In Australia’s superannuation system, most risks — in relation to the level of contributions, investment returns, fees and ultimately the benefit in retirement — lie with the individual. And yet the superannuation system hasn’t always afforded or encouraged individual decision making. Some is well intentioned paternalism, reflecting the compulsory and complex nature of superannuation, while other arrangements are merely a historical overhang. Both elements coexist in Australia’s arrangements for allocating default superannuation members to products (‘default arrangements’). In many ways default arrangements can be beneficial to members and are common around the world in retirement savings systems. But they can also stifle competition and innovation that would otherwise occur when consumers make active decisions, and discourage individuals learning about a sizeable asset held on their behalf. Striking the right balance between these benefits is imperative for a system that collectively compels large mandated savings and affords individual responsibility (and with it risk), and an economy where job mobility is the norm.
The Commission has been asked to develop alternative workable models for a formal competitive process to allocate default superannuation members to products. These new alternative models could be implemented by the Australian Government if deemed desirable following the Commission’s future review of the efficiency and competitiveness of the superannuation system — to be undertaken sometime after 1 July 2017.
This Inquiry represents the second of three related pieces of work on superannuation to be undertaken by the Productivity Commission. These stem from the Australian Government’s response to the recommendations of the 2014 Financial System Inquiry (FSI). The FSI found that the superannuation system was not operationally efficient due to a lack of price based competition in the superannuation default market.
Importantly, the Commission’s task in this Inquiry (stage 2) is to develop new competitive models for future consideration by the Australian Government. The Commission is not tasked in this Inquiry to 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. This is core to the overall competitiveness and efficiency of the superannuation system and will therefore be examined as part of the stage 3 review of the competitiveness and efficiency of the superannuation system.The draft's key points are
- Superannuation has evolved much since compulsory superannuation was first introduced a quarter of a century ago. Today’s default arrangements evolved historically within the workplace relations system, and provide a safety net for employees that don’t or cannot make a decision in a world of compulsion.
- So after 25 years, this Inquiry is a timely opportunity to look at potential ways to introduce more competition into a system that benefits from a large flow of mandated superannuation contributions, and much of that from disengaged members.
- Complementary policy action (including to extend genuine member choice to all employees) is needed to deliver the full potential benefits of member driven competition under the models we identify and even under current default arrangements. The freedom to make choices is necessary to realise the benefits of competition.
- Two thirds of members stick with their default fund. 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.
- In this draft report the Commission has developed four alternative models that are likely to outperform a baseline of ‘no defaults’ on member benefits and competition.
- They try to address the core problem in superannuation — the sheer complexity of decision making coupled with compulsion — by increasing the availability and quality of information or nudging choice to a smaller set of high quality products.
- But these interventions come at a cost, and each model has different relative strengths and weaknesses.
- Members who do not exercise choice should be allocated to a default product only once. The current system’s propensity to create multiple accounts is an egregious systemic failure. It warrants more than the incremental remediation to date.
- This approach would result in a smaller pool of employees being defaulted each year, but it should be sufficient to generate competitive dynamics.
- There should be a government run centralised online information service, with universal participation by employees and employers, to facilitate more efficient allocation of default members to products.
- A centralised clearing house (akin to New Zealand’s), while a more ambitious undertaking, would have wider and more enduring member benefits.
- Member outcomes would also benefit from more transparent disclosure by funds regarding merger considerations, to hasten the exit of underperforming funds.
- Certain reforms indicated in this report will be examined further in the stage 3 review.
Competition can promote better outcomes for consumers, such as lower prices, improved service quality and product innovation. There are several reasons why these competitive ideals may not be realised in the superannuation market.
First and foremost, superannuation in Australia is based on compulsion, which can limit the demand side pressure exerted by members. Member passivity and disengagement are further compounded by the complexity of retirement saving decisions, long time horizons, various behavioural and cognitive biases, and the costs of active involvement. At their core, these are information problems — incomplete information or asymmetric information — exacerbated by cognitive constraints.
The absence of strong member engagement can dull competitive pressure on superannuation funds, regardless of the presence of many funds in the market. Moreover, the information problems can create a risk of unhealthy and wasteful competition, such as excessive advertising and product proliferation.
Policy intervention can potentially improve on these outcomes by helping members make better choices, or via default selection processes reducing risk as members opt out of choice. Policymakers can also intervene on the supply side to steer competition and trustee behaviour to more beneficial aspects.