The Australian Pension System - Case Study Example

The pension or superannuation system refers to agreements made by people in order to have some funds available to them in their retirement age. The Australian government support and encourage pension and superannuation arrangements where there are minimum compulsory provisions for employees. With an increasing ageing population, the main aim of every government is to overcome the untenable burden of funding without raising taxes explicitly. This article involves an analysis of Australian pension system and the comparison of the Chinese impact system and its impacts on company practices. The Australian pension system as compared to other countries has relatively small public in regard to the Age Pension and large private component in defined contribution schemes. The design of this superannuation system is usually in consistent with economic rationalism which has been Australian public policy underlying assumption for the past few decades. It is worth noting that economic rationalism was the foundation for a numerous recommendations of the Wallis report in 1997 (Harper, 2008). The Wallis report (1997) led to shaping of the current Australian finance system with the superannuation system included. According to Greenspan (2007, p. 367), this system assumes that rational individuals will by making their own choices, optimize their own welfare. In turn, the self-interest invisible hand will guide the market economy towards a stable equilibrium of low unemployment as well as high growth. Economic rationalism logically results to efficient market theory where market discipline as a result of competition leads to cheaper pension products with better characteristics of risk-return where people can make a choice of what will suit their own circumstances. Where there are comparable products, it means that people will switch from high cost to low cost products. This in turn will exert a downward pressure on the overall cost of Australian pension system. Choice legislation was enacted by the government in 2005 in order to facilitate the choice of the investor and also to enhance market competition. After the enactment of the legislation on choice, the members of the pension fund seemed to be less active in regard to making of choices contrary to what was expected. The switching rates between funds began to decline from around 6% in 2005 to 2% by the end of 2009 (Morgan, 2010). According to Fear and Peace (2008), the members of super fund appeared to show inertia and apathy. For instance, multiple accounts continued to increase especially the lost accounts which show lack of interest in regard to super funds as the people move between jobs. For the superannuation system, the overall fees as the total assets percentage in 2002 averaged 1.37%, 1.3% in 2004, 1.26% in 2006, and in 2008, it was 1.21%. However, the fee increased for some retail master trusts from 1.67 in 2006 to 1.69 in 2008 (Warner, 2008). Sy (2009) found out that the financial services industry have been ignoring the fees for both academic and fractioned research. As a result Warner (2008) realised that over a 12-year period, about $105 billion was paid to the industry’s service providers. This means that due to the fees paid to this industry, the total investment earning after taxation reduced by 40%. In addition, the total fees paid increased (from $ 8.9 billion in 2005 to $ 13.4 billion in 2009) due to rapid increase in total assets as a result of large superannuation contributions, but the decline in expense ratios was slow. In regard to the system asset and fee growth, 12-years since the release of Wallis Report, the superannuation system’s total assets has been increasing at an average of 10.6% annually from A$ 321 in 1997 to A$ 1.1 in 2009 and A$ 1,26 in 2010 (APRA, 2010). According to Shorten (2010), this growth of assets in Australia has put the country among the top nations in regard to the managed investment savings per capita. Shorten add that this is the main reason for the claim that “Australian pension system is the best in the world”. However, this growth of asset over this period was as a result of A$591 billion in net contribution flow and it was only A$161 billion due to net investment earnings (APRA 2010). According to Squam Lake (2009) which is a group on regulation of finance, there is no connection between increase in fees and higher returns, but the group says that higher fees lead to low returns. The group is also not in agreement with the reports showing better performance results of this system because the calculations on such reports included only selected samples, for instance large funds or calculations over shorter periods by use of simple arithmetic averages. Based on the three historical sequences in regard to annual returns, the results show that since 1997, the dollar would have increased when it was invested in cash deposits, superannuation system or the stock market of Australia as shown in figure 1 (Sy, 2011). From figure 1, in regard to the accumulated wealth, the superannuation in 6 out of 12 years under-performed cash deposits. The system’s accumulated wealth rose above cash deposits in 2000 and 2007 at stock market peaks. However, in 2003 and 2007 stock market troughs, it fell below cash deposit. Even if there the net returns were estimated at 10% in June 2010, the system still trailed the cash deposit’s investment performance in accumulation of wealth to June 2010 (Sy, 2011). Sy add that the under-performance of the system relative to cash is not in itself significant given that there will be times when the return in stock market (thus super funds) is lower that cash. What is most significant is that during the studied period, the superannuation system showed lower return as than either cash