Productivity Commission sets out Four Models for Default Funds in Superannuation

The Productivity Commission (PC) published its draft report relating to allocating default contributions to superannuation funds, a few weeks ago. Their focus was around the issue of competition, and their core finding related to information problems in the market, i.e. buyers are disengaged because they don’t have enough information.

Currently, the Employer selects a default fund, unless this is specified by an Industrial instrument of some kind (an award, agreement, contract, etc.), and this is the receiving fund for SG contributions for employees who exercise no choice (default members).

The PC points out that competition can be promoted either through competition in the market or competition for the market. In the market, competition requires consumers to engage and choose. In the market competition is preferable, but where this is difficult to achieve, an auction or tender approach may be necessary.

The paper defines the “default market”, essentially, as first time contributors, and suggests that on change of employment, the current fund should be used by the new employer, unless the member directs otherwise. This significantly reduces the instances where a default fund needs to be identified, and will over time address the “many funds, many fees” problems that are well documented.

Their focus was around the issue of competition, and their core finding related to information problems in the market

It is worth noting, the PC will be recommending that any fund that wins default status will need to offer the same fees and services to any current default members, not just the new ones after the implementation date.

The PC’s assessment framework consists of five criteria:
• Member benefits
• Competition
• Integrity
• Stability
• System-wide costs

The baseline model that alternatives are considered against is one where there are no defaults, but where employers, unions etc. would be able to bargain with superannuation funds for group discounts.

The alternate models are briefly described below. The first two are in the market competition plays, the second two are for the market plays.

Assisted Employee Choice, wherein consumers would be strongly encouraged to exercise choice with information and nudges. It envisages a non-mandatory shortlist of good products, a voluntary product accreditation process for funds to make them eligible for short listing and a fund of last resort.

Assisted Employer Choice, where two lists would of suitable funds would be available and employers must select a fund from one or the other. The first list would be a “light filter” for large informed employers, requiring funds to meet mandatory minimum standards. The second list would be a “heavy filter” list for smaller less able to choose employers, with stricter criteria around investment performance and other product features.

Multi-Criteria Tender, which contemplates a pre-qualification stage, a tendering stage, a comparative evaluation stage resulting in up to 10 appointed winners, and a performance monitoring and enforcement stage post-appointment. This is analogous to how KiwiSaver appoints work in New Zealand.

Fee-based Auction, wherein a pre-qualification stage is conducted, a bidding metric (composite fee) is constructed, and a first-price sealed-bid auction is conducted to determine the winners. Again, monitoring and enforcement would be a key aspect of the system.

It is proposed that the first three stages in the latter two models be run by a government appointed body, established every 4 years for the purpose and then dissolved.

I think that the eventual public policy conclusion will be that employers should be relieved of selecting a default fund for their staff. “Employer involvement” is an anachronism that springs from the 1970s when employers did the works, including wearing the investment risk for the relatively few employees lucky enough to have super. In a world where the SG is seen by many as analogous to a payroll tax, employers will likely not want to be involved at all. And in a world of clearinghouses, there’s no employer overhead arising from diverse membership, so Assisted Employer choice is, in my view, unlikely.

Governments have, for years, been seeking ways to get people to engage, and what better way than Assisted Employee Choice?

The latter two models require a very complex process to be developed and performed every four years. Given that these kinds or processes are so unfamiliar in this marketplace, there are real risks that even a valid process would be misunderstood by the market and result in poor outcomes. That is something no government of any flavour wants to associated with.

Governments have, for years, been seeking ways to get people to engage, and what better way than Assisted Employee Choice? At base, I think most of us value living in a free society where we can each make our own arrangements, and our economy reflects that. Of the 4 models offered up the first seems the best fit with that.

All four models contemplate that default funds should meet some higher standard than other MySuper products, which I continue to find baffling. I cannot understand where the implied shortfall in the MySuper standards is that requires attention before making a fund a default fund