Productivity Commission addresses superannuation lottery

The Productivity Commission recommends an independent review of insurance in superannuation; that Australians enter default super once; and that super funds disclose trailing financial adviser commissions.

These are a few of the 22 recommendations in the Commission's draft report on assessing the superannuation system's efficiency and competitiveness. The report likens aspects of Australia's $2.6 trillion super system to a lottery.

Default super versus choice

The 571-page draft report pits default super versus choice and the Commission has developed a model which it believes supports a simple choice environment "where members who do not choose end up in good defaults, and those who do exercise choice are able to do simply and safely."

First and foremost, the PC recommends default super accounts should only be created for members who are new to the workforce or do not already have a superannuation account.

An independent expert panel would then select a 'best in show' shortlist of 10 super products with each presented to all new workforce entrants, allowing them to choose.

The model was constructed because the PC found wide variation in performance in both the default and choice super segments.

"About 1.7 million member accounts and $62 billion in assets are in MySuper products that underperformed conservative benchmarks over the 10 years to 2017," the report said.

"This suggests that many members are currently being defaulted into underperforming products and could be doing better. If all members in these underperforming products received the median return from a top-10 MySuper product, they would collectively be $1.3 billion a year better off."

Additionally, in the choice segment, "more than $50 billion in assets are in investment options that underperformed conservative benchmarks over the 12 years to 2016." It should be noted there's about 40,000 options to choose from - and the PC finds that lifecycle products are better suited to the choice segment.

Australian Institute of Superannuation Trustees (AIST) chief executive Eva Scheerlinck generally welcomed the report but questioned its call for a new default selection system.

"While the report acknowledges the superior performance of most default not-for-profit funds it then inexplicably recommends dismantling the very system that has delivered these results," she said.

Association of Superannuation Funds of Australia (ASFA) chief executive Martin Fahy said: "The proposal to allocate default superannuation to 10 so called 'best-in-show' funds would dramatically change the retirement funding landscape, and raises questions with respect to innovation, competitive intensity and diversity."

The PC noted the self-managed superannuation fund (SMSF) segment has broadly tracked the long-term investment performance of APRA-regulated funds on average. However, smaller SMSFs (those with balances under $1 million) have delivered materially lower returns on average than larger SMSFs - exceeding 10 percentage points every year from 2005.

Figure 1. Productivity Commission infographic

One default eliminates multiple accounts

Productivity Commission deputy chair Karen Chester said with default funds being tied to the employer and not the employee, many super members end up with another account every time they change job.

The PC said one-third of accounts (about 10 million) are unintended multiples. The excess fees and insurance premiums paid by members on those accounts amount to $2.6 billion every year.

"These problems are highly regressive in their impact - and they harm young and lower income Australians the most," Chester said.

Over an average member's working life, being stuck in a poor performing default fund can leave them with about 40% less to spend in retirement, the report notes.

"Fixing these twin problems of entrenched underperformance and multiple accounts would lift retirement balances for members across the board. Even for a 55-year-old today, the difference could be up to $60,000 by the time they retire. And for today's new workforce entrant, they stand to be $400,000 ahead when they retire in 2064," Chester said.

Erosion of member balances

The PC estimates low-income super members and their life insurance arrangements could erode anywhere between 14 and 25% of retirement balances.

In terms of premiums paid, default insurance in super offers good value for many - but not all - members, the PC noted. Insurance in super is of little or no value for some members, the PC added, "either because it is ill-suited to their needs or because they are not able to claim against the policy."

Commissioner Angela MacRae said super funds need to do more to provide insurance that is value for money for all members.

"While many members are getting affordable life insurance through their super, some end up with cover that is manifestly unsuitable, including 'zombie' insurance policies they can't even claim on," MacRae said.

"And many unknowingly have duplicate insurance policies, which can erode their super balances at retirement by over $50,000."

Additionally the PC said Superannuation Guarantee non-compliance is hard to estimate, but could be costing members about $2.8 billion a year. It said at least 2% of all member accounts (about 636,000) are subject to (grandfathered) trailing financial adviser commissions - and these may cost members more than $214 million a year.

The PC is now calling on the Federal Government to commission an independent review of insurance in superannuation.

"This review should evaluate the effectiveness of initiatives to date, examine the costs and benefits of retaining current insurance arrangements on an opt-out (as opposed to an opt-in) basis, and consider if further regulatory intervention or policy change is required. The review should be initiated within four years from the completion of this inquiry report, or earlier if the strengthened code of practice is not made enforceable within two years," the PC said.

Figure 2. Problems in super

Other key points

Commissioner MacRae said the super system's governance needs improvement.

"Trustees of underperforming funds should be merging with better performing funds. And the best people with the right skills must sit on the boards of super funds," she said.

The PC recommends legislation which would require trustees of all super funds to use and disclose a process to assess, at least annually, their board's performance relative to its objectives and the performance of individual directors.

It would also require all trustee boards to maintain a skills matrix and annually publish a consolidated summary of it, along with the skills of each trustee director; an external third party evaluation of the performance of the board at least every three years; and a removal of legislative restrictions on the ability of super funds to appoint independent directors to trustee boards.

Finally the PC also says MyRetirement default products are not warranted. It said the diversity in household preferences, incomes, and other assets when approaching, and in, retirement means there is no single retirement product that can meet members' needs.

It highlights the most important task remaining "is to improve the quality of financial advice to guide members among the various complex products, especially where members may decide to make the mostly irreversible decision to take up a longevity (risk pooled) income product."

The PC notes most interest in the inquiry has come from super funds themselves. Public submissions on the draft report are open until Friday, 13 July 2019.

Read more: DefaultPCSuperannuationProductivity CommissionAustralianMySuperAISTAngela MacRaeAPRAASFAEva ScheerlinckFederal GovernmentKaren ChesterMartin FahyMyRetirementSG
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