The Productivity Commission has released its draft report setting out criteria for assessing the competitiveness and efficiency of the superannuation system. The final report will be delivered in November this year.
The study, the first stage of a three-stage exercise, is part of the Government’s response to the 2014 Murray Financial System Inquiry. Murray recommended that the Government “introduce a formal competitive process to allocate new default fund members to MySuper products, unless a review by 2020 concludes that the Stronger Super reforms have been effective in significantly improving competition and efficiency in the superannuation system.”
This first stage does not assess the superannuation system; it merely sets out criteria for evaluating it. The second stage, to be delivered by mid-2017, will develop alternative models for the competitive process. The third and final stage will review the system. Only then, and only if the government finds there is still significant inefficiency, will it consider introducing one or more of the “models” developed in the second stage.
What’s at stake?
The efficiency of the superannuation system makes a big difference to incomes in retirement. Today, the system charges fees totalling about $16 billion, or 1% of GDP. There are too many unwanted accounts, too many funds, and many funds charge fees that are too high. Costs that are too high by even half a percent a year can reduce balances at retirement by over 10%, and many Australians are paying more than that in excess fees. The recent Stronger Super reforms and the Future of Financial Advice reforms have reduced fees somewhat, but billions of dollars in excess cost remain.
What the Commission proposes
The challenge in evaluating superannuation is to make sense of the system’s jargon and its maze of products, sales channels, governance structures, and performance metrics. Even people with real financial expertise struggle to assess funds' performance, and many members are inexpert and disengaged. What’s more, some providers and advisers have interests that are not aligned to those of members.
The Commission proposes a rich set of performance measures for this complex system. It begins from the Government’s announced objective for superannuation: “to provide income in retirement to substitute or supplement the Age Pension”, and proposes five supporting goals, including maximising net returns, meeting member needs, providing appropriate insurance at least cost, complementing a stable financial system, and competition that drives efficient outcomes.
It then sets out separate criteria for the competitiveness and efficiency of the superannuation system. Sensibly, it notes that “competition in the superannuation system is not an end in itself, but provides benefits to the community as a whole and members in particular when it promotes efficient outcomes.”
It proposes that the system’s competitiveness be assessed by reviewing such measures as whether members are engaged and informed, whether advisers and sellers are acting in members' interests, whether funds compete on costs and pass on cost savings to members, and whether member outcomes are affected by vertical or horizontal integration.
The criteria it proposes for the system’s efficiency include net returns after fees and tax, the costs of the system, the extent to which the system’s services align to members' needs and preferences (such as risk management), and the extent of unpaid contributions and lost accounts.
These criteria are all sensible, though many will prove much easier to specify than to measure against an ideal or acceptable outcome. As the draft notes, work must begin now to ensure the data is in place when it is needed.
Three critical additions to ensure the process works
The Commission needs to build on its draft report in three directions.
First, it should be more explicit about the weighting given to different performance measures. Not all measures are equally important.
Second, it should be clear about what matters to different fund members. The draft notes that default and choice superannuation members have different needs; those needs should be clearly set out in the final report. Many of the 9.5 million Australians with default products are disengaged. Few will engage much until they near retirement, if they ever do. Many do not have financial expertise. That means that risk-adjusted net returns should be given strong weight in evaluating default products.
Lost accounts and unpaid contributions will also be particularly important for this part of the market. For the choice part of the market – currently about 5 million people – returns should remain paramount, but member engagement and advice quality may play a larger role.
Third and most critically, the Commission must strengthen the links between the three stages of its work. The government’s response to the Murray Inquiry and the Commission’s Terms of Reference for the first two stages make it obvious that the three are intended to work closely together. Stage 1 must define criteria that inform the development of competition models in Stage 2, as well as the assessment of those models against today’s model in light of the findings of Stage 3.
But the draft hardly discusses these links. For example, there is no discussion of how the proposed measures will inform Stage 2. And there is no discussion of which measures will help government decide whether to deploy the models designed in Stage 2. Without much tighter links between stages, the whole purpose of the process will be defeated.
At a minimum, the set of measures in Stage 1 must include the performance of funds by governance type (industry, public sector, and for-profit) in different competitive contexts (tender, awards, direct, and advised) and across product types (default and choice, accumulation and post-retirement).
It must also include the performance of tenders for investment management and administration separately. And it must include the implications of those segment outcomes for the whole system. That type of detailed assessment will be vital if the Commission is to assess competitiveness and efficiency and so inform the government’s decision about whether and how to change the competition model for default super.
The Commission’s process might seem cumbersome, but it could prove a model for a better way of developing policy. Superannuation is not the only sector in which competition seems to be leaving many consumers little better off.
There are at least two opportunities to roll out the multi-stage market assessment model. First, in its response to the Murray Inquiry, the Government has already committed to implement periodic reviews of competition in the broader financial sector.
More generally, last year’s Harper Review recommended that government set up a new body that would have the power to initiate what it called “market studies”. That was one of the few Harper recommendations the Government left hanging, perhaps because it wasn’t convinced a new body was needed.
But if the Commission’s three-stage process can credibly assess both superannuation system outcomes and the policy options to improve them, it could prove a model for further market studies, whether undertaken by the Commission, the ACCC, or some new body.
Authors: Jim Minifie, Productivity Growth Program Director, Grattan Institute