To understand more about possible pension changes in the UK, we spoke to a world expert on pension reform, The Hon. Nick Sherry, the former Australian Minister for Superannuation and Senator for Tasmania. This formed the latest phase of our thought leadership programme, Thinking Forward.
Australia’s superannuation sector is the fifth-largest pension system in the world, with assets under management of A$3.5 trillion at the end of 2021, according to Moody’s.
Compulsory employer contributions are the key part of this system. This compulsory contribution is set at 10.5%, as of 1 July 2022, and due to rise to 12% in 2025. There’s an additional 4% voluntary employee contribution.
Below is a summary of Nick Sherry’s thoughts on the range of topics discussed.
Australia’s pension industry has seen a lot of fund consolidation in recent years. In 2002 it had 2,484 corporate funds – it now has just 13.
The shift has been underpinned by the sector’s vast pools of assets, along with pressure from the Australian Prudential Regulation Authority (APRA) for non-performing funds to merge or exit the sector.
APRA has argued that the number of funds and investment options within the superannuation sector was too large and therefore detrimental to members.
The government’s “Your Future, Your Super ” (YFYS) reforms came into effect on 1 July 2021. These reforms included an annual performance test for funds, which seeks to hold funds to account for underperformance by increasing transparency and penalties.
The performance test is only its first year, but has already led to a razor-sharp focus on member outcomes and benefits – resulting in every type of expenditure being questioned, says Sherry.
“The test fundamentally examines return after administrative fees and charges, and investment fees and charges. It aims to reduce fees through this mechanism.
“In Australia the default option is broadly similar across all entities. This enables default funds to be compared across seven years. It is clear that four-to-five funds deliver 1%–1.5% better return after fees, per year,” says Sherry.
“It has been found that funds of around A$20 billion in size, or more, generally have the lowest fees. Some funds are now in merger discussions to get to, $20 billion, in order to reduce administrative fees and hopefully increase investment returns.”
Following the performance test, the regulator has demanded that some funds merge. However, Sherry says there is a risk that mega-funds may grow too big. “Greater complexity, doing too much and losing focus on the base, and executive domination can be adverse outcomes. The logic is that funds have to keep folding into the better performer, which eventually leads to one fund – presumably operated by the government, as some are now advocating.
“I have always been a strong advocate of independent, trustee, arms-length governance and diversified investment decision-making by funds with a member focus.”
(In July 2022, the minister for financial services announced a review of the operation of the YFYS reforms after the second round of performance tests have taken place by August 2022. The review will consider whether the performance test has had any significant unintended consequences for MySuper products, and assess how the test should be applied to other superannuation products.)
In the UK there has been much discussion of illiquid/infrastructure investment – an area where Australia has a lot of experience.
Around 14% of Australia’s pension funds are now invested in property/infrastructure – up from practically nothing a few years ago. This investment includes major UK assets, such as Heathrow airport and London’s King’s Cross redevelopment project .
Australian superannuation funds are likely to expand in the UK, given the UK government’s efforts to attract more foreign capital with its “investment big bang ” initiative. Social infrastructure and affordable housing, for example, may offer diversification benefits in a global portfolio.
“This is a more complex investment, so you need a lot of good data,” says Sherry. “Potentially it provides equity-like returns without the volatility. I think the UK could have done more to partner with funds and invest in infrastructure. So far not much has been done.”
A big concern for the UK pension industry is the proliferation of pension pots – particularly since the introduction of auto-enrolment in 2012 . If the issue of multiple accounts isn’t addressed, it will eventually lead to bigger problems, believes Sherry.
“In Australia, there’s been auto-consolidation, which has been a great success. This has been replaced by ‘stapling ’, whereby a person’s new employer must ask them if they have an existing fund, and then contribute into that fund. This approach arguably has some downsides, such as favouring funds – particularly funds with employees at the start of their career.”
In the run-up to the May 2022 Australia election, the Liberal-National coalition government announced that if it won another term it would allow first-time home buyers to access up to A$50,000 (£28,200) of their retirement savings to buy a home.
The government was defeated by the opposition, the Labor Party, and the policy has been parked. However, Sherry believes this approach will ultimately be adopted, though he does not agree with it. “Around 80% of people aged under-35 agree with the idea of accessing long-term savings for home ownership.”
Funds should pay more attention to social housing, says Sherry. “There’s been massive neglect of social housing in both Australia and the UK. But there is now a political attractiveness to doing more in this space, so I think pension funds can play a bigger role here.”
Gender pension gap
In Australia there is no earnings threshold for employer pension contributions, unlike the UK’s auto-enrolment £10,000 threshold , which disproportionately affects some groups of workers, including women. Similarly, the age of pension participation in Australia is 18, compared to 22 in the UK.
In Australia someone can split their pension with their partner, a measure aimed at helping to solve the gender pension gap. However, Sherry notes that this doesn’t solve the fundamental problem of women being paid less on average. Instead, to tackle the gender pension gap, Sherry believes there should be a government-paid pension contribution for parental leave – an idea subject to significant debate in Australia. “No system based on income will be perfect, but this would make a difference.”
With many more baby boomers – those born between 1946 and 1964 – about to retire in Australia, the decade ahead will be significant for superannuation.
Increased longevity will add to the challenge: in Australian the average life expectancy at birth was 81.2 years for males and 85.3 years for females in 2018–20, according to the Australian Bureau of Statistics.
Equity drawdown is likely to play a bigger role in helping to cover care costs, believes Sherry. “In Australia, the average baby boomer’s pension is worth A$200,000, but the average value of their property is A$800,000, so tapping into some of their property equity for later living care makes sense.”
At the point of people retiring, advisers are very important because people need information on their means-tested pension. This is also when most people move out of the default fund. The Retirement Income Covenant (RIC) – which began on 1 July 2022 – is set to bring much-needed focus to how superannuation funds can support Australians to manage their income in retirement.
“A lot of funds are looking at ways to simplify advice,” says Sherry. “Cognitive decision-making typically starts to decline once an individual reaches the ages of 50–55. Yet we expect individuals to make decisions due to the defined contribution system, together with other complex issues, such as in-home care and age care. Although family may sometimes provide important support, pension funds can also play a useful advisory role.”
The opinions expressed in this document do not necessarily reflect the views of Standard Life.