Superannuation: Alternative Default Models

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Key points

• 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.

Contents summary

This report consists of an overview, eight chapters and two appendices.

Chapter 1 provides background information.

Chapter 2 outlines the Commission's assessment framework for assessing alternative models.

Chapter 3 outlines the Commission's approach to the development of alternative models for assessment, including the common foundations across all models.

Chapter 4 details the Commission's no defaults baseline that alternative models will be compared against.

The next four chapters examine the alternative models against the assessment framework outlined in chapter 2.

Chapter 5 examines the assisted employee choice model.

Chapter 6 examines a fee-based auction model.

Chapter 7 examines a multi-criteria tender model.

Chapter 8 examines an assisted employer choice (with employee protections) model.

Appendix A outlines the Commission's public consultation process.

Appendix B provides background on retirement income systems and default arrangements in Chile, New Zealand, the United Kingdom and Sweden.

Infographic: Superannuation Alternative Default Models

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Super easy superannuation (Text version of infographic)

For all Australian workers – super will matter for living the retirement lifestyle you want.

But many of us find it complicated and hard to navigate and don’t engage.

Two thirds of us have super contributions going into a fund that we didn’t choose ourselves – or in other words, a default product.

Our draft report explores ways to:

1. Simplify super choice
2. Improve default products
3. Prevent multiple accounts.

To do this, we have developed four new possible models.

One model where an employer picks a better default product for you with 2 handy lists to guide them.

Two models where funds compete in an auction or tender.

And one model where new comers to super make their own choice, with a handy shortlist to guide them.

We want to hear from you, and what you want from your default super.

Read the draft report and make a brief comment.

Modern options for better default super

The Productivity Commission has released a draft report that identifies possible models to guide employees new to the superannuation system to preferred, simple default super products.

'After 25 years, and notwithstanding a history of reasonable returns as a general rule, structural faults are evident in default superannuation,' Productivity Commission Chair, Peter Harris said.

'These changes are not about the tax or contribution rules for super. They are about how to help the least informed members – those new to system, who fail to make any choice about where their money goes,' he said.

The Commission is proposing a structural change that would mean employees become default members one time only, when they first enter the workforce. This would substantially reduce the current proliferation of accounts created by repeating the default process every time a worker changes their job.

Lower fees and better returns are also in prospect. 'Around two thirds of members rely on defaults. This isn't surprising with super being both compulsory and complex to navigate especially for young workers. Our new models can make default super simpler and easier to compare, and offer the prospect of lower fees and better-performing products,' Productivity Commission's Deputy Chair, Karen Chester said.

The new models will also enable those benefits to ultimately flow through the entire system, not just improving the lot of new default members but also reaching many existing super members. The four models offer different ways to harness healthy competition for the default pool itself. Rather than create even more choice in a system with over 100 MySuper products, it will be easier to identify better performing products.

The draft report also has several structural repairs to reinforce the responsibility to focus on member interests, under any default model.

'The new models are real world and workable. We have drawn on what has worked well and not so well overseas to address the outcomes default models should focus on today,' Ms Chester said.

Proliferation of accounts is both inefficient in a fund management sense and a burden on members, particularly those with the small balances that characterise early years in the workforce. 'Unlike twenty-five years ago, today many more employees are part-time, and there is a greater propensity to change jobs, with much less a job-for-life nature to the workforce. The super system should reflect this,' Chair Peter Harris said.

'To date, most interest in this Inquiry has come from the funds themselves. So we are asking young Australians and those who might want to think about their interests, such as parents, to also share their ideas about how a future default system could work better for them,' Ms Chester said. Click on the draft report at www.pc.gov.au and use the brief comments link.

Formal submissions on all aspects of the draft are as always also welcome.

• Fact sheet - Superannuation: Alternative Default Models - Draft report (PDF - 207 Kb)

Superannuation: Alternative Default Models - Draft report

We have developed four alternative models that use competitive processes to allocate default superannuation members to products. We want workable models for the future that overcome some of the legacy problems affecting the system today, such as members having multiple accounts.

Approach to developing models

Superannuation is very complex and choosing the right product can be overwhelming for members and employers. The models all aim to address this complexity by either improving the quality and comparability of information and/or simplifying choice to a smaller set of products. The four models vary by the degree and type of filtering (which narrows the set of choices), and who ultimately allocates members to products.

