Financial sustainability research

We research issues of concern with regard to financial sustainability.

Risks to financial sustainability relates to the outcomes that may currently seem ok, but in the longer-term are not. We have identified a number of areas in which we believe financial sustainability is compromised. The first one on our list is the Age Pension.

Age Pension

The financial sustainability of the Age Pension is an important issue for society living in Australia given i) the heavy reliance on the Age Pension by a significant proportion of the community aged over 65 (see chart below); ii) improving mortality rates for those in old age; and iii) the increased 'dependency' ratio of over 65s to the 'working age' population. These same demographic changes are putting increased pressure on the funding of public and private health care costs.

Chart: Persons on Age Pension as at 30 June 2014

In February 2015, Scott Morrison the then Federal Minister for Social Services and now Federal Treasurer, said "Well we've got to address the issues of the sustainability of the pension over time. Now I should be very clear, that does not relate to people who are currently 61 and 55, those, that generation of Australians went through their working life with a very clear deal with the Australian government; that is you work hard over the course of your life, then there is a pension at the other end. Now in my generation the deal was very different. We provide for our own, our superannuation and own on retirement incomes wherever we can. And I think this is a generational shift - which the previous government supported in lifting the age to 67, so it's a bit rich for them now to somehow be totally opposed to that idea."

Based on Scott Morrison's comments, the social contract divide is a birth year of 1959. If you were born in 1960 or later, the Age Pension will only be available as a 'safety net' for those who are unable to accumulate wealth during their productive years. This, or a similar, political narrative is necessary as the Age Pension is not financially sustainable. Simply, there is not sufficient distributable (i.e. taxable) income and wealth within society to maintain the existing offer.

The crux of the problem of the financial sustainability of the Age Pension is that the provider, the Federal government, has not backed its Age Pension promises with assets. In fact, it doesn't even accrue the liabilities to pay the Age Pension in its financial accounts. This is a travesty given Scott Morrison's comments that those born before 1960 have a "very clear deal" with the Australian government. If the deal is very clear, then the government should account for the liability, and also put aside real assets to pay for that liability.

The Federal government adopts a 'pay-as-you-go' approach to the Age Pension. That is a euphemism for not bothering to fund the liability, but instead paying the Age Pension from general revenue (mainly taxation) and government debt. The Age Pension is just one of the many priorities for government spending. The pension amount, eligibility and other pension rules become a political decision devoid of any proper considerations of equity.

The present value of the Age Pension to a couple aged 65 has been estimated in the Actuaries Institute's White Paper 'For Richer, For Poorer, Retirement Incomes' at A$816,000 as at 31 December 2014. We prefer to think in terms of 1/4 oz gold coins. In this case, the capital value of the Age Pension is about 1800 gold coins. The median household annual income is about 180 gold coins. Assuming a generous working period of 40 years, the median household would earn a total of 7200 gold coins - requiring a taxing rate of 25% to accumulate the capital just to pay for the Age Pension, let alone any contributions towards other government services including health, education, judicial, defense and general government bureaucracy. It doesn't add up. The current level and availability criteria of the Age Pension was only possible because of demographic factors that are no longer with us.

Our conclusion is that over time the Age Pension will be available to fewer and fewer people (increasing starting age, harder asset test etc.) and that its purchasing power will continue to decline. It may well remain as a 'safety-net', but it won't form a significant portion of most retirees' income. We consider the lack of assets backing the Age Pension is likely to lead to severe intergenerational inequities as future tax payers are forced to cover existing Age Pension promises. The starting point when discussing Age Pension public policy should be the lack of assets funding the unaccounted for liabilities.