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My father’s table: How super could fail

As Australian superannuation assets approach A$4 trillion, politicians on both sides of the divide will be tempted to dip into this massive nest egg to meet their fiscal needs, writes Rob Prugue.
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The government and regulator are both in breach of superannuation principles. This is a breach not of common law but of the actuarial and economic principles underlying all pension mechanisms. This breach raises the risk of moral hazard, which will be borne by taxpayers, and this could change how we ultimately deliver any workable pension savings scheme in the future.

To understand this breach we must first understand the different ways pensions are delivered. The first is pay as you go (PAYG) or social security, which is funded by an additional tax imposed on our collective salaries. While those currently earning a salary are paying into a social security pool used by their parents, it’s not their own retirement that they’re funding. The second is defined benefit (DB), a pension liability funded and immunised by the employer (a debt obligation where employers promise to pay a pension to now retired former staff). The third pillar is defined contribution (DC), a tax incentivised long term savings plan where the risk of funding retirement is borne by the individual. In Australia the vast majority of pension assets are under the DC banner.   

The three mechanisms represent differently funded pension obligations where the risk borne is the main differentiating feature. In PAYG the risk pension underfunding is held by the taxpayer. In DB the risk of underfunding and not meeting required return on the portfolio is held by the employer. In DC the risk is borne by the individual. Want to retire rich under DC? Then salary sacrifice into your tax incentivised retirement savings.   

All three mechanisms are impacted differently by current tax and commercial/debt law. In PAYG governments can change legislation around social security by imposing asset and income restrictions. Under DB companies can declare bankruptcy, moving pension debt into corporate debt default. And in DC, on top of the embedded market risk, governments can alter tax laws, potentially altering the superannuant’s net results.  

If we consider that the purpose behind the superannuation levy was to reduce the future tax burden following the army of baby boomers entering retirement phase, tax incentivised retirement savings reduces future tax burden on our children. But as Australian superannuation assets approach A$4 trillion, Treasury on both sides of the political divide will be tempted to dip into this massive nest egg to assist the incumbent’s current fiscal needs.   

Hot and cold on heat maps
As a former regulator, regulatory oversight in Australia baffles me the most. Regulatory metrics like heat maps (peer weights and rankings) are used to oversee DC superannuation payment structure. In moving regulatory metrics towards peer based return metrics like heat maps and the Your Future Your Super performance test, the regulator has inadvertently placed agency/business risk ahead of market and/or principal risk. I’m yet to see any evidence that the best way to immunise a pension liability is by avoiding fourth quartile against your peers. This is so ludicrous a concept that I’m left wondering if those who wrote “heat maps” think that tomatoes (a fruit) belong in a fruit salad.  

Were a megafund to implode, does anyone really believe that the government (e.g. the tax payer) will allow that many members to see their pension savings disappear? 

Page two of every super fund’s own risk statement states that the fund aims to deliver a CPI+ return, and a 1:7 year negative return with a top drawdown of 10 per cent. There is no mention that the fund aims to be out of the bottom quartile. Under the threat of losing their license, it’s understandable why some super funds would prefer to benchmark themselves against their peers over some actuarial designed and risk/return metric. Manage the greater risk – the risk of closure and negative media.  
Another direction our regulator seems to be taking is towards a belief that bigger is better – that megafunds are both more secure and better able to access economies of scale. 

Yes, there are larger pension funds than our largest ones here in Australia, but these are in markets where the investable universe is equally larger and much more diverse. Still, these foreign megafunds find it difficult to deliver anything more than market beta as their asset size prices them out from accessing any meaningful outperformance. The structural risk emanating from the “bigger is better” mantra, however, is that it slaps the whole idea that the member is the ultimate holder of the funding risk under our DC structure. 

But consider this: were a megafund to implode, does anyone really believe that the government (e.g. the tax payer) will allow that many members to see their pension savings disappear? If your answer is no, can we therefore claim that we still operate under a DC pension system? Or are we just a sugar coated PAYG where the liabilities are still underwritten by the taxpayer? Bigger is does not necessarily mean better – it just means bigger operational challenges.

New taxes and nation-building
As for the government’s breach of actuarial and investment principles, I should stress that any such concern is politically agnostic. Both parties are culpable.  

The former government’s decision to permit  access to super for “financial hardship” purposes was the economic equivalent of “sell low, buy high”.  And what about using one’s super for purchase of a home? Using pension savings to buy an even more expensive asset (e.g. residential real estate) served no one but developers and real estate agents, as it neither made homes more accessible nor could it be construed as a sound pension or investment policy.

The current government’s discussions around super are equally concerning as, like the aforementioned breaches, these don’t appear to be founded on either economic or actuarial science. Investment within infrastructure is indeed a sound investment, but when it’s posed as an alternative to government funded initiatives it pushes more services from being taxpayer funded into for-profit portfolios. 

In my opinion, this is a breach of the social contract all governments hold between our taxes and the services we expect from it. 

And when the government was discussing why its new tax on superannuation balances over $3 million would only affect those with large balances, such justification was grossly one sided (with little or no mention of the net effect of moving towards self-funding instead of the outdated and dysfunctional PAYG model).  

These examples were nothing more than political pandering, with no foundation in economic or actuarial science. Accessing the near A$4 trillion is a nice boost to any government’s fiscal proposal, and as the government debt levels moves from bad to worse following the rise in interest rates, the need to extricate super from politically motivated fiscal policy has never been greater.  

Sadly, while I’d like to suggest pension policy responsibility move towards a policy committee within the regulator, it’s probably not a good idea. Their aforementioned track record is as tainted as that of both political parties. Just as monetary policy is meant to be agnostic towards political aspirations, perhaps here too we need to find a way to protect the pension assets from political interference. Wishful thinking, perhaps, but doing nothing is equally fraught with concern.   

My Father’s Table is a recurring column penned by Rob Prugue. The previous instalment can be found here.


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