Finance in Focus NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES Knowledge Notes William Price, Senior Financial Specialist Pension Funds Our Response The World Bank Group’s pension funds team works to To meet these challenges the World Bank Group’s pension improve the coverage of good quality pensions and to financing team focuses on: increase the supply of pension assets that can safely fund long-term investment. Our work supports financial inclusion i) Improving the coverage of good quality pensions: Our goal and financial integrity, and provides important sources of is to ensure that elderly poverty is alleviated by the provision finance for long-term development including infrastructure. of income in retirement through pension systems that have To achieve our goals we work through country and regional broad coverage and are adequate, efficient, sustainable and engagements, as well as producing research and external secure. Our work supports financial inclusion and financial outreach. integrity. ii) Increasing the supply of pension assets that can safely fund The Development Context long-term investment: Promoting the productive investment of pension fund assets not only supports the goal of providing Securing income in old age and generating assets to adequate and secure pensions, but also provides important fund development is a rising challenge for developed and sources of long-term finance for development. developing economies. By 2050 the share of the world’s population over age 65 will have doubled from 10% to 20%. To achieve our goals we work through country and regional Looking to the future, 80% of the elderly – nearly 1.3 billion engagements, as well as producing research and through our people - will be living in low-income countries. outreach program. Greater economic wealth and security lead to longer lives Country and regional engagements take many forms, and smaller families. But a failure to deal with income in old and involve strong collaboration with World Bank Group age for this and future generations will mean rising poverty or colleagues working in the areas such as Social Protection unsustainable burdens on public finances. and Labor, Capital Markets and Financial Inclusion. Projects include: Some of the drivers are irreversible. Shrinking family sizes, the fragmentation of family units, and rising urbanization in • Designing, reviewing, and reforming the overall pension low income countries translates into less traditional sources policy framework in a country of income support for the aged from the next generation. The • Drafting, reviewing, and revising the pension legislation danger of inaction is a rise old age poverty. The common and regulatory framework challenge is to build pension systems that prevent poverty • Capacity building for supervision of the pension industry in old age and improve labor and capital markets through a – including governance aspects diversified mix of public and private provision. • Improving pension market structure and dynamics including distribution and access; and There is also a pressing need to increase the stock of assets • Reviewing and reforming the fiscal and taxation that support long-term growth and development. Pension environment supporting a pension system. funds can be an important sources of domestic, long-term capital which, if structured properly, can help to meet the Our research and outreach work involves developing new growing demand for capital to fund businesses, housing and solutions shared in a range of publications, peer to peer infrastructure. learning through conferences and training, and work with global standard setters and other partners such as the International Organization of Pension Supervisors (IOPS), OECD, IMF, academics, and the pension industry. We are working on a broad range of topics – from reducing costs and improving investment performance to expanding coverage among informal workers. We seek to develop and deliver evidence-based solutions to deliver long-term impacts for countries. For more details see: www.worldbank.org/pensionfunds NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES William Price, Senior Financial Specialist 15 MARCH 2016 OVERVIEW AND COMMENTARY The Australian Government commissioned the independent Financial System Inquiry or ‘Murray Review’ to provide recommendations to improve private pensions (superannuation) – as well as financial system resilience, innovation and consumer protection. This continues Australia’s proactive approach - regularly reviewing how to improve a system that already has good features. The recommendation for a clear (and legally binding) statement of what the retirement system is trying to achieve is a sensible move. It mirrors what is happening in a range of World Bank projects - to start with the long-run outcomes and then work backwards to find the best ways to achieve them – in terms of regulation, supervision, market structure and efficient infrastructure. The recommendation to introduce bulk-purchase competitive tendering to drive cost reductions into fee reductions is a sound way to raise returns net of fees. It shows that even in a mature system costs reductions do not get passed on to members unless demand and supply works for them. The Australian experience shows the necessity for good data on costs and returns so that clear conclusions can be drawn about what is working. In too many countries the basic data does not exist to allow such evidence-based policy – a weakness many systems should rectify. The Murray Report highlights the central importance of scale and governance in driving good outcomes. It provides an unrivaled way to see the side-by-side comparison of different delivery models. Good trustees or governing boards focused on long run member interest add great value. Finally, the Murray Review stresses once again the importance of the payout phase – and integrating thinking about it with the accumulation phase. The same issues that exist in the accumulation phase - of demand and supply, of securing best value for members in the context of complex financial issues - are present in just the same way in the decumulation phase. INTRODUCTION This note reviews the key analysis and recommendations from the review of the private pension system in Australia known as the ‘Murray Review’. It provides a commentary on the implications for pension reforms using World Bank experience in a range of projects. The full report is at: http://fsi.gov.au/ files/2014/12/FSI_Final_Report_Consolidated20141210.pdf 3 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES SUMMARY OF RECOMMENDATIONS Figure 1: Impact of economies of scale on FROM THE MURRAY REVIEW fees in Australian private pensions • Have a clear retirement income objective for superannuation and include other key desirable elements such as the system being fully funded, simple, efficient and provide safeguards; • Introduce an auction or tender to allocate members to a default fund if the ‘Stronger Super’ reforms (that followed the 2010 Cooper Report) do not deliver significant improvements by 2020. All new prices would have to be offered to existing members (as in Peru). • Require a majority of independent directors on pension fund board to improve governance; • Improve disclosure and transparency for consumers; • Restore prohibition on direct borrowing by superannua- Source: Rice Warmer.25 Line of best fit added by Financial tion funds to ensure they remain unleveraged institutions System Inquiry.. that contribute to financial stability. Lack of efficiency due to lack of price competition was a The review also contained very useful information major driver of the report which highlights “Substantially comparing the long run rates of returns from pension higher superannuation balances and fund consolidation funds with different board structures and different profit over the past decade have not delivered the benefits that orientations. The for-profit retail funds consistently perform would have been expected; these benefits have been offset worse than the different types of not-for-profit funds. The by higher costs elsewhere in the system rather than being not-for-profit sector includes employer sponsored funds reflected in lower fees” (Murray Report, p119, 2014). found in many countries such as the UK, US and Canada as well as developing countries. It also includes industry funds as in the Netherlands. Note that not-for-profit effectively describes the long-term objective or orientation of the DETAILS – with a particular focus on funds – they can and do contract with the private sector for market structure, costs and fees services. However, their long-run member retirement focus is often what sets them apart. The average size of a superannuation fund has grown significantly since 2004 – from AUS$260m to AUS$3.3bn A key conclusion was that market forces within the for- in 2013. But the average fees have only fallen by 20 basis profit market were not leading to lower costs being passed points – from 140 basis points to 120 basis point. Analysis on to members. This was due to the well-known problems for the review suggested a fall of at least 60 basis points – to in the lack of an effective demand side in mass market around 80 basis points would have been expected1 (within private pension provision2. This had a clear impact on net the current market structure). Figure 1 shows there are in of fee returns. Figure 2 shows the breakdown of the top 50 general very strong economies of scale as fund size increases best performing funds and the bottom 50 worst performing in terms of lower fees despite the lack of full pass-through funds over the past 10 years. It shows that overwhelmingly identified above. the worst performing funds are concentrated in the for-profit retail sector and the best performing funds are in the not-for- profit sector established for workers in a particular company or industry. Rice Warner 2014, Superannuation Fees, Data provided to the Financial System Inquiry, 23 July 2014. 1 See for example the discussion at the 6th Global Pension and Saving Conference, World Bank April 2014, including Price (2014) 2 and Impavido and others (2010). 4 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES Figure 2: 50 top performing funds vs 50 The lack of a single account for each person leading to lowest performing funds based on annual fragmentation - and lack of bulk purchasing efficiencies passed to members - was identified as a central cause 10 year ROR to June 2013, by fund of the problem. The Murray Review highlights how they classification and profit orientation would change the current disaggregated model. The proposed changes would also reduce the burdens on employers and members to make choices unless they actively wanted to do so. As noted in the conclusions to this note, recent developments in individual ID systems and in IT provide significantly improved options to develop high quality, low cost, individual accounts that can leverage improvements in financial inclusion to offer people in a wide range of countries access to pension and savings accounts that would previously have been impossible. The most significant recommendation is likely to be the introduction of competitive tendering or auctions to provide the default pension fund for new entrants. The review noted that the Future of Financial Review banned the charging of commissions for the MySuper product – which is expected to reduce costs by 25 basis points, and the ‘Stronger Super’ reforms may also produce benefits and have Source: APRA (2014) Fund-level Rates of Return. not fully taken effect. But there is still a difference of 136 basis points, or 1.36% points between the highest and lowest In terms of absolute rates of return over the 10 year cost MySuper products. So the Murray Review want to go period in nominal terms the same message is seen again. further – subject to a review of outcomes in 2020. The new The not-for-profit structures outperform the retail for-profit approach would move away from the model of employers structures by around 150-190 basis points a year on average selecting a provider from over 100 MySuper funds – with a (1.5% to 1.9% a year). Australia is able to provide these new market structure as in Figure 4. breakdowns because it has been insisting on cost and returns data for many years. The Murray Review assesses a range of objections to having a competitive process and has set out the counter- arguments. Most of the arguments are simple to rebut – not Figure 3: 10 year rate of return, to June least because many countries and employer based pension funds have been using competitive tendering for pension 2013, by fund classification and board services successfully for many years. One problem Australia composition would have is the lack of a centralized account management system as in Sweden, India and New Zealand. The review notes that this could be created in the future, but its absence does not prevent the benefits of the competitive tendering/ auction proposals. Another major area of reforms is in the payout phase where Australians can currently take all accumulated assets in a lump sum. The Review aims to improve the provision of retirement income. The key recommendation is for each pension fund to have a core long-term retirement income product that it would offer to members. Members could do something different – but the hope is that as with the accumulation phase members would go for the core options. However, this may prove to be optimistic as the short-term attraction of the lump sum option may still prove too tempting. Source: APRA (2014) Fund-level Rates of Return. 