Harnessing the Australian Model: Assessing the Potential Benefits and Challenges for UK Pensions

Private pension investment. I would guess few areas of public policy are more dull and more tedious sounding. Defence has its expensive toys, albeit years late and billions over budget; climate change has its apocalyptic consequences; even labour market policies, another dry subject, cover the employment rights and protections we can enjoy in work. It may be only somewhat hyperbolic to suggest that discussions on defined contribution vs benefit schemes and investable start-up assets could lull a baby into a deep, relaxing sleep. Nonetheless, the issue has risen up the political agenda in recent months, with both the Chancellor and Shadow Chancellor stressing the importance of getting British pension funds to invest more in UK assets, particularly riskier, small companies. In fact, the former of the two, Jeremy Hunt, has been holding talks with various industry titans to help draw up a series of reforms to be presented at tomorrow’s Mansion House dinner.

Nonetheless, there is more to this discussion than merely how to better utilise private pension capital. The topic of private pensions covers the essential issues of delivering greater security in retirement and to what extent the state should involve itself in achieving this. The latter point, particularly regarding the financial impact of the state pension, is a particularly thorny subject looking forward to the decades ahead, even if it may not be at the centre of political discussion today.

Sustainability of the State Pension

The fiscal penalty to the Exchequer for Britain’s demographic changes should not be overlooked nor neglected. Whilst the financial stability of the state pension was once under control, the shift in welfare provision towards the elderly, particularly with the introduction in 2010 of the triple lock to state pension increases, has blown the future fiscal cost into the stratosphere. Between now and 2072 (perhaps the stratosphere was a modest exaggeration), the increase in the number of retirees and the growing real-term value of the public pension will add 3.3% of GDP to the already nearly 5% of GDP cost of social security. This would represent an annual expenditure 62% higher than the price tag associated with the government’s furlough scheme, which had paid 11.7 million workers, well over one-in-four employees, their wages during the pandemic.

However, it’s not a surprise why. As said, not only is the UK suffering from demographic changes, but its pensions policy adds immeasurable additional pressure to the public finances. This April alone, the state pension rose by 10.1% at the cost of £1,000 to taxpayers over the next four years. In fact, even if pensions had risen by ‘just’ 5.5%, roughly the rate of earnings growth, it would have cost the Exchequer, and thereby taxpayers, almost £5 billion a year less. Not only is it stretching the budget, but was contributing to widening generational inequality. Today, the proportion of families in poverty is around 72% greater than that of pensioners, largely due to the continued increases in the generosity of the state pension. Furthermore, the Institute for Fiscal Studies notes that the degree of state support for pensioners over those of working age was not just higher, which is fair and to be expected but has grown in recent years from 32% in 1990 to a staggering 137% today.

To some, the claims that this is intergenerationally unfair are branded as “nonsense” given that today’s young people will benefit from considerable increases in the generosity of pensions. However, given the mounting cost, today’s young people will likely face the reality of a much later retirement from which one is entitled to state pension payments. The government’s own review, led by Baroness Neville-Rolfe, suggests that for millennials and those younger, working well into their 70s is likely as a means of cost control. When life expectancy was increasing by nearly 3 years every decade, raising the retirement age made sense but having, in fact, fallen between 2011 and 2021, this risks putting retirement more and more out of reach for many. Meanwhile, without further increases in the retirement age, the cost to the Treasury would be as much as £9 billion a year for every year delayed.

Such prospects for the future of the state pension are why both Conservative and Labour grandees, such as Lord Hague of Richmond and Baron Blunkett, have called for the triple lock to be axed. It seems impossible to reject such a conclusion. This doesn’t imply that pensions should be cut or even frozen in real terms. However, strapping the public finances into a straitjacket cannot continue. Nor need this imply that pensioners should live in poverty and fall behind the rising cost of living. Poorer pensioners can already claim additional support from the government, particularly Pension Credit, but also relief on council tax, public transport, TV licenses, heating and housing costs through the local and national government schemes. In future, it would make more sense to increase the resources available to those in need rather than to every pensioner regardless of income, wealth and other means. In fact, even with the triple lock in place, the state pension is barely keeping up with the rising cost of living as it is. The enormous rise in food and energy costs meant that the income needed for a pensioner to retire with a minimal standard of living rose by nearly £2,000 in 2022, with a reasonable living standard requiring £23,300 a year for a single pensioner and as much as £41,400 for a couple in London.

