Superannuation contributions are regarded as a river of gold into Australia’s finance industry, but is that about to change as fund members retire and draw pensions from their fund?
By James Dunn
One of the features of the Australian superannuation system that most impresses foreign watchers – certainly during the global financial crisis (GFC), when virtually no-one else could raise capital – is the streams of cash that flow into it, mostly from the Superannuation Guarantee (SG), but also from voluntary contributions.
Over the past decade, Australians have contributed A$1.2 trillion into superannuation, of which 52 per cent has been due to the SG, says research firm Rainmaker Group.
In 2015-16 total contributions were A$137 billion – or A$375 million a day. SG contributions were A$77 billion, representing 57 per cent of the total.
That implies that voluntary contributions are also a major growth driver of the system. Rainmaker executive director of research and compliance Alex Dunnin says that while SG contributions are “rock-solid predictable”, voluntary contributions are also remarkably so, albeit slightly more volatile in the long-run trend.
“The two are growing at the same rate,” says Dunnin. “Over the past 20 years, while SG contributions have grown by 4.5 times, non-SG contributions have also grown by 4.5 times.”
It’s been a golden age of endless money for super funds which, along with their investment returns, has doubled the size of the nation’s superannuation kitty since 2008, to A$2.2 trillion.
When do superannuation’s rivers of gold start to dry up?
Shifting demographics will eventually start to threaten these rivers of gold. Sometime in the 2030s, an ageing population is expected to drive the super industry into the net drawdown phase – when more is taken out than goes in.
The system is still growing. Dunnin says Australian super funds paid out A$101 billion in benefits in 2015-16 compared with A$137 billion paid in, so they still had a net inflow of A$36 billion annually, or about A$100 million a day. He says that population factors indicate no projection of super contributions peaking for at least 20 years.
“The long-term projection over the next 20 years is for continued growth,” he says. “That is, the population is growing and the number of working-age Australians is going up too. Yes, the number of retirees is growing, but while they are expected to increase by 2.6 million between 2016 and 2036, the number of working-age Australians is expected to increase by 4.1 million.”
Fewer retirees are taking super lump sums
Besides population, the other major factor Dunnin sees is behavioural: the fact that the proportion of benefits being paid each year as income streams (pensions) rather than lump sums is rising fast, meaning more retirees are keeping more of their money in the system for longer.
“Ten years ago, 59 per cent of benefit payments were paid as lump sums. By 2016 this had plummeted to 36 per cent and by the end of the next decade, our modelling projects it will crash down to 22 per cent,” he says.
“By the end of the following decade it will be just 12 per cent. Interestingly enough, this shift is happening without any compulsory requirements regarding income streams.”
CPA Q&A. Access a handpicked selection of resources each month and complete a short monthly assessment to earn CPD hours. Exclusively available to CPA Australia members.
Challenges for super funds in drawdown
Some super funds are already well and truly into net drawdown, because of their structure. This experience holds many lessons for the chief executives and investment heads at other funds, who will face the same circumstances eventually.
“The overriding consideration is that it is difficult to regain any money that we lose,” says John Livanas, chief executive officer at State Super NSW, whose four defined-benefit plans have been cash flow negative since 2004.
“If a positive cash flow fund makes a mistake, a pile of new contributions is coming in tomorrow, but if we make a mistake, the money is gone. It’s the opposite of compounding, it works against you.”
The level of investment skill required in the negative cash flow phase “goes up exponentially,” says Livanas. “Over the years, with positive cash flows, you’ve had a situation where all that a fund has to do is ‘put some growth assets in there and watch them grow’. You can’t do that in a negative cash flow environment.”
Instead, Livanas says State Super has modelled what it thinks the drawdowns are going to be, until the last member is left – which is 2085.
“We create assumptions around what the drawdown is likely to be, which reflects our view around longevity, inflation and drawdown requirements. On that, we overlay what is the type of investment return we’re probably going to need in order to achieve that. We then take that investment return and look to start getting it in particular ways – if volatility takes place in a certain way, even if you get that return, you won’t get the dollars,” he says.
The importance of asset allocation for super funds
Asset allocation becomes the most critical aspect of the investment process, he says. “That’s how you take the risks.”
State Super “actually has to think about running the portfolio like a hedge fund,” says Livanas, focusing on making money when it can, but not losing it when the market goes down.
“The key takeaway is that one can no longer depend on ‘time in the market’. You have to take money out of the market, you have to put in measures to protect the downside, and you have to tilt into the market if you think it’s rising,” he says.
Countdown to July 1 super changes