The Productivity Commission is proposing a major shakeup to Australia’s $2tn superannuation industry that would introduce competition for employees’ default superannuation funds – including those covered by enterprise bargaining agreements.
The commission’s draft report into the competitiveness and efficiency of Australia’s superannuation system proposes four models which seek to increase competition, end workers having multiple accounts, and also reduce fees. Such a move will be highly political given it could reduce the power of the union-backed industry funds despite the commission’s own research finding that such funds generally perform better than retail funds.
The review into the superannuation system came out of the Murray inquiry into Australia’s financial system and seeks to improve the competitiveness and efficiency of the system with a view to lowering fees. Crucially, however, the current stage of the review does not form a view on whether alternative models are better or worse than the current default arrangements, nor on the merits of the current default arrangements.
The shift to a competitive process is a political one. The union-backed industry super funds are those that largely benefit from the current process which allows the default superannuation fund to be specified as part of an enterprise bargaining agreement.
The commission notes that while, since 2005 workers have been able to have a choice of super funds, approximately 20% of workers covered by enterprise bargaining agreements do not have this choice. The commission also noted that around two-thirds of workers stick with the default super fund, and only around 5% switch afterwards. The commission argues that “if the system is going to rely on defaults, it needs to guide members to products that at a minimum seek to maximise long-term net returns”.
For the commission, the path to this maximum return is through competition, and it proposes two stages.
The first involves shifting from the current situation where there is a default superannuation fund for each worker when they change jobs to a “first-timer” model, where people have a default provider only when they first enter the workforce. Such workers would then “retain that account (including through a change in employer) unless they actively switch”.
The commission estimates there are about 400,000 new workers entering the superannuation system each year worth about $800m in annual contributions – the current total default super market is worth $480bn.
Such a shift would be a significant change given many people’s first-time entry into the workforce is in casual or part-time employment in an industry which they do not end up staying in for most of their working life.
Karen Chester, the deputy chair of the Productivity Commission, argues the process involves people’s superannuation in the “accumulation stage” at which point they only need a “pretty vanilla product”. She says what such workers need is not “bells and whistles” – which bring with them higher fees – but “low-cost, top performers” with a “balanced investment strategy”.
Chester argues people do generally get more engaged with their super funds as they get older, but the commission’s focus was on what’s needed for the default member who is likely to remain disengaged.
The major benefit of this move would be to reduce the number of workers who hold multiple super accounts due to having had multiple jobs – a key issue given the era of the job-for-life is long gone. Chester notes the average young worker today will have 17 different jobs during their working life, with workers under the age of 25 turning over jobs every one-and-a-half years – a situation greatly different to that which was in place when the superannuation system began 25 years ago.
The report cites the Murray inquiry, which estimates that moving from an average of two-and-a-half accounts to a single account over a person’s working life could increase superannuation balances by about $25,000.
The commission also estimates that moving to a first-timer default model would reduce total administrative fees and insurance premiums by the order of $150m for every 500,000 to 600,000 of default accounts permanently removed from the system.
The second stage of the proposed change is to implement one of four different “allocation models” for default superannuation funds.
The first is an employee choice model which would see employees choose from a list of four to 10 of the best-performing super funds (chosen by an independent government body). The shortlist would be accompanied by simple information on key features of each product in a consistent and comparable format.
Employees would still be able to chose from funds not on the list, but the commission argues this process would reward the best-performing funds, force other funds to improve their performance, lower their fees to get on the list (which would be reviewed every four years), and would also encourage poor-performing funds to leave the market.
The commission argues this “would make it easier and simpler for employees to choose a good product that meets their needs – especially for those who have limited financial knowledge”.
The second method is a similar process but one where the employer chooses funds for their employees from two lists – a mandatory light filter that ensures funds meet “mandatory minimum standards” that would be higher than the current standards for MySuper products; and a “heavier filter” which applies stricter criteria and employs higher performance benchmark hurdles.
The third model is for multi-criteria tender process, similar to that proposed by the Grattan Institute. Under this system the government would require funds to compete for default fund status by making proposals against multiple assessment criteria including past performance on net returns, member satisfaction, investment strategy, fee levels and transparency and innovation in unspecified areas. Such a method is similar to that used by New Zealand to select its default superannuation providers.
The final model is perhaps the most contentious as it would involve a fee-based auction process. Such a process is used in Chile, and the commission is somewhat ambivalent about the experience there.
It notes that “Chile’s experience with a fee-based auction suggests that these incentives might be limited in their effect”, but it argues that because of the relatively large number of superannuation funds in Australia compared with the quite highly consolidated Chilean market, the benefits should be greater here.
The commission will hold public hearings in May and finalise its report in August this year.
The models will be highly political given the use of industry superannuation funds within enterprise bargaining agreements – and the desire of retail super funds to get access to that segment of the market.
The report argues it is not just an issue of industry versus retail funds. It noted there was “near-universal agreement” among all funds – both industry and retail against both the tender and auction models. Rather archly, the report suggested that “given the massive flows of mandated contributions at stake”, funds of all types were protecting their own interests.
Industry super funds have also repeatedly noted that, under the current system, those workers in such funds have done much better than those in retail funds:
Data from the Australian Prudential Regulation Authority (Apra) shows that over the past 13 years, only once have retail funds delivered a higher average annual rate of return than industry super funds:
The commission itself notes that the top quarter of MySuper products “is dominated by industry funds”. But it also found that the worst-performing quarter of funds “is populated by a roughly even number of industry, retail and corporate funds”.
As one of the key aims of the model is to remove the lower-performing funds, however, the commission doesn’t take into account whether industry is better performing than retail (or vice versa). It is mostly concerned that under the current system, workers have little knowledge of which are the better-performing funds, and that they are just as likely to be in a poor-performing fund as a well-performing one.
Thus even though Apra also finds that in 2015-16 the bottom 25% of industry funds performed better than the bottom 25% of retail funds, the key for the commission is for workers to choose from the best performers:
Moreover, retail funds account for a much larger slice of fees paid compared with the amount of funds they hold. The commission’s proposal would see default funds being low-fee, no-frills options:
Excluding self-managed funds, retail funds account for 38% of funds held in the superannuation market, but for 57% of all fees paid by superannuation members.
The commission’s report will inevitably be seen as a retail versus industry fight, and a political one at that. But given the on-average better performance of industry funds, it would seem to be a fight that industry funds should be up for. And given one of the biggest gripes about superannuation is the complexity – and workers having multiple accounts that are easily forgotten – the moves proposed by the commission could be quite popular.