Consequently, it’s become clear that the public finances cannot face the strain of an ageing and retiring population into the medium term, and more must be done to rein in the projected cost of state support to pensioners. Again, this doesn’t mean spending won’t or shouldn’t rise but spending 1.6 times the amount that furloughing a quarter of all employees costs every single year is a nigh-impossible task for future governments to do sustainably, particularly as an older population will result in fewer people in work and paying the bulk of taxation needed to finance pensions and the rest of government. Scrapping the triple lock is a common-sense point at which to start. However, by not increasing the state pension at this rate, a system will need to be put in place to seriously and substantially expand pensioner incomes through other means to meet rising living costs. Enter the Australian model.

Superannuation and the Australian Experience

The Land Down Under. It may be close to 10,000 miles away, but its pension industry is an example that the UK can learn from being among the largest in the world. By the end of 2021, it managed assets worth A$3.5 trillion, largely supported by its compulsory superannuation guarantee through which employers contribute 11% into a super fund every year. Employees can also contribute 4% of their own salary into their pension pot. The superannuation rate has risen from its inception to its current rate. It is expected to increase further towards the end of this decade as it accommodates greater savings needed to safeguard retirees as life expectancy rises. Since the introduction of the superannuation guarantee, around 90% of all employees are now covered by it, building up their savings for retirement in massive pension funds. This is an exceptionally vast savings pool worth some 160% of GDP and thus enormously significant in capital provision for business investment. In fact, the enormous reserve of savings is credited with helping Australia avoid recession during the Global Financial Crisis, one of the only developed economies to do so, by financing significant capital expenses pursued by private industry at the time.

It also provides enormous choice and control to those involved. With a number of significant super funds, employees can choose what sort of investment they want to pursue. Those younger may choose a riskier, higher-return allocation, whilst those close to retirement may opt for a balanced, if not cautious, investment portfolio. This choice and freedom come from the fact that the Australian system is substantially different from the British one. The superfunds that provide pensioners with so much of their income through retirement are based on a defined contribution rather than a defined benefit model. Naturally, defined contribution means that the actual returns from your savings are not guaranteed. In 2022 the average superannuation fund reported a decline of nearly 5% in their investments due primarily to global economic instability and the weak performance of global stocks. However, that is a rare outcome for such large funds and, over the medium to long term, perform very well, having earned an average of more than 6% per annum returns since the new millennium. In fact, Australian funds have had the fifth-highest average returns over the last five years in the world.

This success is primarily credited with focusing nationally on these defined contribution schemes where riskier but potentially more lucrative investment opportunities are incentivised rather than relatively penalised as defined benefit pensions. However, it’s also attributed to the enormous consolidation and concentration of the pensions industry. Unlike a typical market where small businesses providing extensive competition are seen as the bedrock for an optimal outcome, the rise of large, dominant superfunds in Australia has given these companies tremendous capital to invest. This allows superfunds to better invest in those riskier typically start-up opportunities as, with the size of its portfolio, it can better spread its investments across bonds, equities and other return-providing openings. With this incentive for funds to merge, it’s not surprising the market has concentrated over the years of superannuation. Yet, the sheer scale certainly is. The number of corporate funds has fallen some 99.5% since 2002 (and no, that’s not a typo), while industry funds have declined in quantity by a less staggering but still impressive 47% between 2004 and 2011 alone.