5 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES Figure 4: Improving the market structure and value chain for Australian Pensions Source: Murray Review, 2014, pp 93. Table 1: Issues to address to establish a new competitive process in Australia Potential design issues or Response or design approach concerns A formal competitive process is Large corporate funds successfully run tenders. A number of other jurisdictions unproven. Furthermore, governments use competitive tendering in pension funds; for example, New Zealand, Chile, have a poor track record of running and Sweden. Governments around Australia run successful tenders, including formal competitive processes. the Future Fund, and the Northern Territory Government for its public sector superannuation scheme. The market disruption would be too The effect on market structure could be gradual, as only new entrants to the great. workforce would be assigned to funds under the competitive process. By default, existing members would remain in their current fund, thereby minimising market disruption. Unsuccessful funds may have increased switching rates; however, current switching rates are very low.53 All funds can still compete for choice members. A Chilean-style auction that selects a A significant number of successful funds would be selected, which would drive single or small number of successful competition and innovation. Some market consolidation is likely to occur, but bidders would inhibit competition excessive market concentration can be avoided if a sufficient number of funds and innovation, and lead to excessive are selected through the competitive process. market concentration. Mobilization of Institutional Investors to SME Financing in Emerging Markets 6 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES Fees should not be the sole focus. This The Inquiry agrees with this sentiment and considers a focus solely on fees is would result in a ‘race to the bottom’ not in members’ best interests. As discussed above, the focus should include whereby funds change asset allocation expected ability to generate high after-fee returns based on asset allocation and and investment strategies to reduce investment strategy, as well as past performance. fees. How will the competitive process Competitive pressures will help to keep fund costs down as assets in the lower fund costs? system continue to grow. Member acquisition costs will fall as funds do not need to compete for default fund members (outside the tender process). More consolidation of funds and reduced proliferation of multiple accounts across members will better realise the benefits of scale. Focusing on the default fund market Successful funds would be required to offer the same fees and MySuper products and only targeting new entrants to to all members (both new and existing). They could not price discriminate the workforce is too narrow-focused. across the market. Outcomes in the default market represent a baseline against which choice products could be compared and could be expected to It will not address competition and drive greater competition. Transfers to these funds would be facilitated by efficiency issues in the broader the recommendations to allow all employees choice of fund (discussed in this superannuation system. chapter) and increase member engagement (see Appendix 1: Significant matters for further detail). A competitive process would lead to Existing corporate funds could be allowed to continue to receive new default fund the loss of existing high-performing members from new entrants to the workforce provided the fund gives members corporate funds. comparable benefits to funds successful in the formal competitive process. Any competitive process can be Careful design, rigorous execution and the highest standards of probity gamed. and expertise will be required. As mentioned above, other jurisdictions and corporations already run tenders successfully. Past performance is not an accurate Past performance would be only one element of the selection process when predictor of future performance. assessing expected ability to generate high after-fee returns to members. What would stop unsuccessful funds Funds that do this could be disqualified from future competitive processes. significantly increasing their fees for Prompts on myGov for individuals to look at a central repository of MySuper existing default fund members? dashboards would also help encourage members to engage with superannuation and transfer to the fund that best meets their needs (see Appendix 1: Significant matters for further details). What if a successful high-performing Funds could lose the right to receive new members. Members would be advised fund underperforms? if their fund was no longer deemed a successful fund. A competitive process would impose While SuperStream will simplify how contributions are made, Government costs on employers, who would have to should consider implementing a national ‘payment hub’ or ‘clearing house’ by make contributions to multiple funds. which employers make superannuation contributions to multiple funds. This concept has been implemented in other countries, including New Zealand and Sweden. The core payout product suggestion is to combine some provide a bridge for countries where there is no effective use of drawdown and some longevity protection from annuity market – where an initial drawdown approach can a group-annuity product (GSA) or a deferred annuity be taken that can allow more time for a well-regulated (DLA). This mirrors the approach suggested in new insurance market to deliver the final part of the retirement proposals by the UK’s NEST provider on how to deal with income puzzle. the UK’s recent switch from an annuity-based system to one with complete freedom of choice. The approach could Mobilization of Institutional Investors