Statement by David O. Harris*, Research Associate
Watson Wyatt Worldwide, Bethesda

Testimony Before the House Committee on Ways and Means

Hearing on Social Security Reform Lessons Learned in Other Countries

February 11, 1999

Mr Chairman, I am pleased to appear before the House Ways and Means Committee to discuss the structure, success and ongoing improvements to the Australian retirement model. I would like to begin by sharing with you today how an industrialized nation like Australia moved its retirement system from a reliance on an unfunded pay-as-you-go (PAYG) system towards a more fully funded, defined contribution approach. I will then discuss the structure of the superannuation (pension) industry, paying particular attention to the issues surrounding asset allocation and administrative costs. These details I am confident will add further clarity to the debate on reforming social security which President Clinton highlighted in his recent proposal. After that, I will look briefly at some of the issues that surround maintaining the integrity of the superannuation system, with particular reference towards regulation, consumer protection and meeting the special needs of women and minority groups. Finally, I will conclude by linking the main features and aspects of the Australian superannuation system with some of the arguments associated with individual retirement accounts.

Developing and Nurturing an Individual Retirement System

For Australia, a country that at the beginning of the twentieth century had one of the highest standards of living in the world, the Old Age Pension, introduced in 1909, appeared to be both a stable and viable approach to meeting an individual's retirement needs in the future. Under the system a flat rate benefit is provided which equates to a maximum of 25 percent of male total average weekly earnings (MTAWE). Before the 1980s a common mentality among retirees was that after paying taxes over their working lives, they were entitled to an Old Age Pension from the Federal Government.

In the early 1980s both politicians and bureaucrats alike began to realize that the current Old Age Pension could not be sustained with the rapid aging of the population. Simply put, Australia could no longer afford a 'non-earmarked PAYG Old Age Pension' with its associated generous qualification requirements.

Australia's demographics are similar to those in the United States. Today, roughly 15 percent of the population is age 65 or over. Their share in the population is expected to rise to 23 percent by 2030. The percentage age 85 and over is expected to more than double from around 2 percent today to more than 5 percent by 2030. Australia's aging population poses a threat to the nation.

It may be surprising for some in the United States, but it was the Australian Labor Party, a social democratic political party, working with organized labor that generated the momentum for change of Australia's retirement system. Elected in 1983, Prime Minister, Bob Hawke, a former Australian Council of Trade Unions President (the Australian equivalent of your AFL-CIO), and his Cabinet began the task of restructuring Australia's national retirement system. They began by ensuring the long-term viability of the Old Age Pension, at its current level was maintained. To this end, maximum payments per fortnight by the mid 1980s would now be determined through the interaction of a comparatively stringent income and asset tests. These income and asset tests, as they stand today, are outlined in Table 1 and Table 2. At the current time, maximum payments per fortnight are $347.80 ($US225.65) for a single pensioner and $290.10 ($188.22) each for a pensioner couple.

Table 1: Summary of the Income Test Provisions of the First Pillar

Source: Department of Social Security

Table 2: Summary of the Asset Test Provisions of the First Pillar

Source: Department of Social Security

In Australia's case, the Federal Government, with full trade union support was able to convey to the nation effectively the impending problems Australia would confront, if it did nothing about addressing its pension system in the face of its aging population. This theme of the realization and an acceptance of a future retirement hurdle was best summarized in the Better Incomes: Retirement into the Next Century statement which expressed a commitment to:

"'Maintain the age pension as an adequate base level of income for older people' but went on to state that persons retiring in the future would require a standard of living consistent with that experienced whilst in the workforce."^;(1)

For trade unions, which had strongly supported the election of a Federal Labor government in 1983, increasing superannuation coverage was seen as a major priority. Before the introduction of a mandated, second pillar, superannuation accounts, the extent of coverage was limited to roughly 40 percent of the workforce. Typically employees who were covered by superannuation were employed in middle class, 'white collar' jobs where usually women and people from minority groups were under-represented. By 1986 circumstances were ideal for the introduction of a widespread employment based retirement incomes policy. The situation was facilitated by the role played by the Conciliation and Arbitration Commission in setting wage increases for workers in the union sector. Continuing pressure for wage increases and demands by the union movement on the government for a comprehensive superannuation policy combined to result in the introduction of award superannuation. The Conciliation and Arbitration Commission set a wage increase of 6 percent for the year, but provided that half the increased wage was to be paid into individual superannuation accounts.