What’s more, superannuation is designed to lift the vast majority of working-age people’s retirement income and alleviate the pressure on the state system. The UK’s state pension problems discussed are not a unique phenomenon. Most developed countries have rapidly ageing populations which draw increasingly on help from the state, whether it be in healthcare, income support and much else. The compulsion of private saving was designed to reduce the enormous increase in future pension provision from the state as, with a high rate of saving from 18, workers can build up pension pots that can support them in retirement. Not only have Australian governments scheduled much more aggressive increases in the retirement age than British administrations, but it also, whilst universal in its basic provision, remains highly means-tested for those seeking more substantial pay-outs. Instead of the UK, which has some means-testing but has become much more generous universally, the Australian pension is tapered away at certain income and asset or wealth thresholds. The withdrawal rate, the point at which it’s tapered, and the maximum assistance have varied over the decades under different parties, but the principle has remained in place. It has made the state pension system far more sustainable than its peers.

At this point, however, it is essential to note that the savings system created by the superannuation guarantee is not just a state-mandated, penalising approach to retirement financing. Relative tax incentives and generous concessions are central to encouraging workers to save further into their superannuation beyond the employer contribution. With a tax rate of 15%, superannuation savings are preferentially treated by the state compared to wage income which incurs a marginal rate of between 19% and 45% depending on income. However, this is where some significant problems with the existing begin to build up. Clearly, at a fixed tax rate of 15%, workers taxed at 19% on their income will benefit from investing in their retirement rather than spending that money today. Someone on a high income, though, who would ordinarily attract a 45% tax rate on the highest portion of their earnings, could instead save into their superannuation at a tax rate of one-third of their income tax bill. The imposition of a flat tax rate for super savings means that naturally, the gains from preferential tax treatment flow towards the top earners in society, who may use it for avoiding higher rates of taxation rather than necessarily for giving them a good life in retirement. In fact, the wealthiest 20% of Australian society benefits from nearly 50% of all the concessions available for superannuation contributions. Now no one can blame a high-income earner for doing this. It’s not illegal or even immoral. It’s an apparent problem with the system itself, however, that it allows for such a regressive addition to an income tax which is, by design, meant to be the dominant progressive form of taxation available for narrowing society’s divides. Any lessons to be learned from Australia must learn from its shortcomings and flaws. Tax concessions and advantages for saving have their place, but the design will have to be made more progressive and restrictive to minimise tax avoidance. Incentivising regressive and unequal policy, especially at potentially significant cost to the Exchequer, shouldn’t be a priority for reform. Reform, however, is clearly needed, especially when considering the failure of pension funds to invest in Britain.

Pension Funds and UK Investment Record

The preceding section details a private retirement system which, by no means perfect as established, provides the nation with a savings pool that secures not only the immense investment that the UK’s policymakers are seeking to deliver from its own pensions industry but also the additional income retirees will need to live with dignity.

Concerning the former, it’s obvious why the Chancellor is placing so many eggs in the pensions basket: Britain’s investment record is shockingly abysmal. In 1989, business investment accounted for close to 15% of GDP. By the end of last year, this was down to 10%, and the CBI expects it to be 9% less than its pre-pandemic figure by the end of next year. Even then, business investment had flatlined since the 2016 referendum, with the UK incurring a 1.3% of GDP loss due to £29 billion in lower expected business investment. This is worth around £1,000 per household in the UK. In fact, since 2005, the UK has lost £354 billion in private sector investment compared to the growth in investment among our rival advanced economies. The spiralling cost of HS2? No problem. This missed out on investment could’ve paid for three of them with enough to spare for another two-and-a-half Elizabeth Lines.

It may seem trivial to add this, but that is a lot of money. With investment, rather the lack thereof, seen as a crucial reason for the UK’s equally tragic record on productivity growth since the Global Financial Crisis, it’s no surprise that Britain’s economic prospects for the years ahead are as weak as they are. With the lowest investment in the G7 between 2010 and 2018 and now ranking 27th out of 30 in the OECD for business investment, the UK needs to break out of the investment spiral that has led to much of its lag with comparative economies.

