Superannuation: Are you feeling lucky?

In October 1987 my father’s retirement superannuation pay-out was sitting in the trustee’s bank account pending payment to him. He wanted to invest it in the stock market. Those with a keen eye for dates might already have guessed that while he waited to extract his money - like teeth - from the red tape encrusted super system, global share prices fell by almost a quarter!

This final stroke of luck was symbolic of how financially lucky his generation was to enjoy the long boom of the 50s and 60s. Dad’s own father’s generation cobbled together their retirement savings between two world wars and the great depression!

Will your generation be lucky or unlucky? Who knows? Shouldn't we be thinking about that as we move further towards the goal of putting you in charge of your superannuation with “super choice”?

Super schemes have typically operated to guarantee contributors a “defined benefit” (in the way that the old age pension is a “defined benefit” and independent of the tax you’ve paid when younger). We’ve been unpicking this system - in a way deregulating it - and instead moving towards “accumulation” funding of superannuation (where your ultimate benefits are a simple function of how much you’ve accumulated).

This produces some of the classic benefits of deregulation. Defined benefit schemes create arbitrary unfairness like unexpected benefit changes and or unexpected increases or reductions in contributions. Accumulation funding is transparent, and “choice of fund” puts you in control.

But there are two problems - big problems. Both arise from applying a deregulatory formula rather than optimising the complementary roles of government and markets in a mixed economy.

First, as I argued in my last article (On Line Opinion), “investment advice” is riddled with poor skills, poor information about investment performance, and conflicts of interest. We should regulate to improve performance rather than just encrust it in yet more red tape.

Second, full funding exacerbates intergenerational risk. Someone in a “lucky” generation earning a 6 per cent real rate of return on super would retire with nearly twice as much as someone in an “unlucky generation” earning a 3 per cent return.

Many people would buy insurance against that kind of bad luck - like they do against having their house damaged. But no-one’s selling it. Even with burgeoning derivatives markets assisting firms manage risk, markets won’t ever do much more than scratch the surface of insuring against “intergenerational risk”.

Now pooling risks that markets can’t pool is one of the core functions of government. Could governments help us manage intergenerational risk?

One possibility among several would be to create what I’ll call “retirement bonds” and offer them to superannuation funds. The bonds would pay a yield that was higher than the yield from a diversified share portfolio for an unlucky generation, but lower than the yield for the same portfolio for a normally lucky generation.

A variation on this would be for these bonds to “smooth” returns over long periods of time with excess returns being “banked” and returned to people in poorer years - as occurs within the Commonwealth super scheme, and in a way that is loosely analogous with some of the instruments the government has made available to farmers to average and otherwise smooth their after tax incomes.