By its action, the Conciliation and Arbitration Commission in requiring compulsory contributions of 3 percent to be made into individual superannuation accounts, award superannuation was born. The trade union movement and the Federal Government worked together in refining and improving the delivery and regulation of superannuation products to employees. Moreover trade unions did not simply advocate a policy of increased superannuation coverage for their members but would become specifically involved in the day to day operations of superannuation funds. These funds were generally organized around an occupation or industry and were sponsored by employer and employee organizations. Fundamentally they were established to receive the 3 percent mandated award contribution.

Most experts and politicians agreed that 3 percent was not a sufficient level to generate adequate retirement income for employees once leaving the workforce. On this basis the Federal Government would again intervene in 1992 to reposition Australia's long term retirement income strategy.

Structure of the Australian Superannuation Industry - Second Pillar

With a delay to the 1990-1991 wage case (centralized wage fixing) occurring, where the ACTU and the Government supported a further 3 percent round of award superannuation, the then government realized that compulsory superannuation contributions needed to be separate from wage setting mechanisms. Some employees for example were not covered by federal and state award wage setting guidelines which meant that compulsory contributions, often did not apply to certain professional and occupational groups.

In August 1991 the Government's Treasurer, the Hon. John Dawkins MP, foreshadowed the Government's intention of introducing a Superannuation Guarantee Levy that would commence on July 1, 1992. In issuing a paper on the levy the Treasurer indicated that such a scheme would facilitate:

• a major extension of superannuation coverage to employees not currently covered by award superannuation;
• an efficient method of encouraging employers to comply with their obligation to provide superannuation to employees; and
• an orderly mechanism by which the level of employer superannuation support can be increased over time, consistent with retirement income policy objectives and the economy's capacity to pay.⁽²⁾

Additionally in a statement Security in Retirement, Planning for Tomorrow Today given on 30 June 1992, the Treasurer reaffirmed the government's position and direction on the aging of Australia's population and the need for compulsory savings for retirement:

"Australia-unlike most other developed countries meets its age pension from current revenues. Taxation paid by today's workers is thus not contributing to workers' future retirement security; the revenue is fully used to meet the annual cost borne by governments. And, like most other people, Australians generally undervalue savings for their own future retirement. Private voluntary savings cannot be relied upon to provide an adequate retirement security for most Australians. This is so even with the very generous taxation concessions, which are available for private superannuation savings. ….In the face of these factors, changes are required to the current reliance on the pay-as-you-go approach to funding widely available retirement incomes. This means that we need now to start saving more for our future retirement. It also means that saving for retirement will have to be compulsory. It means that these savings will increasingly have to be 'preserved' for retirement purposes. Lastly, the rate of saving will have to ensure retirement incomes, which are higher than that provided today through the age pension system. There seems to be a general awareness in the community that something has to be done now to meet our future retirement needs."⁽³⁾

The Superannuation Guarantee Charge Act 1992 encompassed these views of the Treasurer and required that all employees contribute to a complying superannuation fund at a level, gradually phasing in from 3 percent in 1992 to 9 percent by 2002. It should be noted that some relief was provided for small business in how the levy was introduced, based on the size of the annual payroll. If an employer chooses not to pay the levy he or she will have a superannuation guarantee charge (SGC) imposed on their business operations by the Australian Taxation Office (ATO). By deciding not to meet the obligations under the Act, an employer will not receive favorable taxation treatment in regard to contributions made on the employees' behalf.

At the present time the levy is currently at 7 percent which will increase progressively to 9 percent by 2002. The threshold for paying this levy was based initially on the individual earning a minimum of A-$450 (US-$294) per month. More recently employees may decide to opt out of the system and take the contribution in cash up to a level of A-$900 (US-$587) per month.