I would take this opportunity to rein in expectations. I’m not going to imply that encouraging pension funds to invest more in UK assets will or even could create a period of unprecedented prosperity and a booming Britain standing tall in the world. Naturally, the problems of stagnant business investment are deep-rooted, and the reasons are all primarily interconnected. Clearly, issues of taxation, from the business rates system to the inefficiencies of the VAT threshold, are a roadblock to business confidence in Britain. A tight labour market is leaving firms with uncertainty over capital purchases, and clearly, the state has a role to play as well, with government investment also ranking amongst the lowest in the OECD over the last decade and a half.

Nonetheless, there appears to be clear space for pension assets to be better targeted, invested and reformed to boost British business and retirement savings. For example, the UK’s national savings average is slightly over 13% of GDP, with the US rate 43% higher, France 70%, and Germany a staggering 112% at 28.2% of GDP. It would be hard to dispute that a higher savings rate would represent good things for retirement income and investment. Meanwhile, a lack of long-term capital for start-ups, with just £81 million raised in the first quarter of the year, one of the worst for IPOs since 1995, has meant that a growing number of British companies have delisted and opted for New York’s Nasdaq. This capital drought for small companies is explained somewhat by the divestment over decades of pension funds from UK equities towards overseas assets and, domestically, government bonds. Since 2000 the share of defined benefit pension scheme investments in UK equities has fallen from almost 50% to 29% in 2008 and just 2% today, whilst Australian pension schemes invest a proportion of 47%. As such, clear measures that can address these shortcomings and reverse the trends mentioned above should be sought by governments present and future.

Ahead of his Mansion House speech and the measures he’ll unveil, Chancellor Jeremy Hunt stressed that his goals would be achieved through “evolution, not revolution” and voluntary action rather than compulsion. However, the Australian experience of retirement and pensions is tied closely to the duality of state regulation and intervention with the return-seeking instincts of private enterprise. The options available to UK governments addressed below are just a narrow selection of the wide-ranging measures that may succeed in meeting the criteria of greater pensioner returns and start-up capital but also come with varying political risks, degrees of state interference and certainty of impact.

Routes to Greater Investment and Savings

The most obvious first target for the Chancellor, policymakers and those seeking reforms to the pensions industry is to tackle its existing fragmentation. There are something like 27,000 defined benefit pension schemes in the UK, both in the public and private sectors, in addition to the defined contribution schemes that exist as well. Compare this to Australia, where, with the sheer scale of consolidation discussed earlier, the number of funds registered with the nation’s financial regulator is down to just 186. This may seem trivial. So what if the UK has more than 145 times the number of pension schemes? A clear, immediate and practical benefit of consolidation is reducing the proliferation of fees, thereby keeping costs down for investors and, by extension, those saving for retirement. Fewer schemes would reduce these costs and enable greater risk-taking by fund managers, which in turn can secure the release of capital the way American, Canadian and, yes, Australian superfunds do.

Regarding this objective, a simple, pain-free and relatively uncontroversial measure would be to introduce auto-consolidation and ‘stapling’ as exists in Australia. These policies aim to reduce the number of pension pots employees accumulate through their employment, a common problem in the UK where more than £19.4 billion worth of savings have been lost due to people forgetting and losing track of them. Not only would this help to amalgamate smaller funds by pooling together pension pots, but it would also reduce the degree to which pension savings are lost in this country. These savings can deliver much-needed income in later life.

However, a more radical programme of merging smaller funds is also under consideration by some of the nation’s leading think tanks. The Resolution Foundation and Tony Blair Institute have backed a set of reforms that would create a number of superfunds in the UK, much in the style of Australia’s superannuation industry. The focus is on the Pension Protection Fund (PPF), used as a lifeboat by the government for pension funds that have gone bankrupt. It could be used as Britain’s first superfund by merging it with around 4,500 of the nation’s smallest defined benefit schemes. Here, rather than acting as a last resort option, the PPF would allow these schemes to opt in with the possibility of tax incentives to encourage as many as possible. The PPF is a highly suitable option for this experiment, not least of all because of its own successful investment returns having a £12 billion surplus over its liabilities and invested over £40 billion since 2004. Under these plans, the fund could become a £400 billion titan for pension investment and, as the World Bank showed, the economies of scale created by a superfund would reduce the risk of investing in equities and start-ups whilst also receiving greater returns (by investing in a range of these high-growth companies). If that isn’t enough, it’s also been proposed that some form of compulsion could be required for these superfunds to invest their assets, a 25% figure was proposed by the Tony Blair Institute, in UK equities. It’s uncertain whether such mandated investment and the application of the stick is needed; perhaps the pension consolidation carrot could prove incentive enough for fund managers.

