The missing link in Intergenerational forecasting

Superannuation funds need to find ways that better engage fund members in order to improve their retirement outcomes. In particular, this relates to the information, education and advice prescribed to members as they prepare for retirement – including identifying the implications of an inadequate retirement savings plan. Left alone, most members will lead a retirement lifestyle somewhere between modest and comfortable. With proper planning and support, most members can do much better than this.

Improving longevity and likely cutbacks in future Age Pension benefits together mean current superannuation fund members will need higher savings. It is also possible that tax concessions will be reduced following the Government’s White Paper on taxation due to be released later this year. Members are largely ignorant of the impact of these changes, so funds need to spell out the implications and help members act early.

The Intergenerational legacy

The first intergenerational report was issued in May 2002 by then Treasurer Peter Costello as part of the Budget Papers. It showed that Australia would encounter future fiscal deficits due to increased spending, particularly on health and aged care. Over the 40 year projections, health costs were expected to double to 8.1% of GDP while pension costs would grow from 2.9% to 4.6% of GDP.

As these costs are paid out of consolidated revenue, they are borne by the taxpayer of the time. Effectively, the children of the Baby Boomers pay for their parents’ retirement. The fifth report “Australia in 2055” released on March 5, 2015 is more optimistic about future health and pension costs. In 2055 (53 years after the first report), annual health costs are expected to be about 5.7% of GDP and Age Pension costs about 3.6% of GDP.

Despite the improvement since the first report, the government is still trying to introduce policies to reduce these costs further. It does not believe current policies are affordable and it needs to ensure there is intergenerational equity by holding these costs to reasonable levels.
Cause of cost escalation

The cause of the increase in health and Age Pension costs is twofold. First, there is a population bulge from the large cohort of Baby Boomers, meaning many more people will receive benefits. Secondly, Australians are living longer and spend more time in retirement, so the benefits are paid for longer. In fact, life expectancy at age 65 has increased by 18 months for males and 11 months for females over the last decade; more than half of Australians aged 65 today will live for at least another 20 years.

Given the demographics, the cost escalation is reasonably modest. We have achieved some savings from the future increase in the employer superannuation contribution (SG) rate to 12% (although this has been deferred and will not reach 12% until 2025) and more from increasing the eligibility age for the Age Pension to 70 (by 2035).
Pension Indexation

The government is also trying to modify the future indexation of the Age Pension. It wants to change the half-yearly indexation from wage growth to CPI growth. If this were to take place, the cost of Age Pensions in 2055 would actually be a lower percentage of GDP than it was in 2002!

Rice Warner, in its submission to the Financial System Inquiry, set out its concerns with the Government’s proposed change to indexation of the Age Pension. We concede that these Pension costs have blown out and accept that the government wants the level of the single pension to fall from its current historically high level (about 28.7% of male average wages).

We believe it would be better to tighten the means test rather than alter indexation. This would reduce benefits for better off pensioners whereas changes to indexation would hurt the poorer retirees the most. Indexation to CPI will preserve the purchasing value of current pensioners, but new pensioners in future years will receive benefits that are progressively lower than their income and expenditure requirements immediately prior to retirement.

If indexation were to be changed, we would, at a minimum, maintain the floor of 25% of MTAWE (Male Total Average Weekly Earnings) which was legislated by the Howard government. After the initial 13% reduction in pensions (from 28.7% to 25% of MTAWE), future pensioners would still enjoy some benefit from the future growth in the economy.

Michael Rice, CEO