Table 3: Details of the Prescribed Superannuation Requirements Linked with the Mandated Second Pillar

Source: Australian Taxation Office

In March 1996, the then Labor Federal Government lost office and was replaced by a conservative, Liberal Coalition Government under Prime Minister John Howard. It had been the intention of the Australian Labor Party, with trade union blessing to further expand the compulsory nature of superannuation by gathering a 3 percent contribution from individual workers and providing an additional 3 percent to certain workers who met pre-defined income criteria. In total this would have meant that many workers' individual superannuation contribution accounts would have been receiving total contributions of 15 percent. Treasury estimates suggested that over a forty-year period these contributions would finance a benefit equivalent to approximately 60 percent of one's salary on retirement.

With regard to the taxation of superannuation, Australia has pursued a course which is quite unique and which on the whole I cannot agree with, in terms of design and the overall rate of taxation applied. Contributions to the funds are taxed at a rate of 15 percent, along with possible additional taxation of 15 percent for members' contributions who earn over $73,220. A tax of 15 percent is levied on the investment income of the superannuation fund. Finally, the benefits can be subjected to varying tax treatment of between 0 and 30% percent at distribution.

Superannuation funds are managed in a highly efficient and effective manner for members through a trustee structure. Life insurance companies and fund managers, like those in the United States play an active role in the management and investment of superannuation fund assets. Additionally specialized administration companies have developed services that allow superannuation fund trustees to outsource much of their investment and administrative functions. Intense competition has led to an environment of high returns being maximized and relatively low administrative fees.

Varying measurements exist for evaluating the success of how Australia has contained administrative costs, compared with other international models. Keep in mind, that this is a system that is still being phased in. As it matures, it is becoming increasingly efficient. In a recent paper presented at the National Bureau of Economic Research Conference, on the administrative costs of individual accounts systems, Sylvester J. Schieber, Vice President, Watson Wyatt Worldwide and John B. Shoven, Charles R. Schwab, Professor of Economics, Stanford University made the following conclusions about Australia's cost structure:

"The Association of Superannuation Funds of Australia estimates that the average administration costs of their system equal A-$4.40-i.e., U.S.-$2.85-per member per week. In U.S. currency terms, administrative costs at this rate for a system that held average balances of $1,000 would be nearly 15 percent of assets per year. For a system that held average balances of $5,000, it would drop to 3 percent per year. For one that held average balances of $10,000, administrative costs would be 1.5 percent per year. By the time average account balances got to be $30,000, administrative costs would be under 0.5 percent per year.⁽⁴⁾

Further evidence of the relatively low cost structure associated with superannuation accounts in Australia is highlighted in Table 4 prepared by the Financial Section of the Australian Bureau of Statistics, on behalf of Watson Wyatt Worldwide.

Table 4: Administrative Costs as a Percent of Assets under Management in Australian Individual Account Superannuation Funds during 1996 and 1997⁽⁵⁾

Source: Australian Bureau of Statistics, Belconnen, Australia Capital Territory, tabulations of a joint quarterly survey done by the Australian Bureau of Statistics and the Australian Prudential Regulation Authority (APRA).

I would like to mention briefly that investment decisions and strategies are developed solely between the investment managers and the trustees of each superannuation fund. The Australian Government plays no role in shaping directly or indirectly the investment decisions of the individual superannuation fund but rather through regulation, stresses the need for a sensible and sustainable investment strategy. Regulations refer to this approach as the prudent man test. Further, the September issue of the APRA Bulletin highlights that 36.2 percent and 15.7 percent of the total superannuation assets of the A-$364.6 billion or US-$234.07 in superannuation assets are invested in equities & units in trust and overseas assets. Clearly this level is deemed acceptable by government, trustees and superannuation fund members alike. A concise overview and asset allocation of the Australian superannuation industry and as at September 1998, is provided in Table 5 and Table 6.