Politically it’s doubtful that action relating to pension consolidation would spark fierce controversy. As said earlier, pensions are a dull topic which doesn’t arouse the same public debate as the NHS, asylum seekers or the economy (even if it is tied to that last point). If 44% of the public sees health as a priority and only 6% pensions, which one will trigger policy backlash? That’s not to say that pensions couldn’t be a controversial issue (which will be explored later), but this modest goal to see pensions act more efficiently certainly wouldn’t. Either way, making a decisive move towards reducing the enormous pension fund industry into a smaller number of more prominent actors able to entertain riskier assets would mark a positive change from the timid bond holdings of small funds today.

Returning to that point about pension policy arousing backlash, another way funds may be encouraged or find greater incentive to invest in UK equities could involve a dramatic change in the security of people’s pensions. What I’m referring to here is the idea of dismantling much of Britain’s defined benefit pension framework and encouraging a wholesale shift towards defined contribution pensions. The foremost reason for this change would be the need to no longer deliver a set, fixed income for members in retirement, which would allow funds to take riskier investments and expose themselves more to enterprising start-ups. This is the approach Australian schemes have taken, with over 76% of funds being defined contribution (compared to just over a third for the rest of the developed world). The problem with defined benefits is that the risk for pensions is on employers rather than members, which, given they must provide guaranteed income, leads to a higher allocation in safe bonds that deliver lower returns. However, this approach is fraught with difficulty. In the UK, most defined benefit schemes are already closed to new members, and the defined contribution market is expected to leap to £1 trillion in assets by the end of the decade. Even then, many of these schemes have been shifting away from the UK market and investing more overseas.

If defined contribution is already on the rise and perhaps not a panacea to British investment woes, is any government action, regulatory or otherwise, really needed? The answer, although this discussion could deliver enhanced business access to capital, is it doesn’t matter. The reason is simple: no politician could ask those who have saved for years of their working lives to suddenly bear the risk of their pension when they had expected a fixed, safe income in retirement. In fact, in light of the government’s public debt, having risen above 100% of GDP, the Chancellor has stressed the importance of maintaining the bond-seeking defined benefit schemes that can continue to fund the public sector borrowing requirement and sustain the demand for gilts that hold down the interest that has to be paid.

What then? Are consolidation and superfunds the only bullet in the barrel? Not exactly. There’s another central element of the Australian system which relates more closely to the issue of raising retirement income and reducing reliance on the state pension. This is the increasing rate in the superannuation guarantee from 9% in 2013 to 12% of incomes by 2027. The effect is that the average Brit saves less than 25% of what an average Australian worker does for their pension. This model is sustainable, rising with rising life expectancy and securing the more significant savings required to sustain retirees. It also provides funds with greater capital for investment purposes. The problem is that the UK had no comparable system for much of its recent history. Whilst the Australian superannuation was established in 1992, bringing people into pension saving, the UK was heading the wrong way with a 58% decline in the number of those with a workplace pension between 1991 and 2012. However, the situation has since improved as the policy of auto-enrolment into a workplace pension was established in 2012, with those saving rising to 73% of eligible employees by 2016, an increase of almost three-quarters on 2012 figures.