Model 1: Assisted employee choice

In this model employees choose a superannuation product themselves (active choice), but are assisted by a set of policy interventions. The primary feature is a non mandatory shortlist of 4 to 10 high quality products that are selected using a thorough administrative filter. The shortlist would be accompanied by simple information on key features of each product in a consistent and comparable format.

Overview of models

Supplementing this would be a voluntary system of product accreditation (a longer list of quality products involving minimal filtering), which would encourage funds to provide products which have a common, simple design that allows for easy comparisons across different products. Product accreditation would be akin to a strengthened MySuper authorisation process (with a stronger emphasis on minimum performance standards).

Finally, a simple, low cost last resort fund would hold contributions from employees who fail to exercise choice and encourage them to choose their own product.

Model 2: Assisted employer choice (with employee protections)

In this model, employers choose a default product for their employees who do not exercise choice. A long list of default products that meet mandatory minimum standards (the light filter) is the primary feature. These minimum standards are important to protect member interests given the potential for conflicts of interests in the employer choice environment. The light filter would be akin to a strengthened MySuper authorisation process (with more emphasis on minimum performance standards).

Second, a thorough filter would apply criteria around investment performance and other product features to identify a 'preferred default' list of the best performing default products. This would be voluntary for employers and designed to assist those not well placed to select default products for their employees.

The model recognises that some (mainly larger) employers are well placed to choose a default product and negotiate favourable arrangements for their employees, while many (mainly small and medium size) employers are not and would benefit from some assistance.

Model 3: Multi-criteria tender

In this model, fund participants compete for rights to a share of the default pool by making proposals against a number of different assessment criteria, which are weighted by their relative importance. A well designed multi criteria tender could therefore engender a product that performs well on the key areas that matter to members.

Funds would submit bids against criteria such as past performance on net returns and member satisfaction, investments strategy, member services, fees, and innovation in unspecified areas. Five to ten of the best product offerings are chosen by a Government appointed selection body, with a best and final offer stage used to encourage convergence where proposals are close. The winning products are then allocated new entrant default members on a sequential basis.

Model 4: Fee-based auction

A fee based auction would see funds compete for default status by out bidding each other on fees. To the extent that investment returns are largely market driven, competition on fees would promote long term net returns. Funds would submit a sealed bid to the Government appointed selection body specifying their investment and administration fees, and combined with a best and final offer process, this would produce one to five winning products that would be allocated new entrant default members on a sequential basis. A set of minimum standards would address non fee product characteristics like investment strategy and member services.

What features are common across all models?

Defining the default pool — Employees who fail to exercise choice will be allocated to a default product only once — typically on joining the workforce — and will retain that account unless they actively switch (employees maintain the right to choose their own fund and product at any time in all models). Restricting the default pool to first timers would reduce wasteful account proliferation, particularly among younger members. Under all models, any fund whose product is awarded default status must extend the same fees and service terms to its existing members in the default product.

The default product — Default products selected under all models should be simple and provide the minimum services necessary to meet the Government’s stated objective for superannuation — that is, to provide income in retirement to substitute or supplement the Aged Pension. The quality or range of ancillary services should not be the main driving factor in selecting default products — funds should compete primarily on long term net returns and costs for a threshold level of service.

Default product selection process — All of the models require a body responsible for selecting eligible products. The Commission considers that this body should be established and overseen by the Australian Government. Its composition and conduct should be subject to several key principles including: a strong focus on member interests, sufficient expertise to evaluate products, be free of conflicts of interest, and accountable for its decisions. The product selection process should initially be repeated every four years and can be reduced in the future.

How has the Commission assessed and compared the models?

The assessment framework involves promoting members best interests and more broadly, the wellbeing of Australians. The alternative models were assessed against five assessment criteria: member benefits, competition, integrity, stability and system wide costs. Models were compared to a baseline of unassisted employee choice. The baseline should not be interpreted as an alternative model but rather an objective starting point against which to compare the relative merits of the models.

What next?

The Productivity Commission is keen to hear your feedback on this draft report. You are welcome to make a written submission to the Commission, by 28 April 2017. Alternatively you can leave a brief comment. Public hearings will be held in early May 2017 — likely locations are Sydney and Melbourne. Information on making submissions and hearing dates is available on the inquiry website: www.pc.gov.au/inquiries/current/superannuation/alternative-default-models

The final report will be provided to the Australian Government in August 2017. The Australian Government may consider implementing one of these models following the Commission’s future review of the efficiency and competitiveness of the superannuation system, which will take place after 1 July 2017.