in permissible voluntary contributions as a cost to the Budget in revenue otherwise forgone - such increases, in essence, would provide the government with certainty in the out years by de-risking its future funding obligations - obligations in exchange for reduced tax revenue today.

Rates of return

I would like to say something about expectations, as expectations affect strategies as to rates of return.


And I mention this to pass commentary on the rapid growth of self managed superannuation funds.

As a general statement, I believe people expectations as to rates of fund returns are too high.

The Australian superannuation system is not only large in world terms, it is large in absolute terms.

Currently, the system has $1.4 trillion in assets.

The Treasury RIM Group forecasts total system assets to grow to $2.8 trillion by 2020 and $8.6 trillion by 2040.

Currently, the system stands at over 100% GDP and will mature nearer to 200% of GDP.

It is simply too large in aggregate to consistently return high single or double digit returns.

If compound annual returns reflected nominal GDP plus say 1%, the system would be doing well.

Indeed, the Treasury forecast of system assets growing from $1.4 trillion today to $8.6 trillion in 2040 - represents a compound annual growth rate of around 6.7%.

Probably a little better than nominal GDP.

I am certain expectations as to returns and the search for yield has done two things:

i. Managers have adopted a higher risk profile in portfolios and ii. Lower returns have soured expectations - encouraging more people to take the initiative and manage their own


• Average returns for APRA regulated funds averaged 3.8% over the 10 years to 2011 - notwithstanding volatility from the unprecedented growth in equities and investment markets between 2002 and 2008 - juxtaposed against the impact of the GFC.

Over the same period the average cash rate was 5.2% and the average GDP growth 3.1%.


These results indicate that significant risk was taken by superannuation managers to secure returns in line with the relatively risk-free government cash rate.

Importantly, these risks were taken on by managers who had limited direct exposure to losses - losses ultimately borne by superannuation beneficiaries.

However, if the funds did return a significant amount, those same fund managers were entitled to performance fees!

And generally calibrated to annual returns rather than long term returns required to fund a retirement income.

I am certain expectations as to returns are inflated and those expectations lead to incentives to drive higher fees for managers - but at much higher risks - as was the case between 2002 and 2011.

We only have to look at the asset allocations:

As at December 2011, total Australian superannuation assets were weighted:

50% to equities

18% to fixed income

24% to cash and term deposits

and the rest across other asset classes including property.

By contrast, the average weighting of OECD country pension assets were:

18% to equities

55% to fixed income

11% to cash and term deposits

and the rest to other asset classes including property.

So, Australia is 2.5 times more heavily weighted into equities and relatively underweight in other asset classes.

We are disproportionately weighted into equities - the most volatile and unstable asset class.

The question is - how does this weighting work to deliver the key objective of the system?

60% of total superannuation assets are held by investors over the age of 50. A large proportion of these assets should be moving towards less risky, more stable asset classes, protecting capital ahead of the retirement phase.


Where we reach the point where outflows are increasingly matching inflows - the weighting to equities will need to be rectified.

As the system matures, a real capital adequacy risk may start to develop - this will need to be monitored and seriously monitored, by the government.

Which brings me to SMSFs.

• Self managed superannuation funds currently represent approximately 30% of system assets - a pool of $416 billion - and growing strongly.

• As I said earlier - generally - this group has unrealistic expectations as to how much is a good return.

Single digit returns sour their enthusiasm for managed funds - they think they can do better themselves.

• Some sophisticated investors probably can - indeed will - but how many self managers have the required level of investment expertise? And by investment expertise, I do not mean falling prey to financial advisers.

• Notwithstanding the costs of setting up a SMSF - you need something like $600,000 of assets to make the decision to self manage, a better relative fee proposition, to management by larger managed funds.

• The issue gets back to investment skills - how many SMSF investors are competent in matters of asset allocation and general investment savvy.

This becomes a real issue for the SMSF system and its deliverability as it occupies an increasingly higher proportion of overall system assets.

