Competition in Superannuation plans

We recently had a number of young Australians visiting us and discussion focused on life, family but we did talk about the differences between the Canadian retirement planning model and the Australian model. 

For those interested here is a quick review of the Australian model showing some of the concerns. The concerns were highlighted in The Financial System Inquiry, which was established to develop a direction for the future of Australia's financial system. 

Superannuation is primarily a long-term savings vehicle to fund retirement. Australia’s superannuation sector has grown rapidly in the period since the Wallis Inquiry and is an important source of funding for long-term capital formation, which is important for productivity growth. Although the superannuation system has considerable strengths, the efficiency of the system is a significant issue. Superannuation in Australia is part of a three prong approach to retirement savings.

The Inquiry has examined the superannuation issues most relevant to the financial system and the economy. In general, it is difficult to separate these issues from Government policy settings because the size and growth of the superannuation system are largely a creation of Government policy.

There is little evidence of strong fee-based competition in the superannuation sector, and operating costs and fees appear high by international standards. This indicates there is scope for greater efficiency in the superannuation system.

Notwithstanding the difficulties in comparing fees and costs across funds, Australia’s superannuation sector has some of the highest operating costs among Organisation for Economic Co-operation and Development countries. The decline in fees over the past decade is modest, given the economies of scale that the sector has achieved. That said, high allocations to growth and alternative assets contribute to these costs, but they can also deliver higher after-fee returns to members.

In general, competition has led to feature-rich, but more costly, superannuation products, in part reflecting that many consumers are not fee sensitive. High demand for liquidity from superannuation funds may be reducing after-fee returns to members. The mandatory inter-fund portability timeframe of three days is contributing to higher allocations to liquid assets than the system requires.

It remains unclear whether funds are chasing short-term returns and, if so, whether this is contributing to lower after-fee returns, as well as to what extent more individual tailoring of asset allocations would produce net benefits to members.

Superannuation funds compete to attract and retain members. Competition between funds for members has largely been conducted on a non-fee basis, which has led to feature-rich and more costly superannuation products.

The Super System Review found “the model of member‐driven competition through ‘choice of fund’ … has struggled to deliver a competitive market that reduces costs for members

Superannuation funds also attract members by being the default fund for mandatory employer contributions.

The costs of superannuation funds, and the features they offer to members, are affected by the degree of competition among those providing services to the funds. This includes fund managers competing for superannuation fund clients, fund managers competing for access to platforms, and platforms competing to attract advisers. A trend in the wealth management sector is towards more vertical integration. Although this can provide some benefits to members of superannuation funds, the degree of cross-selling of services may reduce competitive pressures and contribute to higher costs in the sector but to date it has not reduced fees.

Why hasn't competition delivered optimal outcomes already?

Failure to exercise choice: Often a member does not choose the fund to which they belong. New employees typically become a member of their employer’s default fund.

Lack of price awareness: Compulsory contributions do not come directly out of members’ pockets, nor do the fees and other costs charged by the fund — at least not until they retire. This makes people much less price aware and much less likely to make a decision based on price or cost.

Lack of interest: Members are often not engaged with their superannuation until closer to retirement, so will not be sufficiently interested to respond to competitive behaviour on the part of funds until that time — if at all.

Agency and structural issues: There are limited opportunities for member vigilance or incentives for agency vigilance to reduce prices.

Complexity: Superannuation is inherently complex, and many consumers do not feel confident making decisions about it.

Lack of comparability: Even if members are engaged, contestability is weak at consumer level. This is because of product complexity and the lack of information and transparency about fees and performance.

Frictions: Even if members are interested in switching funds, often the paperwork and other ‘frictions’ in changing funds become too big a disincentive and they give up.