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Volatility in Superannuation Investments and the Australian Age Pension Clare Bellis Department of Actuarial Studies, Macquarie University cbellis@efs.mq.edu.au
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How may changes in superannuation investment strategies affect the proportions of retired Australians who receive a part or full age pension?
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Before: most members in one strategy Now: choice of strategy, eg “cash” or “growth Future: member choice of fund → specialised investment vehicles → very low level of diversification possible, → increased variation across members
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The interaction with the Age Pension Does the means test give members a put option on their superannuation assets: keep the upside, but collect the age pension if the downside occurs? It depends on post-retirement income.
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2 extremes: People on full age pension, can only lose pension if their investments soar → the state should encourage low income earners to gamble with their super. People on no age pension, can’t lose pension but can get it if their investments flop → the state should discourage wealthy from gambling with their super.
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Projection model Assume: 30 year-old single male 35 years of unbroken employment SGC 9%, taxed at 15% Salary: $50,000 or $100,000 in 2005 dollars. Ignore insurance and administration costs. Converted into a single life CPI-indexed pension at 65 at $17.40 per $1 pa
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Projection model Assume: Age pension $12,535 pa less 40% of income between $3,172 and $34,508. No change in the social security legislation! Salary, age pension and the means test limits increase by 4% pa. Investment returns are independent log normal
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Base case (“balanced”): 6.5% mean 7% standard deviation for net investment return.
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Base Case Results for a salary of $50,000 90 percentile range without age pension: 16% to 36% of final salary. including age pension: 37% to 49% of final salary All members receive a part age pension, averaging 71% of the full pension.
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Split members into “defensive” and “growth” funds Suppose balanced portfolio = 50% “defensive” + 50% well diversified “growth” assets net investment returns: “defensive” = 5% mean/ 1% st dev well diversified “growth” = 8% / 13.8% Members divide into defensive or growth investors.
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Results for a salary of $50,000, defensive investors 90 percentile range, including age pension: 38% to 39% of final salary → Very little uncertainty, but gave up 10% upside to reduce downside by 1% → Very little uncertainty, but gave up 10% upside to reduce downside by 1% All members receive a part age pension, averaging 81% of full pension (up from 71% for base case).
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Results for a salary of $50,000, growth investors 90 percentile range, including age pension: 35% to 68% of final salary 96% of members receive a part age pension, (and 4% get none), averaging 60% of full pension (down from 71% for base case)
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Result of dividing the investors on salary of $50,000 State now pays out 2 different rates to 2 groups Combined ave. pension = 71%, as before (defensive investors get more, growth investors get less, on average)
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Base Case Results for a salary of $100,000 90 percentile range including age pension: 23% to 36% of final salary 94% of members receive a part age pension, averaging 34% of the full pension.
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Results for a salary of $100,000, defensive investors 90 percentile range, including age pension: 17% to 19% of final salary All members receive a part age pension, averaging 51% of full pension (up from 34%).
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Results for a salary of $100,000, growth investors 90 percentile range, including age pension: 22% to 66% of final salary 65% of members receive a part age pension, averaging 25% of the full pension (down from 34%).
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Result of dividing the investors on salary of $100,000 State now pays out combined ave. pension = 38%, up 4% (extra cost for defensive investors not fully offset by savings on growth investors)
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Results of choosing a less diversified growth portfolio Assume 8% mean (as before) but 20% s.d. Compared to diversified growth, members gain about 16% upside for 3% extra downside (means test does not affect upside, dampens downside by 40%) – attractive!
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Results of choosing a less diversified growth portfolio average age pension for $50,000, = 63% (up 3% on diversified growth) → 72% combined average (up 1% on base) for $100,000, = 35% (up 10% on diversified growth, up1% on base ) → 43% combined average (up 9% on base)
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Results of choosing a poorly performing high risk portfolio Assume 5% mean, 20% st dev (as before). Not attractive, but quite possible!!
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Results of choosing a poorly performing high risk portfolio average age pension for $50,000, = 81% (up 21% on diversified growth, up 10% on base) → 81% combined average (up 10% on base) for $100,000, = 57% (up 32% on diversified growth, up 23% on base) → 54% combined average (up 20% on base)
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Summary of Age pension % 50,000 salary 100,000 salary Base (balanced) 7134 Half defensive, half growth 7138 Half defensive, half less- diversified growth 7243 Half defensive, half poor performing growth 8154 All poor performing growth 8157 All defensive 8151
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Conclusion The means test on the age pension does create a put option (on our assumptions). Cost to the state increases as choices become less efficient OR overly defensive.
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Areas for further thought Allow for tax - could help the state’s position, though tax payable would be low. Try a more sophisticated economic model. Consider allocated pension instead of lifetime annuity (which cuts off volatility at age 65).
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