How the Productivity Commission can shake up super

by Jim Minifie

Published by the Australian Financial Review, Wednesday 29 March

The Productivity Commission has released its draft report on alternative models for the half-trillion dollar default part of the superannuation sector.

It is the second stage of a three-stage exercise to wring better value from superannuation that the government devised as part of its response to the 2014 Murray Financial System Inquiry.

The first stage, completed last year, set out criteria for assessing efficiency and competition in superannuation. The third stage will actually evaluate the sector, to help the government decide whether to introduce one or more of the options developed in the current work.

The commission proposes four default superannuation options. In each, a new body would assess and shortlist default funds.

The first model, “assisted employee choice”, would increase the proportion of employees who actively choose their super accounts.

A government-appointed body would create a shortlist of high-quality superannuation products from which employees might choose, while remaining free to select products not on the list. Those who failed to make a choice would be allocated to a back-up fund.

Under the second option, employers would select default funds on their employees’ behalf. Again, the government-appointed body would provide guidance in the form of a recommended set of funds.

In the third and fourth options, the government body would play a more prescriptive role. It would select a shortlist of funds through a tender based on multiple criteria, or through an auction based on fees given the investment strategy. Winning funds would have to give their existing default members the same terms as new members.

All four models would result in a single default account for employees joining the workforce for the first time. Everyone would have the right to select any super fund of their choice – including the 20 per cent or so of members who, unbelievably, still don’t have full choice today.

Firms would retain the option to negotiate better deals for their members, for example by running a corporate fund. The commission also makes recommendations for improving the quality of choice more broadly, for example via MyGov and the Australian Taxation Office.

Retirement savings vehicle

The commission sees super as a retirement savings vehicle, not primarily a workplace entitlement. Employers play a role in only one of the models. Awards and the Fair Work Commission are in the background at best. So there is plenty here for the weaker industry funds to dislike.

Some retail funds may welcome the purely advisory shortlists in the employee and employer models. The tender or auction would be welcomed by the leanest funds, but also by new entrants to the workforce (if only they were engaged).

There is less, however, for the existing 9 million-or-so default members, except the few who would end up piggybacking on a tender to lower fees.

The PC has made good progress. The draft recognises the obligation of superannuation system designers to ensure defaults are delivering.

It recognises that most members will not have the skills to weigh up a wide range of products. It sets out the strengths and weaknesses of alternative models, rather than closing early on a single option.

It recognises the value of central clearinghouses and improved and comparable fund information. And it recognises the potential benefits of limiting account proliferation (but overplays them compared with the other main causes of excess cost: failures of funds to merge, high margins, and unwarranted investment expenses on fully active management of large-cap equities).

In its final report, the PC must provide clear guidance on how these assessments fit into the broader framework that will be used in the next stage, thus informing government decision-makers about what to do.

To achieve this, the final report needs a sharper assessment of options. It should give more attention to root factors behind performance of default systems around the world – for example, there is some evidence that more cooperative or non-profit models perform well.

It also should compare the options directly and objectively with today’s default arrangements now or in stage 3. It should consider whether several options could be used together (for example, a tender for new workers, with MyGov or the ATO making it easy for others to switch to the tender winners).

It should analyse the models in more detail, to test how robust they are to being gamed (for example, by hiding fees, using misleading benchmarks, or loss-leading, then upselling).

The commission should consider expanding the proposed coverage of its default arrangements. The draft report proposes restricting the new defaults to new labour-force entrants (and existing default members of winning funds).

But the inflows of new workers are scarely more than 1 per cent of inflows into MySuper products. Many more people switch jobs than join the labour force each year, and they already have super balances. Including them in the plan would boost its coverage and make it far more attractive for funds to compete.

The Productivity Commission is off to a good start. Now it must ensure its final report gives appropriate and comprehensive guidance to policymakers.