A group of academics at the Australian National University, including former asset consultant and investment industry executive Geoff Warren, has studied what should be the “right” amount for the compulsory Superannuation Guarantee. Like most aspects of super, they found the answer is not simple.
The group – Geoff Warren, Gaurav Khemka and Yifu Tang – set out to analyse whether the SG should be increased from 9.5 per cent to 12 per cent, a topical issue. The paper, ‘The ‘Right’ Level for the Superannuation Guarantee: A Straightforward Issue by No Means’, was published earlier this month. It identifies two main conditions required to support an increase in the SG. They are:
- There needs to be a policy objective for super to replace the Age Pension, therefore attempting to ensure as many people as possible save enough to become self-funded retirees
- Potential “over-saving”, where super is used as a self-insurance mechanism against the risk that fund members end up saving too little where they live to a very old age, retire earlier than hoped, or suffer lower-than-expected investment returns.
The authors say: “However, we caution against using the SG for risk hedging, as this could lead to over-saving with its own costs. Our analysis highlights that the appropriate SG is highly sensitive to assumptions, and that a single one-size-fits-all SG seems questionable in the face of significant differences across fund members.”
The main findings from the study, and the most important messages to emerge from the work, each of which has policy implications, are:
- There is no single SG that suits all. “We generate a very wide range of optimal SG estimates depending on income level and objective, as well as assumptions… The large variety in the level and pattern of these estimates highlights that a single SG rate is a blunt instrument being applied across all members despite potentially significant differences. It questions whether it makes sense to require everyone to save more by imposing a higher SG because it suits some.”
- Two assumptions might support an SG above 9.5 per cent: while the baseline optimal SG estimates stand below 9.5 per cent, the more important issue is what assumptions lead to a majority of those estimates coming in above that level. The two critical issues to emerge are the role attributed to the Age Pension and whether the SG is used to hedge against various risks (see next two points.
- Age Pension: replace or supplement? An SG of 12 per cent or more can be readily justified if the Age Pension is excluded from the analysis, implying an aim of using superannuation to replace rather than supplement the Age Pension. This establishes the assumed role for Age Pension as a critical issue. We implore policy makers to provide more clarity on whether the Age Pension is considered an income stream that is made widely available for use by to all, or if it should be viewed only as a safety net for those who really need it.
- Hedging risks – Members face three notable risks that could lead to savings being insufficient to sustain an adequate income through retirement. These include: the possibility of living to a very old age (longevity risk); being forced into early retirement where contributions cease and the need arises to draw down on savings to fund spending; and lower investment returns. An SG above 9.5 per cent emerges if it is assumed the aim is to get members to self-insure against these risks: that is, to boost savings ‘just in case’. However, a higher SG could contribute to over-saving if these risks do not come to fruition, meaning that members would have sacrificed pre-retirement living standards without commensurate benefit if they then die with unused balances. We note that there are other mechanisms for addressing these risks, such as social security and pooling solutions under which risks are shared across members.
- Issue of ‘who pays’ – A higher SG can be more beneficial from the member’s perspective to the extent it is paid for by employers rather than coming out of their take-home pay. In this situation, where the burden ultimately falls may depend on whether profits take the hit, or the cost emerges in the form of higher prices or lower employment meaning that fund members bear most of the cost regardless.