The OECD has recently published a roadmap for the design of DC retirement savings pension plans. In doing so, the OECD has stated that its aim is to help countries strengthen their retirement income adequacy. Essentially the roadmap boils down to 10 recommendations. The recommendations all make good sense, yet it is instructive to review the Australian experience of the last two decades to see how sensible recommendations are not necessarily easy to implement.
Australian DC design has been developing over many years, and some of the recommendations of the OECD are either in place or well under way. For example, the Superannuation Guarantee system ensures employees are enrolled for their full working careers. Investment option design, including default options, offering different risk profiles, lifecycle options and so forth has been developing alongside the SG regime as has financial education and communications with the consumers. The importance of these factors is been well known to plan providers, employers and industry advisors.
However, certain other recommendations of the OECD, such as providing the means to hedge longevity risk, have not developed in Australia. The OECD recommends the encouragement of annuities as such a hedging instrument and encourages Government to promote an effective annuity market. It also recommends the development of other risk-hedging instruments. The Australian market has a very limited supply of annuities, perhaps because there has been limited demand. It is highly likely that there is a latent demand for effective risk hedging financial products among the population, but it’s just that the current annuity design is not sufficiently attractive to sell in material quantities. Mostly, Australians enjoy a means-tested safety net defined benefit pension provided by the State, and take their private savings in lump sum form, without any effective strategies to manage investment and longevity risk.
Why is it that the Australian system stands up well in some instances and not in others? Perhaps Government policy has something to do with it. For example, there are constraints in regulation that makes it very hard or impossible to introduce innovation in the annuity market. Perhaps the individual is being entirely rational and the utility afforded by a lump-sum, secure in the knowledge of a risk diversifying safety net DB pension, exceeds the utility of hedging longevity risk through an annuity or something similar. Perhaps it has become simply too complicated for the typical person and they lose interest in actively managing their retirement savings. It is certainly the case that the sheer volume and complexity of the law surrounding superannuation is very off-putting to people, and I would contend is likely to be counterproductive in the long run.
Will anything change any time soon? Probably not. The opportunity for effective change in the structure and operation of superannuation has recently been and gone. The Government initiated a review of superannuation in recent years, called the Cooper review, and the main recommendations of that review are now being implemented. The changes will take 5 years to complete. Despite that, the changes focus on developing a low-cost low frills product as the default superannuation product. Inexplicably, after several years of review process, and 5 years to implement changes, there is nothing being changed in the area of dealing with longevity risk and market risk in the retirement phase. The Cooper review predominantly focused on trying to reduce costs in the accumulation phase. Of course, whether that will be successful is not clear either. Normally the best way to reduce costs is to remove regulation and promote competition, not to add regulation and encourage oligopolies.
Government and bureaucrats do not often get the opportunities to make substantial change for the better. When there is a window of opportunity for reform, if it is not exploited, the window can shut for a long time. In the case of Australian superannuation, I suspect that we will still be saying in a decade that some of the OECD recommendations are handled well here, but we still don’t know what to do about the retirement phase.