For systemic prudential reasons, investment in stable asset classes - such as government bonds or higher rated corporate bonds could be desirable for SMSFs - that is, perhaps some form of minimum investment which is mandated to mitigate downside risks.

As the system reaches the tipping point - as it matures - where inflows are increasingly being matched by outflows - it will need to be monitored for capital adequacy risk.

Finally, let me say something about one of my favourite subjects: the company tax system


As some of you will remember, before I became Treasurer, when ‘the people of business’ were in charge - the Liberals - company income was taxed twice. Once at the company rate, then Treasurer Howard’s 46% and the dividends at Treasurer Howard’s top personal rate of 60%.

On $100 of company income this left $21 in the hands of the taxpayer.

$21 out of $100.

In 1985, I changed the system completely by removing the Liberals’ double taxation of company income.

And I did this by introducing a system of full dividend imputation.

This meant that company income would only be taxed once.

And this concession was reserved to Australian taxpayers.

Why am I mentioning this today?

Because I want you to understand that for Australian taxpayers, the company tax is simply a withholding tax.

The government collects it at the 30% rate on company income - and temporarily hangs onto it - before giving it to the shareholders (and superannuation funds) in the form of imputed credits.

In other words, when a company issues its dividends, it is able to do so on a fully franked basis. It hands back the company tax paid earlier and staples it to the dividend.

This is my point. If the company tax rate is reduced from 30% - the principal beneficiaries are foreigners who do not qualify for imputation credits.

And a reduction in the 30% rate to say, 25%, will diminish the value of dividends paid to superannuation funds and self funded retirees.

Such a move would effectively increase the rates of tax applying to superannuation.

The question is: do you know any foreigners you want to give 5% of national company income to? Any deserving cases out there?

Or should we leave the company tax rate where it is - as a withholding tax - for the benefit of Australian taxpayers?


I believe the superannuation industry should have a jaundiced view of reductions in the existing company tax rate but, more than that, remain vigilant in protecting ‘Dividend Imputation’.

Dividend Imputation revolutionised capital formation in Australia - the Treasury has never like it - because of its cost to revenue - and about every seven years tries to be rid of it.

Never let them do it.

Lastly, I want to say something about cost of capital.

Before mandatory superannuation, the equity risk premium in Australia was way above the OECD average. Today it is well under it.

Superannuation now massively underwrites capital formation in Australia.

Indeed, one of the principal reasons the 2008 GFC was less severe for Australia, was our ability, through super, to rapidly and effortlessly fund $90 billion of re-capitalisations.

This would have been unthinkable in earlier financial crises.

This is another reason the Business Council of Australia and its constituency should continue to support the consolidation of the mandatory superannuation to the point of maturity.

In conclusion:

1. For the system to reach maturity we have to consolidate the 12% up to 2019

2. The current system of 9% + 3% + voluntary contributions should meet the Super Phase 1 objectives I began work on in 1985

3. But we are living much longer, so the Phase 1 system needs to adapt - we now need Super Phase 2, for the 80 to100 years cohort

4. We need a national consensus on this. We need the Liberal Party to take co-ownership of the system with the Labor Party as we need the business community

5. Managing cross-generational risk is a difficult task for capital markets - which are not in the position of governments to pool risk. The Government might be called upon to have a bigger role in longevity - outside the pension itself for which it is already responsible



6. Investment expectations, in systemic terms, are too high - fund managers are adding risk to the system - largely to little avail, other than their own fees, when for the bulk of over 50s assets we should be de-weighting from risk to more stable asset classes

7. The Government should be encouraging the growth in alternative asset classes which will return something like nominal GDP + 1%:- such classes as infrastructure and housing mortgages come to mind. The Reserve Bank could play an enhanced role in bringing more liquidity to the system

8. We should remember that scale superannuation was designed for middle Australia; people on 1 to 2½ times AWOTE. The SG was never meant as a tack-on to the welfare system - though people on low incomes and part time work should be appropriately looked after.