Australia’s superannuation system has been judged to be the third best retirement system in the world, according to the Melbourne Mercer Global Pension Index (MMGPI) Report released this week. The 2013 Report replicates last year’s findings, with Denmark’s retirement system found to be the most robust, followed by the Netherlands and Australia.
The MMGPI Report ranks the pension systems of countries across a range of indicators to determine an overall index value for each nation. The Report now covers 20 pension systems affecting approximately 4 billion people, or some 55% of the world’s population, including China and India. It is a collaboration between global consulting firm Mercer and the Australian Centre for Financial Studies (ACFS), with support from the Victorian Government.
How the Global Pension Index is calculated
The overall index value for each country’s system is made up of three sub-indices; Adequacy, Sustainability and Integrity.
Adequacy is 40% of the total, and represents benefits, tax support and asset allocation. Sustainability has a 35% weighting based on the likelihood that the current system will continue providing benefits into the future. It includes coverage, the level of current government debt and trends in labour force participation rates for older workers. The Integrity sub-index is worth 25% and considers governance, protection, communication and costs, all of which impact on public confidence.
An ‘A’ grade system requires an overall score above 80 and is “a first class and robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity”.
Danes hold off the Dutch and Aussies (again)
In a repeat of last year’s podium, Denmark’s pension system had the highest overall index value ‘A’ grade at 80.2, followed by ‘B+’ grades for the Netherlands (at 78.3) and Australia (at 77.8). Switzerland and Sweden were close behind, while the UK slotted into 9th place (65.4) at the lower end of the ‘B’ grade. It was judged to have an inferior pension system to Canada, Singapore and Chile. The US fared no better, placing 11th (58.2). Japan is the only mature, developed economy with a retirement system rated ‘D’, having been given an index value of just 44.4. Japan’s low overall score was primarily due to a woeful Sustainability sub-index score of 28.9, the equal second lowest with China across the 20 nations.
When it comes to retirement, what makes the Danes great?
According to the Report’s lead author, Dr David Knox, Senior Partner at Mercer, Denmark has design features that would be the envy of most other nations:
- a universal age pension that equates to 17% of Danish average earnings. This is reduced if an individual’s income from employment is greater than 75% of average earnings
- in addition to the basic pension, there is an income-tested supplementary pension of up to a further 17.1% of Danish average earnings. This means that the poor receive a pension of 34.1% of average earnings
- both pensions are adjusted in line with movements in average earnings. According to OECD tax revenue data, the average wage in Denmark for 2012 was US$49,887 versus US$48,199 for Australia
- a nation-wide statutory fully-funded system covers all employees and provides a lifelong pension in retirement. Contributions to this system are based on hours worked per month
- occupational schemes round out the system, with fully-funded Defined Contribution (DC) schemes enjoying almost universal coverage where end benefits are usually taken as annuities rather than as lump sums.
The level of mandatory contributions in Denmark is more than 12% for most employees, versus the current 9.25% Super Guarantee rate in Australia.
Denmark is also held in high esteem for its universal government-funded health and education systems, but it comes at a price borne by the Danish taxpayer. Danes are amongst the highest- taxed citizens in the world, with a top tax rate of 60.2% phased in at 1.1 times the average wage. Australia’s top tax rate of 47% (plus Medicare) phases in at 2.4 times our average wage.
Can Australia turn its ‘B+’ into an ‘A’?
Australia’s ‘B+’ rating indicates “a system that has a sound structure, with many good features, but has some areas for improvement that differentiates it from an A grade system”. Improvements could come from:
- increasing the labour force participation rate amongst older workers
- increasing the age pension age as life expectancy continues to rise (note: it is already scheduled to move to 67 for those born after 1 January 1957)
- increasing the minimum benefit access age so that preserved benefits aren’t available more than five years before age pension eligibility
- removing legislative barriers to encourage more effective retirement income products, and
- introducing a requirement that part of the retirement benefit must be taken as an income stream of some description.
The final two issues received much discussion at the MMGPI launch. As Dr Knox put it, “Developing effective and sustainable post-retirement solutions has to be one of the most critical challenges for policy makers and retirement industries around the globe.”
SMSFs – the $500 billion ‘joker in the pack’?
Australia’s overall index value rose 2.1 points year-on-year, mainly due to a significant jump in its Integrity sub-index, which scored the highest of any nation. A major factor was the introduction of the Stronger Super reforms that are already leading to improved governance and stronger regulation. Australia is now one of only three countries that require public offer funds to have a conflicts of interest policy in place.
However, these reforms apply primarily to ‘APRA-regulated’ funds, which account for approximately 66% of the nation’s superannuation. SMSFs are not, other than at the margin, affected by these regulatory changes. SMSFs will not have to create an operational risk reserve, nor supply members with a ‘Standard Risk Measure’ statement outlining the likely frequency of negative returns over a 20-year period. SMSFs trustees need to prepare an investment strategy but, unlike their public fund counterparts, do not need a risk management strategy nor a conflicts of interest policy. SMSF members do not have access to the Superannuation Complaints Tribunal, a government body that arbitrates on member grievances made against super funds.
It would not be unreasonable to question whether, if the SMSF sector continues to grow apace, the differing governance standards between APRA-regulated fund and SMSFs will affect Australia’s Integrity sub-index score over time, compromising Australia’s overall place in the list of elite retirement systems. Recent signs are that regulators are watching closely.
Enhanced focus on delivering sustainable incomes
The Melbourne Mercer Global Pension Index is an ambitious undertaking, but one that pays dividends in the quality of data it brings to the comparison of pension systems around the globe. The Report is now keenly anticipated by superannuation professionals and global pension managers globally. It is a key source of insight into the health and robustness of pension systems and how these systems might be improved. Australians should be justifiably proud that work of such global importance is being undertaken here.
One of the key messages from the latest report is the need to ‘start with the end in mind’. Pension systems exist to provide benefits in retirement, and the best systems deliver that goal to the greatest number by the most robust means possible. A mind-shift away from focussing primarily on capital accumulation and more toward post-retirement income generation is needed.
Harry Chemay is a consultant to superannuation funds, an alumnus of Monash University and a member of Finsia. Both organisations are consortium members of the Australian Centre for Financial Studies. He previously worked for Mercer.