Streamlining superannuation: not as simple as it seems

Bill Shorten has flagged that there will be significant structural reforms to the superannuation industry. AAP

Financial Services Minister Bill Shorten has set up a Productivity Commission inquiry to define the criteria for selecting a default superannuation fund under “modern awards”. By October, commissioners Mike Woods, Angela MacRae and Paul Costello must come up with a ‘transparent’ set of standards for deciding which superannuation funds make the default A-list.

The majority of Australian workers accumulate their savings in default super funds, which are nominated by their employer. Research by the Australia Institute showed that fewer than 10% of workers actively chose their own superannuation fund. At present, the only restriction is that employers choose a default super fund that complies with prudential standards. Clearly, the government’s view is that prudential compliance is not enough and that efficiency demands more. The inquiry is made difficult by the crucial role of defaults in the superannuation system, the number and variety of stakeholders and the huge differences between the funds being assessed against any new criteria.

While the inquiry terms of reference are strictly confined to awards, the consequences for the superannuation industry are more far-reaching. First, awards are a key reference point for much of the rest of the labour force, including for the many workers covered by enterprise agreements and individual contracts. Second, no funds want to be disqualified for a default fund business by failing to meet the Commission’s criteria.

Managing the funds of the majority of super fund members who choose not to choose is the industry’s bread and butter. Default funds are necessary in a mandatory system like the Superannuation Guarantee (SG) and in Australia they have become core business. In 2010, the Cooper Review estimated that almost all super fund members go with the superannuation fund chosen by their employer. Most also let the fund decide where to invest their savings. This puts around 60% of members and $600 billion in retirement savings in “default” investment options in “default” superannuation funds.

Funds are very happy to look after pots of money for members who don’t keep a close eye on performance. Funds management equals fees, and fees are easier to collect when people are not watching. For a typical superannuation fund member, there are plenty of players taking a cut: the super fund trustees, insurers, investment managers, custodians, asset consultants, actuaries, auditors, stockbrokers, financial planners and so forth. With so many disengaged members and a contribution rate now rising from 9% to 12%, the superannuation default business can be “rivers of gold” to the finance sector. If members are not monitoring their own money, it remains to be seen whether any review of super funds against assessment criteria can keep a lid on fees and costs.

Setting standards with real teeth will be challenging. The inquiry has considerable scope: criteria can address the default investment option, investment performance, fees, scale, insurance, governance and costs to employee mobility. That’s a lot of features to consider. Some funds must be feeling nervous about the looming exam.

To gauge the potential threat, bear in mind that funds currently vary hugely on these measures. For example, in 2010, the average asset allocation of default investment options was around 65:35 growth to conservative assets but individual default allocations ranged from 100% in Australian equities to 100% in cash. (All of these allocations could be right for one member and wrong for everyone else at the same time.) The number of investment options offered ranged from 1 to 2801! Annual rates of return went from low negatives to highs of 25%.

Expenses and fees also varied enormously. As a percentage of net assets, total operating expenses ranged from almost zero to 9% with an average of about 1%. Investment expenses, which include manager, custodian, property manager and asset consultant’s fees, averaged around 0.2% but went as high as 2%. Cost ratios can make huge differences to retirement nest eggs when accumulated over a working life, but funds will argue that their particular settings provide the right options for their members, or that they offer a higher level of service, or greater flexibility, or better in-house financial advice.

Truly discriminating criteria that can be applied across the industry will be difficult to find, but will certainly shape future superannuation fund practice and reporting.

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