A certain fusion
Nick Sherry
It is just over 10 years ago, the 1st of July 1992, that the Superannuation Guarantee (SG) commenced operation in Australia. The final 1 per cent bringing the total to 9 per cent was reached on 1 July this year. Therefore it is an opportune time and an appropriate venue at this IFSA conference to release the first of Labor's two policy options papers on superannuation. This first policy paper: Broader Choice, Stronger Protection and Fairer Tax will concentrate on industry structure, regulatory regime, fees and charges and tax. A second paper will focus on adequacy of contributions levels, health and, or, education and other accounts, women, investment and income streams.
Before I go into detail it is appropriate to briefly outline the development of Australia's Retirement Incomes System over the past 20 years, largely a product of a Labor government. In particular I will touch on the philosophical parameters that underpinned Labor's approach.
The Labor Party's approach to superannuation
The Labor Party when in office between the years 1983 and 1996 established the framework for Australia's retirement income system: the so-called 'three pillars'. The 'first pillar' is a guaranteed minimum retirement income, the age pension provided by government from budget revenue. This was set at the modest level of 25 per cent of Male Total Average Weekly Earnings (MTAWE). The 'second pillar' is a system of compulsory contributions for employees which are privately managed. Initially it dated from the 1986 National Wage Case, when the Labor government supported a wage trade-off in the form of a 3 per cent employer superannuation contribution. This was extended by the Superannuation Guarantee (SG) to 9 per cent. The 'third pillar' is additional savings over and above the compulsory level. Such additional contributions are a matter for individuals to decide and are strongly influenced by income levels and tax concessions.
The three pillars are recognised as world's best practice by the World Bank. Despite best practice, there are still some issues that need to be addressed - but more of that later. Labor had proposed to go further with a co-contribution model of an additional 3 per cent employee and 3 per cent government contributions, bringing the total to 15 per cent by 1 July last year. In a short-sighted move, that drew surprisingly little adverse comment at the time, the co-contribution was abandoned by the Coalition government in 1997, despite the fact that the cost had been included in the budget forward estimates. It was reshaped into a savings rebate, and reshaped further to assist funding of the GST package and the health insurance rebate. That opportunity has gone; probably forever.
A Labor government will operate within the parameters of a balanced budget. For any additional dollars flowing into superannuation there is a loss to current government revenue. Every extra dollar (of deducible contributions) comes off taxable income, hence a short to medium term loss to revenue results. Labor will present and prioritise fair policy options within the limited revenue available.
There were a range of philosophical parameters that underpinned Labor's approach. They are still important today and will continue to guide Labor into the future. One could even say there is a certain fusion between past, present and future Labor superannuation policies, significant given the theme of this conference.
Fairer retirement income The base of the system - the pension safety net - was indexed at 25 per cent of MTAWE so that all Australians dependent in part or full on a modest basic pension could be certain of regular pension increases, and also receive a share in increasing national economic prosperity. The majority of Australians had no additional retirement income. Superannuation was largely the preserve of the better off in society, some 40 per cent of Australians - middle to high income and usually male.
Labor's introduction of compulsory superannuation was in the main aimed at adding to the retirement incomes of Australians, not replacing the pension. It spread coverage from 40 per cent to 88 per cent.
Sustainable retirement system Labor foresaw the consequences of an ageing population. It recognised that the long-term financial pressures would increase on both government and the individual. Policy measures such as the SG, assets and means test, phased increase in the female pension age from 60 to 65, Reasonable Benefit Limits (RBLs) to cap tax subsidised benefits at $1 million (if taken as an income steam) are examples of balanced, fair and necessary steps to maintain sustainability.
Efficient private savings vehicle Labor, while accepting that the 'second pillar' should be delivered through the private sector in the form of superannuation, wanted to ensure value for money. It extended the existing model of 'non-profit' trustees in corporate and public sector schemes across the private sector. This is a regulated retail membership model. The larger the superannuation fund the greater the economy of scale - the lower the unit costs of administration and funds management.
Labor was determined to avoid the worst features of some private retirement systems in other parts of the world that have very costly retail distribution systems. For a considerable majority of fund members in Australia, the current regulated retail structure is very cost effective - total costs of 1 per cent of assets or less. Long-term average investment returns are no different as a consequence. Labor's cost estimates, based on Treasury advice, which is still used, assumed average costs of $1 per week each for administration insurance and up to 1 per cent of assets for investment management.
Maximising long-term returns Many countries have chosen to prescribe superannuation investment in various forms, for example government bonds, ratio of investment types, average returns, borrowing by the state, prohibition on overseas investment. This approach can have adverse consequences.