to SME Financing in Emerging Markets 7 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES Table 2: Options for Retirement products with drawdown plus longevity protection Longevity product Allocation to Draw-down of account- Allocation to account- (a) longevity product based pension based pension CIPR 1 DLA 23% Exhaust balance at age 85 77% CIPR 2 Deferred GSA 17% Exhaust balance at age 85 83% CIPR 3 GSA 75% Minimum rates 25% (a) Deferred products commerce payments at age 35.. without dealing with the underlying cost drivers can have CONCLUSIONS AND COMMENTARY unintended negative consequences. The competitive tendering or auction approach can be effective in reducing The Murray Review continues Australia’s proactive costs and fees in a mature system – particularly where there approach of regularly reviewing how to improve a system is little appetite to re-draw the entire market structure of that already has many strong features. As seen in a range existing providers. This is not to say that there should always of countries globally with well-respected systems such as the be a not-for-profit or public sector provision model. Rather Netherlands or Chile, there is a need to ensure both solid the key point is that there has to be close attention to what implementation of changes but also a process of continual provides the best long-run outcomes – and to ensure that both renewal every 5 to 10 years to ensure gaps in the system are the demand and supply side of the question is scrutinized tackled and the system continues to evolve. closely. The first recommendation of the Murray Review is The Australian experience shows the necessity for good for a clear (and legally binding) statement of what the data on costs and returns so that clear conclusions can retirement system is trying to achieve – or in other be drawn about what is working5. In too many countries words greater clarity on the desired retirement income the basic data does not exist to allow such evidence-based outcomes. This is a sensible move and mirrors what is policy. It should be a core feature of any regulatory and happening in a range of World Bank projects - from Turkey supervisory system to insist on the production of accurate to India to Costa Rica - to start with the long-run outcomes cost and returns information, to publish it for transparency and then work backwards to find the best ways to achieve and to use it proactively to understand what is working and them – and then to tackle systematically the biggest risks what can be improved. to the outcomes. It also mirrors some of the Bank’s recent knowledge management work3. The Murray Report highlights the central importance of scale and governance in driving good outcomes – along The Murray Report recommendation to introduce bulk- with a well-designed ‘market structure’ – the way in which purchase competitive tendering to drive cost reductions demand and supply come together in the pension market. into fee reductions is a sound way to raise returns net of These themes will be developed in future Knowledge Notes, fees. It mirrors a trend globally where growing scale but for example highlighting the importance of developing within multiple vertically integrated providers has failed efficient collection, record keeping and account management to improve member outcomes sufficiently. There are a systems as in pension systems as diverse as India’s NPS or range of solutions across countries that can have benefits - in Sweden. The benefits of scale provide a strong argument from the use of sensible price caps to establishing centralized for building it into the initial design of a pension system – or administration – if well designed4. Simply capping prices 3 See for example Stewart (2014) ‘Proving incentives for long-term investment by pension funds: the use of outcome-based benchmarks’, World Bank Policy Research Working Paper No. 6885 and work by John Ashcroft, William Price and Michael Hafeman ‘Strategy, Risk Based Supervision and Outcomes’, presentation by Michael Hafeman at the 6th Global Pension and Saving Conference. 4 Future notes will highlight the experience in a range of developed and developing countries that have developed very efficient collection, record keeping and account management systems. These are delivered in different ways – sometime leveraging tax collection as in Sweden, or developing a central record keeping and account management function that can be used by a wide range of providers, as in the NPS in India. Combined with effective Identification these developments offer a unique opportunity to expand pension and saving coverage and to link with modern payment systems to channel small payments across often turbulent work histories in the formal and informal sector. 5 See the APRA Superannuation Reporting Framework for all reporting requirements including the associated forms, including those on fees at http://www.apra.gov.au/Super/Pages/Superannuation-reporting-framework.aspx 8 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES improving the operation of existing system, for example as same way in the decumulation phase. Scale and governance seen in the recent mergers of providers in the Netherlands. are critical to improve outcomes for members – along The Governance benefits of having not-for-profit trustees with ensuring that there is an option to translate the assets including independent directors to focus on the long-run into a stream of income for retirement. Likewise, the right best interests of members will also be examined – in order to investment strategy needs to explicitly match the nature of highlight the range of options that can then be tailored to a the draw-down phase. Without these features, much of the specific country context. good developments in improving asset accumulation can be dissipated through high charges, inappropriate asset Finally, the Murray Review stresses once again the allocations and poorly designed products. These issues importance of the payout phase – and integrating too will feature in future knowledge notes – in particular thinking about it with the accumulation phase. The how to deliver retirement income flows at low cost and in same issues of demand and supply, of securing best value environments where annuities are not possible for capital for members in the context of complex financial issues, market or policy reasons. that exist in the accumulation phase are present in just the 9 NEW LESSONS FROM AUSTRALIA TO IMPROVE PENSION OUTCOMES 10