In all the fuss over the Financial System Inquiry (FSI) and its 320-page Final Report, one potentially far-reaching theme has attracted relatively little analysis.
Bang, smack in the centre of the first recommendation of Chapter 2 Superannuation and retirement incomes is the statement that the heart of the system remains the achievement of a retirement income. Recommendation 9 creates a hierarchy of objectives where all other honourable objectives are merely subsidiary to the primary objective:
“The Inquiry’s single primary objective prioritises the provision of retirement incomes and precludes the pursuit of other objectives at the expense of retirement incomes.” (Recommendation 9 – Option Costs and Benefits) (my bolded emphasis).
Straying from super’s primary objective
Most of us in the industry were not conscious of having strayed. The pressure to drift away from this singular purpose has led the FSI to ask for statutory protection to ensure the primary objective is achieved. There is, however, a potential sting in the tail of a law enshrining the primary purpose of superannuation. David Murray clearly wants to guard the system from further political tinkering, but he also appears to be re-focussing trustees by laying upon them a new de facto legal obligation; that is, to deliver income.
What were they doing before that?
The wry answer would be that trustees were busy complying with repeated waves of regulatory change and fending off pressure groups wanting to tap the pot of money for all manner of nation-building projects. While this may be true, the real issue is that the current system treats the accumulation phase as an end in itself. It is this mindset that the FSI seeks to ‘reorient’.
“It will help reorient the community mindset around superannuation, away from account balances and towards the provision of retirement incomes. Nobel Laureate Robert Merton wrote: “Sustainable income flow, not the stock of wealth, is the objective that counts for retirement planning.” ” (Recommendation 9 – Option Costs and Benefits)
Lack of risk pooling
A key argument of the FSI is that the lack of risk pooling has led to an inefficient provision of retirement incomes (see the Executive Summary). Our individual asset accounts are ‘pooled’ only for the purpose of investment and administrative efficiency. Our liabilities, on the other hand, are not pooled. They remain inefficiently distributed no matter the size of the super fund to which we belong. This contrasts with the risk pooling inherent in a Defined Benefit (DB) scheme or an insurance fund where the greater the variety of individuals, the cheaper the cost for all.
In this sense, the current system means our risks are borne by each of us individually and, furthermore, these liabilities are really not the responsibility of anyone other than the individual. No official entity, fund, trustee, regulator or agency has responsibility for achieving or monitoring this. The end result is a retirement system that fails to materially alleviate the burden of the age pension on the Federal budget.
It is ironic that the collectivist instincts that brought about our near universal superannuation system should result in such highly individualised outcomes. As the system matures, we are all becoming aware that this policy objective falls between two stools. David Murray, quoted in Cuffelinks at the SMSF Association (formerly SPAA) Conference, 18 February 2015, said that the FSI saw three objectives of super, one of which was “to improve the government budget position by reducing reliance on the age pension, but this has not happened.”
The FSI seeks, within the present construct of our system, to redress this almost complete lack of official accountability for individual outcomes. At the heart of their response seems to be the message that our trustees simply look after assets and have no direct responsibility to look after liabilities. Why else would they be mandating trustees to add a specific new responsibility of nominating post-retirement products?
Investment programmes for DB schemes place much more emphasis on meeting a specified set of long-term liabilities. The risk appetite of pension trustees in predominately DB countries like Canada, US, UK and the Netherlands is therefore shaped by asset-class behaviour relative to liabilities, and is inherently and overtly long-term.
Australian superannuation has wrong focus
By contrast, the Australian super industry simplistically defines risk as raw market volatility within reporting periods. Australian trustees are increasingly pre-occupied by competitive product ranking and business considerations such as brand and pricing within the context of peers.
The competitive war between industry funds and retail may be an additional distraction as they reference each other, rather than an overarching immutable single objective. More worrying is that as industry funds shift from the strategies that served them well in the past, increasingly, the investment programmes of the two streams look the same and bragging rights will disappear.
The December 2014 Chant West survey makes the point that retail and industry funds increasingly experience very similar returns and their January 2015 numbers show no evidence of industry funds out-performing in the last five years. That’s half a decade since industry funds delivered a convincing win over their retail competition.
When I returned to Australia in 1999 after a decade managing DB assets in the UK, I saw an Australian industry had blossomed in my absence. Pleasingly, I saw earnest and diligent trustees making, perhaps in a paternalistic way but nevertheless, wise, considered, long-term strategy calls.
However, since the introduction of fund choice in 2005, the old world of long-term investment horizons has been replaced by a more peer-competitive, internally self-referencing industry of ‘products’ designed to do well in their respective Chant West (or other) survey categories. This shift to a short-term retail-ised industry is possibly the ‘account-based’ mentality with which the FSI panel takes issue.
Their proposal is subtle but potentially far-reaching. They propose a system where trustees are legally bound to accumulate super assets for the purpose of achieving a single result; a post-retirement income. As Dr Samuel Johnson said years before the first fleet set sail; “Nothing so concentrates the mind as the hangman's noose.” Will this legal noose cause our DC industry to act more like DB schemes in its investment strategy? Turning back the clock to a collectivist DB risk-sharing system does not seem possible. However, the FSI has sown the seeds of an elegant compromise that might achieve a similar result.
David M Brown is a Senior Advisor at Cambian Corporate Advisory in Melbourne, and a Non-Executive Director at Clearview Wealth. He has managed pension and superannuation assets in the UK and Australia for over 25 years.