or shares. Figure 1: Growth of one dollar invested (Sy, 2011, p. 54). Such comparisons provide the measure of Australian pension system’s cost efficiency. During the 12-year period, there are some funds in the system that gave better performance than the entire system, but it also means that there are some funds that performed much worse (Squam Lake, 2009). From the study of Australian superannuation system, it can be seen that higher fees has impacted investment performance negatively. Given that the 2005 legislation on choice that expected lowering of fees did not apply, there is less market competition especially at consumer level. Chinese pension system is has undergone various reforms but when compared to Australia, Chinese pension system is facing significant challenges. First, the system population covered by this system is very small and the functioning of the system is not as planned. Second, the rate at which Chinese population is ageing is very fast (Barr, & Diamond, 2010). The system expenditure for urban employees was around 2.5 % of GDP while the revenue from the expenditure was 2.7% in 2008. From this time, the revenue exceeded the expenditure and accumulated to around 3.3% of GDP. Such figures are relatively small while the population from rural areas hardly added anything to the figures. The main reason is because the system 30% employees only were covered while the elderly in rural areas received no pension (Barr, & Diamond, 2008). The current pension system in China was designed to cover all urban employees adding up to 302 million people. However, the contributions are made on behalf of 55% of these employees. The compliance is low due to relatively high rate of contribution where the total employee and employer contribution amount to 28% of the wage. Other reasons may be due to lack of trust of the system as a result of suspicion that such contributions may be diverted to other expenditures rather that the declared purpose. For around 473 million employees in rural areas, only 12% were covered by the pension scheme. With a large number of retires, the ones who received pension got over low amounts which can be as low as $8.8 per month. The system is experiencing a great challenge on coverage especially in rural areas. In addition, Chinese population is fast where over 111 million people are over the age of 65 and by 2050; this population is expected to grow to 331 million. In addition, life expectancy is expected to increase from the current 73 year to 80 by 2050 (Grayson, 2009). The government has steeped its efforts for the past few years with an aim of building an adequate as well as a sustainable system of retirement. It has enacted various reforms in order to address the basic pension system shortcomings. Some of the reforms include a national pension reserve fund as well as a system of supplementary private pensions. Although such initiatives are pushing the pension system in China in the right direction, it still requires more fundamental reform (Barr, & Diamond, 2010). However, the best word to describe the pension system in China is “basic”. Compared to Australia, the Chinese pension system will require more reforms to be at the same level with Australian superannuation system. Conclusion Due to the immediate impact of investment performance in regard to pension benefits of the retirees, many nations are now paying a very close attention in terms of diversification of pension investments. This has led to development of domestic capital markets. Although the reforms in Australian superannuation system have been successful, the system has not yet delivered the anticipated economic efficiency to be ‘the best superannuation system in the world’. This is due to inefficiency in market competition in regard to bounded individual’s rationality and complexity of the products. Improvement of market competition can be achieved by making simpler choices and as result, there will be potentially lower costs as well as better investment returns. However, as compared to Australian system, the Chinese pension system is facing more challenges in population coverage and rapid increase in ageing population. This means that more reforms are required to improve their ‘basic’ pension system and to increase development of capital markets. References APRA (2010). Quarterly Superannuation Performance: March 2010, APRA Statistics. Barr, N., & Diamond, P. (2008). Reforming pensions: principles and policy choices, Oxford University Press: Oxford. Barr, N., & Diamond, P. (2010). Pension reform in China: Issues, options and recommendations, manuscript. Fear, J., & Pace, G. (2008). Choosing Not to Choose: Making superannuation work by default, The Australian Institute, Discussion paper, no. 103 Grayson, C. (2009). The financial control of social insurance in China, EU-China Social Security Reform Co-operation Project, Manuscript Greenspan, A. (2007). The age of turbulence, Penguin, New York, p. 367-368 Harper, I. (2008). PM-Call for a new Australian financial system inquiry, Interview with Stephen Long, Radio National Morgan, R. (2010). Superannuation and wealth management in Australia, Roy Morgan research report, 30-31 Squam Lake Working Group on Financial regulation (2009). Regulation of retirement saving, Centre for Geo-economics Studies Working Paper, Council of foreign relations. Sy W. (2009). Towards a National Default Option for Low-Cost Superannuation, Accounting Research Journal, 22(1), 46-67 Sy, W. (2011). Redesigning choice and competition in Australian superannuation, Rotman International Journal of Pension Management, 4(1), 52-60 Wallis Report (1997). Financial system inquiry final report, Publications of Commonwealth of Australia Warner, R. (2008). Superannuation Fee report: Market segment analysis, IFSA Report Read More