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					        Volatility in
     Superannuation
       Investments
            and
the Australian Age Pension
                Clare Bellis
     Department of Actuarial Studies,
          Macquarie University
         cbellis@efs.mq.edu.au
How may changes in superannuation
investment strategies affect the
proportions of retired Australians who
receive a part or full age pension?
               Before:
      most members in one strategy


                   Now:
  choice of strategy, eg “cash” or “growth


                 Future:
         member choice of fund
   → specialised investment vehicles
→ very low level of diversification possible,
 → increased variation across members
 The interaction with the Age
           Pension
Does the means test give members a put
option on their superannuation assets:

keep the upside, but collect the age
pension if the downside occurs?

It depends on post-retirement income.
                2 extremes:

 People on full age pension, can only lose
 pension if their investments soar
→ the state should encourage low income earners
 to gamble with their super.

 People on no age pension, can’t lose pension
 but can get it if their investments flop
→ the state should discourage wealthy from
 gambling with their super.
          Projection model
              Assume:
 30 year-old single male
 35 years of unbroken employment
 SGC 9%, taxed at 15%
 Salary: $50,000 or $100,000 in 2005
  dollars.
 Ignore insurance and administration costs.
 Converted into a single life CPI-indexed
  pension at 65 at $17.40 per $1 pa
          Projection model
              Assume:
 Age pension $12,535 pa less 40% of
  income between $3,172 and $34,508.
 No change in the social security
  legislation!
 Salary, age pension and the means test
  limits increase by 4% pa.
 Investment returns are independent log
  normal
Base case (“balanced”):

    6.5% mean
    7% standard deviation
   for net investment return.
            Base Case
  Results for a salary of $50,000
 90 percentile range
 without age pension: 16% to 36% of final
 salary.
including age pension: 37% to 49% of
 final salary

 All members receive a part age pension,
 averaging 71% of the full pension.
 Split members into “defensive”
       and “growth” funds
Suppose
 balanced portfolio = 50% “defensive” + 50% well
  diversified “growth” assets
 net investment returns:
 “defensive” = 5% mean/ 1% st dev
 well diversified “growth” = 8% / 13.8%

 Members divide into defensive or growth
  investors.
 Results for a salary of $50,000,
      defensive investors
 90 percentile range, including age
 pension: 38% to 39% of final salary
→ Very little uncertainty, but gave up 10%
 upside to reduce downside by 1%

 All members receive a part age pension,
 averaging 81% of full pension
 (up from 71% for base case).
 Results for a salary of $50,000,
       growth investors

 90 percentile range, including age
 pension: 35% to 68% of final salary

 96% of members receive a part age
 pension, (and 4% get none), averaging
 60% of full pension
 (down from 71% for base case)
   Result of dividing the investors
       on salary of $50,000

State now pays out 2 different rates to 2
  groups

Combined ave. pension = 71%, as before
 (defensive investors get more, growth
 investors get less, on average)
           Base Case
 Results for a salary of $100,000

 90 percentile range including
 age pension: 23% to 36% of final salary

 94% of members receive a part age
 pension, averaging 34% of the full
 pension.
Results for a salary of $100,000,
      defensive investors


 90 percentile range, including age
 pension: 17% to 19% of final salary

 All members receive a part age pension,
 averaging 51% of full pension
 (up from 34%).
Results for a salary of $100,000,
       growth investors

 90 percentile range, including age
 pension: 22% to 66% of final salary

 65% of members receive a part age
 pension, averaging 25% of the full pension
 (down from 34%).
   Result of dividing the investors
      on salary of $100,000

State now pays out combined ave.
  pension = 38%, up 4%

(extra cost for defensive investors not
  fully offset by savings on growth
  investors)
   Results of choosing a less
   diversified growth portfolio


 Assume 8% mean (as before) but 20% s.d.

 Compared to diversified growth, members
 gain about 16% upside for 3% extra
 downside (means test does not affect upside,
 dampens downside by 40%) – attractive!
   Results of choosing a less
   diversified growth portfolio
average age pension
for $50,000, = 63% (up 3% on diversified
  growth)
→ 72% combined average (up 1% on base)

for $100,000, = 35% (up 10% on diversified
 growth, up1% on base )
→ 43% combined average (up 9% on base)
Results of choosing a poorly
performing high risk portfolio


 Assume 5% mean,
  20% st dev (as before).

 Not attractive, but quite possible!!
Results of choosing a poorly
performing high risk portfolio
average age pension
for $50,000, = 81% (up 21% on diversified
  growth, up 10% on base)
→ 81% combined average (up 10% on
  base)

for $100,000, = 57% (up 32% on
 diversified growth, up 23% on base)
→ 54% combined average (up 20% on
 base)
      Summary of Age pension %
                              50,000   100,000
                              salary    salary
Base (balanced)                 71        34
Half defensive, half growth    71        38
Half defensive, half less-     72        43
diversified growth
Half defensive, half poor      81        54
performing growth
All poor performing growth     81        57
All defensive                  81        51
             Conclusion


 The means test on the age pension does
 create a put option (on our assumptions).

 Cost to the state increases as choices
 become less efficient OR overly defensive.
    Areas for further thought
 Allow for tax - could help the state’s
  position, though tax payable would be low.

 Try a more sophisticated economic model.

 Consider allocated pension instead of
  lifetime annuity (which cuts off volatility at
  age 65).

				
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posted:10/1/2011
language:English
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