Merit-based selection preferable to current superannuation safety net

By David Donaldson

April 20, 2015

Reducing superannuation fees could save more than $2 billion per year but recent policy initiatives “will not cut fees much”, argues a report by think tank the Grattan Institute.

Grattan says Australians pay $4 billion per year above what would be charged by lean funds, and that cutting fees to what high-performing, lean funds charge “could save more than $2 billion a year.”

Currently the total cost of running superannuation is about $21 billion in total — 1.2% of funds under management per year, or $16 billion across the collective funds, plus about $5 billion in self-managed super.

There is “little evidence” that funds charging higher fees provide better member services, argues the report.

The Stronger Super reforms, introduced by the Gillard government, are expected to cut total default account fees by about $1 billion by reducing administration costs. The Future of Financial Advice reforms could yield benefits for choice account holders. The report states:

“But even if regulators pursue these initiatives with zeal, they will leave billions on the table.

“If remaining excess costs are not removed, they will drain well over 5% — or $40,000 — out of the average default account holder’s fund by retirement. Excess costs in choice [retail] superannuation are even larger.”

The main reason fees refuse to fall is that competition in the industry relies on account-holders and employers selecting the best products, but the majority of account-holders are insensitive to price signals — few are even aware of what they pay. The report reveals:

“Some account holders do pay attention to fees, but because they tend to buy different products, such as those designed for people with large accounts, they put relatively little fee pressure on average fees  … very few people — about two per cent of Australians with a superannuation account, at most — switched funds in 2013 for reasons other than switching jobs or their employer switching default funds.”

To combat this problem, Grattan recommends acting to close excess accounts, merge funds and run a tender to select default products.

Default super products are those to which a worker who does not actively choose a fund is allocated, nominated either by his or her employer or specified in an industrial agreement. “Choice” products are those other than defaults:

  • A competitive process for defaults could save over $1 billion a year. Government should design the tender now and run it as soon as possible.
  • New steps to remove excess accounts could save $360 million a year. It would not be a particularly complex initiative and would be a natural extension of work that has already been done to consolidate accounts.
  • Steps to encourage less efficient funds in the choice segment to merge with efficient funds could save an extra $200 million a year or more.
Grattan Institute: Proposed initiatives save more in defaults than in choice.
Grattan Institute: Proposed initiatives save more in defaults than in choice.

The Financial Services Inquiry recommended that a review should be undertaken between 2017 and 2020 to examine if significant inefficiencies still existed within the superannuation industry. The FSI also suggested it was likely that review would find continuing excess costs. The report argues:

“If that is so, government should act now to establish the tender, since delay merely costs more money.”

Similar tender processes in Sweden, the United States, New Zealand and Chile have produced default superannuation products typically cheaper than Australian equivalents.

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