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The regulatory framework for default superannuation arrangements is a matter of keen interest for those with a stake in Australia’s superannuation system. The most recent chapter in this story has been the nomination of default funds in the award modernisation process. Where an employee does not nominate a superannuation fund, their employer must make its superannuation guarantee contributions to a default fund nominated in the relevant award.
Now, the Cooper Review into the superannuation system is examining default arrangements more closely and considering models from other countries. It canvasses the option of a national default superannuation fund sponsored by the Federal Government. The national default fund could be one of the 27 “super” superannuation funds the Chairman of the Cooper Review, Jeremy Cooper, suggests might best serve the interests of Australians [1].
Government intervention
A key issue for default superannuation arrangements is the level of government intervention involved. Government could “provide” the default superannuation product, as with a national default fund. Alternatively, it could prescribe the conditions to be met in order for a fund to be eligible as a default fund. Both types of intervention could be present at the same time and to greater and lesser extents.
In Australia, the regulatory framework currently includes elements of both provision and prescription. Although default superannuation is not “provided” by the government, a government agency (formerly the AIRC, now Fair Work Australia) is empowered to make awards, particularly “modern” awards, which specify default funds. (There has been significant criticism of Fair Work Australia’s bases and qualifications for doing so.) Although the nominated funds are not operated by the government, they have in a sense been given the government’s blessing and, to that extent, constitute a form of outsourcing.
Where awards do not apply, it is open to the employer to select a default fund from the wide range available within the different sectors - retail, industry and corporate. In this case there is an element of prescription, in the form of the rules that must be satisfied for a fund to be eligible as a default fund for superannuation guarantee purposes. Most notable is the requirement to offer minimum levels of death cover within the fund. There is no attempt to impose any caps on fees or mandate a particular investment approach.
Compare the current situation in Australia with the position in the UK, where a national fund sponsored by the government is being established. The target market for the new fund is moderate to low income earners. It will be open to all employers, and to all employees of employers who elect to participate. Members who cease employment can stay in the fund and continue to make contributions. An annual contribution limit will apply.
There will also be restrictions on moving benefits into and out of the UK scheme. This concept of “stickiness” in super finds a counterpart in the second phase of consultation by the Cooper Review. In particular, the Review asks questions about “short term-ism” in super and whether there is currently too much priority given to portability, switching and choice.
In a similar vein, the Australia Institute has recently published a paper advocating a “universal” default fund. As in the UK, the fund would be sponsored by the government. Key features would include:
- Passive not active investment management
- A “lifecycle” approach to asset allocation
- Smoothing of annual investment returns
- Low fees.
In New Zealand, KiwiSaver bears some similarities with the process in Australia of specifying default funds in “modern” awards. The NZ government has selected six default KiwiSaver providers, each a well-known name in retail financial services. Contributions to KiwiSaver are made to the NZ tax office which then remits the contributions to the funds. In this way, the tax office performs the function of a clearing house, making the collection and processing of contributions simpler for employers and providers alike.
In addition to the type and level of government intervention, there are two other key issues associated with default superannuation arrangements:
- Investment approach/asset allocation
- Fee and cost levels.
Investment approach/asset allocation
The Cooper Review observes that a “lifecycle” approach to asset allocation is common in other countries, including with 401(k) plans in the US. As noted, it is a key feature of the model advocated by the Australia Institute. Many Australian funds, particularly retail funds, offer a lifecycle investment option.
However, even with this type of approach, there is still a question about what the right allocation is between growth and defensive assets.
In Sweden, the pension system includes a “premium-determined pension” which appears to share many features of a defined contribution/account based pension product. This pension includes a wide range of member investment choice (over 700 options) but also has a default “option”. Formerly, the default could not be actively selected (nor re-selected, if the individual opted out of it). The default will now be able to be actively selected and, in addition, will be a lifecycle option.
Even so, the default lifecycle option will involve a relatively aggressive asset allocation. The individual’s savings will be 100% invested in equities until the age of 55, after which time the proportion of bonds will be gradually increased. In addition to this default option, there will be other ready-made lifecycle options which have different risk profiles.
This can be contrasted with the asset allocation rules for default arrangements in KiwiSaver. The allocation to growth assets must be between 15% and 25%, irrespective of the account holder’s age. This relatively low allocation to growth assets is perhaps explained by the fact that a KiwiSaver account, while an investment for retirement, doubles as a first home saver account, making short-term protection of capital more important.
Another issue that arises in relation to the investment of default superannuation monies is “active” versus “passive” asset management. The Cooper Review’s paper includes a table showing that two-thirds of active managers in the “Australian equities - general” category were outperformed by the S&P/ASX 200 Accumulation Index for the five years to the end of 2008. In Australian bonds, the result was yet worse: 97% were outperformed by the UBS Composite Bond Index. The Australia Institute claims that over a 20-year period only 10% of managers outperform the market.
In his speech to the ASFA conference on 12 November, Jeremy Cooper queried the role of investment managers in superannuation, without distinguishing between active or passive management. He appeared to criticise Australian superannuation trustees who entirely outsource their investment management and contrasted this with the two Canadian pension schemes which recently bid for Transurban. He asked whether Australian funds could follow suit and own major assets directly, thereby cutting out the intermediary and reducing agency costs?
Fee and cost levels
The flipside of the question of investment performance is the question of fees and costs.
Jeremy Cooper’s views on asset-based fees, particularly for investment management, are well known. In the same speech, he asked why superannuation trustees allow asset-based fees at all. In Jeremy Cooper’s view, superannuation trustees should be dictating terms and fee levels with investment managers. In noting that the starting point for investment management agreements is usually the IFSA standard agreement, he asked: “shouldn’t it be the person with the cheque book” who dictates the terms? Superannuation trustees, he said, “must start acting as if they are at the top of the food chain”. His views are directly linked to the scale of Australian superannuation savings, tipped to reach $3 trillion by 2025.
When the NZ government chose the default providers for KiwiSaver, the selection criteria included “competitive fee levels”. In order for any fund to be a KiwiSaver fund, its fees must be “reasonable”. The government actuary has provided some guidance on what will be regarded as reasonable. Cooper expects that the total of “non-numerically defined charges and expenses” should not exceed 0.2% in the first year of a fund’s operation and that this total should reduce “as funds increase and the fund achieves greater economies of scale”.
The fee levels in the Swedish premium-based pension scheme appear to be low. The Australia Institute claims that index funds typically have MERs in the region of 0.3% to 0.4%. A leading Australian retail superannuation provider launched a new product earlier this year with an investment fee for an index tracking balanced option of 0.65% (along with a $1.50 / week member fee).
Concluding comments
The second phase of consultation by the Cooper Review is focusing on reducing costs and lowering profit margins.
In doing so, the Review poses some fundamental questions about the right level of government involvement in default superannuation arrangements. Should the government “provide” default superannuation products, by means of a national default fund? If the Review ultimately recommends this approach, it could herald a major structural change to the Australian superannuation system.
It may be that the Review, or the government’s response in due course, takes a more incremental approach, focusing on prescription, rather than product “provision” by government. In our view, tighter rules around both fee and cost levels as well as investment approach/asset allocation are likely. The current “minimalist” approach to prescriptions for default arrangements (leaving aside “modern” awards) seems unlikely to survive.
Endnote
[1] The comments by Jeremy Cooper referred to in this article were made by him in a speech to the ASFA 2009 National Conference and Super Expo in Melbourne on 12 November 2009.