Take one example, Singapore. An often quoted model with 40 per cent contributions into the Provident Fund, in turn used by the government to invest in the national economy via the Development Corporation. It was certainly very effective as an economic development tool. However, with declared rates of return of only 2.5 per cent to the retirement account, less than a market rate of return and often less than inflation, the pension replacement rate now that people are retiring is only 15 per cent - 18 per cent of pre-retirement income with no minimum pension. A flop as a retirement incomes system.
A strong trustee system guided by the 'prudent person' principles of diversified investment enshrined in the Superannuation Industry Supervision (SIS) Act provides the best long-term investment strategy. It is in both the national and the individual's interest. It is particularly important to continue to emphasise this in the current climate of lower returns. Labor's policy, based on Treasury projections of final retirement outcomes, was based on a long-term average real rate of return of 4.5 per cent - not the 14.5 per cent that some have come to expect.
Improving private savings Compulsory savings for retirement, particularly for low and middle income earners will, long term, lift total private savings, even with some displacement from other forms of savings. This is particularly important in generating the savings needed for national economic investment and job creation.
No retrospectivity
Individuals, rightly, do not expect governments to retrospectively change rules that have an adverse impact. This is particularly so given the long-term nature of retirement savings.
Strong protection
An essential element of any private retirement income system is safety. Australian society correctly will not accept retirement savings being wiped out as a result of theft or fraud. Leaving it to the 'free market', particularly a market that is guaranteed a massive cash-flow as a consequence of the SG and other tax concessional revenue, is not an option. Labor created a strong regulatory regime through SIS, trustees and the then regulator, the ISC. Amongst a range of other protections it provided: an easy to access dispute tribunal, the SCT; prohibited borrowing against a fund; phase down in in-house assets to 5 per cent - no Enrons in Australia; allowed compensation if theft or fraud occurred.
Labor's policy options
Broader choice The so-called choice legislation proposals - Mark 3 - to deregulate the existing retail structure of superannuation have massive implications for the future of our superannuation system. Proponents present a range of justifications:
It is a fundamental right of any human being to exercise choice - it is self-empowerment and creates more interest and awareness;
Fees and charges will go down through enhanced competition and greater consolidation of accounts with members choosing the best funds on offer;
Individuals will enjoy greater protection and enhanced returns by being able to transfer monies out of poorly run funds;
Protection of the individual is ensured by disclosure and education.
That's the theory. As anyone knows, superannuation products are extremely complex. It requires a huge investment of time to achieve a minimal level of understanding. It is not like buying a fridge, CD, car or even a house. It is compulsory for employees so no-one has to be convinced to join the system. The consequences of a poor decision can take years to emerge and are difficult to correct.
If the system is to be deregulated, let me pose a fundamental question: how are 8 million Australians to be educated to make an informed choice? Just look at a typical product disclosure statements; how many Australians will actually read and understand these statements? What will be their behavioural pattern if they don't? A good many will seek out advice; advice they do not currently receive or need in our regulated system. The need to seek advice will add a significant extra cost structure to a compulsory system. And the industry will be caught up in a whirl of increased advertising costs and growth in commission based selling.How then do fees and charges go down?
We already know that those fund members who are part of the deregulated retail system, who can exercise co-called membership choice, pay total fees of at least double that of fund members in the regulated retail system. Let me give you a few real life examples of fees and charges:
A 5 per cent entry fee when an individual is required to switch from a corporate master trust to a personal product with the same company;
Exit fees of $11,500 on savings of $65,500; $4,000 on savings of $33,000 and $3,324 on savings of $3,300 with the member left owing the provider $24!;
Insurance premiums of $1300 against contributions of $1600;
Five different fees and charges on SG contributions under a workplace agreement totalling over 11 per cent of the fund balance.
Contributions in all cases were either SG or predominately SG. Fortunately these excessive fees and charges only apply to a minority of fund members; those in the unregulated retail market. Aside from the harm to individuals, it only takes a small number of cases like this to discredit the industry. Remove the structural regulation and these excessive fees will spread, over time, right through the system. How many individuals will be able to anticipate market downturns and switch funds to beat the downturn? Very few of you could and you're experts. How will individuals know if their money is going to be mismanaged or stolen in advance?
It is noteworthy that the worst effects of the Commercial Nominees case were felt by those already in a so-called choice environment. It would be both absurd and unfair to suggest that these individuals should have anticipated the fraudulent conduct that led to capital losses of up to 100 per cent, yet that seems to be the position of proponents of choice.
An increasing number of Australians are voluntarily choosing to directly participate in financial investment, which is to be encouraged. But should we be forcing 8 million Australian superannuation funds members to do so? The Choice Mark 3 legislation is not even full choice:
it will only apply to federal award employees ; leading to more complexity;
employers with AWAs and certified agreements have a veto;
exit and entry fees - barriers to true choice - will still be allowed.
