Lessons from the Retirement Savings System in Australia Pauline Vamos Chief Executive Officer Association of Superannuation Funds of Australia (ASFA) May 2008 1

Retirement system Asset and income tested Age Pension set a a flat 25% of average earnings financed out of general taxation Benefits from superannuation funds largely financed by compulsory employment related contributions (the Superannuation Guarantee) Voluntary savings, which include sums voluntarily placed in superannuation funds, the purchase of owner-occupied housing and other private savings

Age Pension - lessons Targeted and flat rate publicly funded payment to retirees keeps government expenditure low Government expenditure on income support for the aged currently 3% of GDP, will rise to only 4.5% of GDP as population ages Flat rate payment at just above the poverty line does not deliver adequacy of retirement income

Compulsory superannuation (private pension) system Compulsory contributions started in late 1980s, but tax concessions for superannuation for more than 100 years Prior to compulsory system around 40% of employees with superannuation Now 98% of full time employees covered Self employed make own arrangements, as do those not in paid labour force Very strong community support

Compulsory superannuation - lessons Compulsory private contributions easier to introduce if: public provision is at low level phased in over period of years as part of wage setting arrangements makes allowance for what employers were already doing allows access to both lump sums and pensions after retirement age

Voluntary superannuation contributions A few funds have compulsory employee contributions, all encourage employee contributions Government co-contributions for those who are eligible (the low paid) Employees make salary sacrifice contributions because of tax advantages Annual caps apply to contributions

Voluntary superannuation contributions - lessons Defaults dominate Government incentives can be effective One in ten get co-contribution Around 20% of employees salary sacrifice Many delay extra contributions until approaching retirement

Challenges flowing from compulsory system Many members assume default outcome will be sufficient Members signed up by employers may have little engagement with their fund Can be costly and difficult to provide education and advice to members Over 6 million accounts where member has lost contact with fund

Assets in superannuation Currently about $A1.2 trillion (about $US 1.1 trillion) in ($A165 billion in 1992) Fourth largest managed funds market in the world Will continue to grow as a percentage of GDP for many decades to come

The organisation of the superannuation market Superannuation is regulated by, not provided by, government (other than for government employees) Many funds operating No barriers to new funds other than meeting licensing requirements Gradual fall in fund numbers, but still many hundreds of them

Market structure Fund type % of total assets Number of funds Corporate 6% 258 Industry 17% 73 Public sector 15% 40 Retail 31% 170 Self managed 26% 380,000

Role of Trustees Each fund is governed by a board of directors known as the trustee The trustee is the legal owner of assets and ultimately accountable for the fund investment and administration – but must make decisions in best interests of beneficiaries Fiduciary duties set out in trust deed and codified by legislation

Role of Trustees in investment No legislative rules specifying required or prohibited categories of investments The trustee must develop its own investment objective and strategy The strategy must take into account risk, return, diversity, liquidity, liability and the circumstances of the fund Most funds provide investment choices for members

Investment Most investment strategies require investment in a range of different asset classes: equities, fixed interest, property and cash The proportion of investment portfolios in equities has increased The proportion of overseas investments has increased There is increasing investment in unlisted companies, infrastructure and hedge funds Many trustees engage “specialist” managers

Investment

Investment management Method of investment Percentage of total assets Directly invested 35% With investment manager 43% Invested in life insurance funds 22%

Investment returns Time period Average annual return 10 years to 2007 8.4% 5 years to 2007 10.7% 1 year to 2007 14.1% Likely 2007-08 Negative 3%

Legal Framework Two major pieces of legislation that govern superannuation funds The Superannuation Industry (Supervision) Act 1993 (SISA) - concerned largely with the prudential management of superannuation funds - administered by Australian Prudential Regulation Authority (APRA) The Corporations Act 2001 - concerned with protecting consumers – administered by Australian Securities and Investments Commission The legislation is enforced by the provision of civil and criminal penalties, and by the potential loss of tax concessions

APRA Licensing - The trustee must meet “fit and proper” requirements Propriety good character – assessed individually Fitness skills and knowledge – assessed collectively

APRA Licensing - implications Processes used by funds are heavily regulated, but not specific actions or outcomes Still many funds and trustees, but less than there used to be Low incidence of fraud and theft Members still exposed to investment market risk

Use of service providers Some superannuation trustees directly undertake administration Administration benefits from economies of scale so 5 or 6 administration firms dominate Trustees make use of many investment managers Also contracting of other specialist service providers

Consumer protection Funds must provide prescribed information to members Before/when a person joins a fund Annually (about the fund performance and operation and about there own savings) when a person leaves the fund, and if there is a special event (eg, if the fund rules change)

Level of fees Typically a mix of $ per year and % of assets in account Total cost depends on the account balance of the individual member Group arrangements less costly to member because of scale economies and generally no advice component Costs of advice in personal products recovered through fee for service and/or by way of commission on contributions

Fees for a $50,000 account balance Fund type Annual fees as % of account Industry fund 0.5% to 0.8% Public sector 0.4% to 0.5% Large group retail plan 0.6% to 0.8% Retail personal account 3% (often negotiable) Self managed fund 5% or more (due to fixed costs)

Consumer protection - remedies Superannuation Complaints Tribunal provides low cost review of trustee decisions affecting a member Compensation mechanism in cases of fraud or theft funded by industry levy after the event

Consumer protection - lessons Disclosure requirements can lead to too much information rather than effective disclosure Regulation of provision of advice necessary Need to balance consumer protection and effective delivery of advice and information on basic matters

For more information www.superannuation.asn.au