Nonetheless, the amount saved remained scarce. Whilst the Australian superannuation has already been at a 9% rate from employers since 2002, the UK currently only mandates employers contribute 3% (which can also be opted-out of). This disparity in savings means although the UK has gone in the right direction, it’s a step rather than a leap. As such, 61% of middle-earners in the private sector still save less than 8% of their income for their pension. Compared to the Australian saving rate, this disparity means that British workers are far from prepared for retirement and sustaining their lifestyle, largely through their private pension schemes. Some small further steps can be taken to improve savings. Firstly, the UK’s scheme currently has a £10,000 earnings threshold under which savings are not mandated whilst the age of participation is 22. Compare this to the Australian model, which begins at 18 and has no such threshold. Lowering the age makes clear sense as it gives employees (should they not be in further or higher education) four more years of saving to accumulate their pension pot, a not insignificant period. Eliminating the earnings threshold may seem like it penalises those workers on the lowest incomes and could prove more challenging as a political sell. However, the problem is that this policy already penalises those on the lowest incomes and those groups that disproportionally work part-time, including women, by preventing them from having security in retirement. With the state pension age likely to increase and little to no private pension savings, the cost of maintaining the threshold is that low-income workers will have to work longer and longer in life for a state pension that doesn’t cover even a basic lifestyle.

A genuinely challenging and politically contentious option is setting a timeline for raising the auto-enrolment contribution rate for employees and employers to something like the Australian target of 12%. This would give businesses time to plan accordingly and substantially increase savings, retirement income and the capital available to big pension providers. The trouble is that such a timetable would allow any opposition to the measure, if elected, to scrap most of the contribution escalator and thus nullify the process. In Australia, the Liberal-National Coalition, when returned to government after Prime Minister Keating oversaw the superannuation guarantee, froze the rate in 2001 and prevented it from rising as planned. This indicates the need for political bipartisanship and common cause on the issue for any meaningful reform to take place. There is hope for the issue. Already the government has backed plans to improve the system, including backing proposals to lower the qualifying age and earnings threshold. Whether this is actually delivered on is to be seen, but it paves the way for a future government to raise contributions and savings for retirement. Governments can do things to ease the pain. Tax relief can be extended as savings rise, but lessons need to be learned from the Australian example of how to keep the cost of such relief affordable and fair.

Concluding Thoughts

This analysis is not nearly substantive enough. Other similar national examples could be considered, perhaps most useful of all, Canada. Far more reforms, interventions and policies could be targeted at the pensions industry to improve savings and investment. Broader still, swathes of other policies could be implemented to raise the savings rate and investment in the UK. However, I hope that, despite the relatively tedious nature of discussing pensions, it has provided some insight into the various issues facing the UK present and future. There will likely be no significant substantive changes announced tomorrow. A little nudging here, a little encouragement there but a revolutionary change to the regulatory system has been all but ruled out. Nonetheless, the increasing attention paid to pensions is welcome, even if only from policymakers and not the voting public.

A final remark would remind us that although learning from other countries is enormously valuable, particularly in gathering the advantages and pitfalls of specific actions, they aren’t a piece of IKEA furniture. We can’t look at the example of Australia and build a set of public policies together by following the assembly instructions in the letter. Different countries have different institutions, public attitudes, political histories and much more which determine in what way, if at all, policies can be replicated from elsewhere. The United States won’t follow Portugal’s decriminalisation of all drugs. Norway won’t ban new oil and gas exploration in the way that Ireland has. Nonetheless, the lessons we can draw from the Australian superannuation industry are substantial. Not only do the UK and Australia have a significant institutional and governance overlap, a by-product of their historical colonial ties, but the specific problems addressed here, namely an ageing population and private pension development, can provide us with an understanding of what compulsory saving, consolidation of funds and a focus on returns vis-à-vis risk-aversion can do for retirees and investors.

Within the next quarter of a century, England’s population of over 85s will double. Demand for healthcare and social care will rise enormously, and the tax take, so much of which comes from working-age people, will either have to fall or be shifted markedly towards those out of work and further onto consumption. The dilemmas, trade-offs and problems this dramatic change will pose may fundamentally change the nature of the British state. Pensions don’t have the razzmatazz of other government areas; that is clear. We can only hope that for New Year’s, our politicians resolve themselves to address it regardless.