In addition, deregulation will destroy corporate funds. How can they continue to exist? The employer cannot bind the members as they are forbidden from doing so. Generally when a corporate fund shuts the more generous contribution levels and subsidised administration and insurance cease. This means less savings flowing into retirement incomes. At least at present when a large company choses to outsource its fund it can negotiate a bulk discount of fees with a master trust. This will not be permitted in a deregulated retail market.
Labor intends to offer a broader choice; effective and informed choice; choice with the strongest consumer protection; full portability. In this area, the following options are being considered:
Automatic consolidation for accumulation accounts unless a member elects otherwise;
Entry and exit fees, which are barriers to choice and portability, are to be prohibited;
Genuine choice: no overriding of employee choice by any mechanism;
Improved disclosure of fees and charges: the current FSR requirements aren't good enough;
Capping of fees, charges and insurance costs that can be directly debited against the compulsory Superannuation Guarantee for a standard product, effectively prohibiting commissions and similar in principle to the government's regulation of health insurance and aged care fees. Cap levels would be set based both on Treasury assumptions referred to earlier and on the current average Total
Expense Ratio identified by IFSA and other recent industry surveys. If the industry argument is that fees and charges will come down it need have no fear of a cap;
Reporting of fees, charges and commissions to the regulator for public (consolidated) disclosure;
Expanding the powers of the SCT;
Prohibiting employers and, or, providers from linking superannuation with other benefits to the employer; and
Requiring all funds to provide a menu of investment choices, including an ethical investment choice.
Stronger protection With the maturing of the system over the last 15 years it is also an opportune time to review general protections in place particularly with new types of investment products, technology and a new regulator APRA. The following options are being considered:
Reviewing the resourcing and structure of APRA to improve its effectiveness;
Legislating for full compensation in the event of theft or fraud;
Expanding the definition of an 'eligible loss' beyond theft and fraud to include losses resulting from in-house dealing and other breaches of the SIS Act by fund trustees;
Extending theft and fraud provisions to certain pension/annuity products;
Reviewing current arrangements between APRA and ASIC to improve cooperation and coordination;
A consumer one-stop-shop for the referral of superannuation complaints and inquiries to the appropriate agency;
Providing for standard contract provisions for fund administrations to eliminate confusion when administrators change;
Reviewing the structure and resources of the ATO Superannuation Business Line with a particular emphasis on SG compliance;
Amending the current secrecy requirements in relation to SG enforcement so that the ATO can provide employees with information on enforcement action and payment arrangements;
Reporting of all superannuation payments by employers on employee wages and salary information;
Creating a new employee entitlements scheme that protects all entitlements including outstanding superannuation contributions when a business collapses. This would be achieved through insurance cover attached to an employees superannuation fund as announced by Simon Crean on 11 March this year.
Voluntary contributions Additional voluntary contributions as part of the third pillar are an important element of lifting retirement savings. Labor proposals for a lower contributions tax will improve incentives. Salary sacrifice is spreading rapidly. Labor will support the government's co-contributions scheme for low-income earners. The following options are being considered:
Ensure that SG contributions are calculated before salary sacrifice is deducted by including salary sacrificed income in the definition of the employees earnings base;
Ensure that all employers make the option of salary sacrifice available to their employees; and
Improve incentives for the self-employed.
Taxation Lower taxation on superannuation boosts retirement income and incentives to save. Given current budget constraints, tax concessions must be targeted in the most effective and fair way. A cut to the so-called surcharge for high income earns - those on a surchargable income greater than $90,500 per year, some 4 per cent of taxpayers - is not well targeted. Nor is it fair. Expensive measures to close the Commonwealth public service schemes and to allow splitting of contributions are unnecessary.
Labor's alternative is to redirect the costs to revenue of these measures, some $1.161billion, into either: a cut to the contributions tax for all Australians who pay it from the present 15 per cent to 13 per cent, or a cut to the tax to 11.5 per cent for those aged 40 and over. Either option would add many thousands of dollars to retirement incomes. Labor's tax alternative is fairer and better targeted.
Conclusion In concluding, the goal of a private retirement savings system, superannuation, based on a mix of compulsory and voluntary tax concessional contributions, is to maximise retirement savings for all Australians. Labor proposals to provide for broader choice, lower fees and charges, fairer taxation and stronger protection will maximise the income Australians rightly expect in their retirement years.
Nick Sherry is a Senator for Tasmania in the Australian Parliament and Labor's Shadow Minister for Retirement Incomes and Savings, and Consumer Affairs. This is the text of his address to the Investment & Financial Services Association Limited (IFSA) Fusion Annual Conference held in Brisbane on 2 August 2002.