Table 5: Overview of the Australian Superannuation
Industry - September 1998

Source: APRA Bulletin, Australian Government Publishing Service, September 1998

Table 6: Asset Allocation of the Australian Superannuation System

Source: APRA Bulletin, Australian Government Publishing Service, September 1998

The third pillar of Australia's retirement income system is characterized by individual retirement accounts generated on a voluntary basis through the private annuity, retail funds management, and life insurance markets. Government taxation and concessional rebates provided to certain taxpayers have seen this segment of the retirement system grow in recent years. With regard to final benefits, Australia allows these to be taken in the form of a lump sum or an annuity. Past experience has seen lump sums, favored by many retirees but with changes in recent tax laws, annuity and allocated pension vehicles are increasing in popularity.

I would like to now turn briefly to the mechanics associated with selling, distribution, and withdrawal of benefits from superannuation accounts. One of the reasons why Australia has been so successful in keeping administrative costs low and also avoiding the problems associated with misselling is through effective and cost efficient regulation. Strict rules govern how superannuation policies are sold and switched. Moreover consumers are required to receive minimum levels of information about the superannuation products at the time of sale and also on a regular basis. Clearly it is felt that, as this is the largest financial transaction that a consumer will enter into in their life, effective disclosure should be provided to encourage transparency in the transaction. Increasingly, superannuation account holders are being provided with greater investment choices. Some retail funds for example offer between 5-7 investment choices and proposed legislation by the Federal Government will force employers to offer choice of funds. Consequently, effective consumer protection strategies will provide an important deterrent for any forms of mis-selling from occurring.

I would now like to refer to Attachment 1 that depicts part of the public education campaign that was initiated in 1994 and implemented between 1995-1996 by various government departments. To build a better understanding and stress the value of superannuation to individual workers, the Federal Government initiated a comprehensive public education campaign. This campaign harnessed both electronic and print media to convey several main themes including the future benefits of superannuation for the nation and the individual, information on how the new mandated superannuation system functioned and how a regulatory body was active in safeguarding superannuation assets. The estimated cost of this campaign was approximately A-$11 million in 1995 or A-$0.60 cents for every man, woman and child in Australia. When devising this elaborate and integral public education campaign, the Federal Government was committed to directing part of the campaign towards women and ethnic minorities. An example of this specific element of the campaign is presented in Attachment 2. For many years government agencies like the Office of the Status of Women (OSW) had highlighted genuine concerns that women were disadvantaged by the retirement system, largely prior to compulsion. Although compulsion had increased the overall superannuation coverage level of the workforce to 91 percent it was argued, many issues still remained in terms of education, product structure and aspects surrounding divorce.

Conclusions

Australia, as a nation with close cultural, industrial, and historical links with the United States has addressed already many of the issues that are being discussed with regard to the future of social security in the United States. Aspects of choice of investment, the role of the government and the private sector in the management of retirement and administrative costs linked with individual accounts, have largely been resolved. Today individual Australians wake up knowing that they are contributing effectively to a retirement vehicle that they own and control. Moreover these superannuation accounts do not generate excessive fees and pay poor returns. Rather superannuation and individual participation in the system is seen to be the only option where effectively Australians can shape and mould their future retirement outlook into the next century. What is also important to consider is that government, while establishing a mandated individual retirement accounts system has not infringed on the efficiency of the financial markets in Australia, for generating the necessary returns of individual accounts. Finally Senator Sherry, the former Chairman of the Senate Select Committee on Superannuation in Australia commented recently in Washington DC, that "the government in directly controlling Australian superannuation was not, an option"^(6).

*  The views in this statement are those of the author and do not necessarily reflect the views of Watson Wyatt Worldwide or any of its other associates.

1. Senate Select Committee on Superannuation: 'Safeguarding Super', June 1992, p.7, Canberra, Australia

2. Senate Select Committee on Superannuation: 'Safeguarding Super', June 1992, p.13, Canberra, Australia

3. The Hon John Dawkins, MP, Treasurer: 'Security in Retirement, Planning for Tomorrow Today, 30 June 1992, pp1-2, Canberra, Australia

4. Schieber SJ & Shoven JB: 'Administering a Cost Effective National Program of Personal Security Accounts' (Draft), NBER, Cambridge MA, December 4, 1998, p.16

5. Ibid., p.17

6. Consultations with leading Government and Industry Representatives, January 20-22 1999