Following on from the Grattan Institute’s ‘Super Sting’ (of which I was somewhat critical – see Grattan and the fuss about Chile’s pensions), the follow-up paper ‘Super Savings’ is worth a read. At a minimum it should be reflectively read by the executive and trustee of every super fund in Australia. Valid and, given my role at a large super fund, sometimes humbling points are made. However now is not the time to proceed to a default tender process. Indeed if default tenders were implemented now it could damage the retirement outcomes of Australians.
What does Super Savings say?
The essence of Super Savings is that the existing industry is inefficient from a cost perspective and that a range of measures need to be implemented to reduce costs. The key efficiency measures recommended are:
- The government should run a tender to select funds for default superannuation
- Government should take steps to slow the creation of new excess accounts
- Encourage less efficient funds to merge with efficient ones
- Introduce measures to strongly encourage the selection of lower cost products in the choice part of the superannuation market.
The Grattan Institute estimates that these initiatives could save over $1.5 billion per year.
In-depth cost analysis
Super Savings finds that administration costs are too high, because there are too many accounts, too many super funds and many charge high administration fees (compared to what Grattan labels ‘lean funds’). Some areas identified as sources of excessive cost are marketing and sales costs, some member communications, and overly diverse product lines.
This is where a system review is most confronting for those in the superannuation industry. Faced with competition for members, funds spend more to retain and attract members to ensure a stable fund base to support the planned implementation of value-adding services. Without a stable membership it is hard to commit to projects with a capital expense, examples being MySuper and the Stronger Super reforms. So at a fund level, marketing and sales are justifiable, but when we step back to an industry or system level, Grattan highlights the negative impact of these costs on the Australian public.
The Super Savings report also claims that investment fees are too high and that active management does not add value. In my article on Grattan’s first report I suggested that it is difficult for people with little funds management industry experience to understand all the nuances of the investment fee / fund performance debate. To Grattan’s credit this paper provides much more analysis and I can see they have considered seminal academic literature and consulted with the private sector. However the debate around investment fees and outcomes is far more complex than they have presented. It seems that when an outsider looks at the issue of investment fees the recommendation is to head towards a passive solution. This is because many other issues are not considered, simple examples in this case being risk reduction and the quality of passive benchmarks. Unfortunately this is the case with Grattan’s report.
Is low cost the solution? A critique of Super Savings
All else being equal, should a reduction in costs improve the retirement outcomes of Australians, as claimed by Grattan? I don’t believe so, at least at the present time. Indeed a focus on cost reduction could lead to worse outcomes for superannuants. There is a productivity and cost efficiency persuasion to this report: the primary report author, Jim Minifie, is the Productivity Growth Director at Grattan. However are the conditions right for implementing productivity and efficiency reforms in superannuation? Consider the following:
- Though the Superannuation Guarantee has been around for nearly 25 years, the retirement savings industry is still not fully formed. This may sound strange but consider the lack of a clear direction, changing regulations, and the more recent focus on longevity issues and it becomes easier to accept. This is the same for retirement systems in most countries around the world (the exceptions being the well-established collective systems we see in some European countries). Our post-retirement solutions are embryonic. It is important that these solutions interact efficiently with our costly Age Pension system. What is not well understood is that the design of the post-retirement solution will impact upon the optimal design of our accumulation strategies. The complexity, technology, people and creativity required to create the wonderful fully formed whole-of-life solution that Australians deserve is significant. The solution is unclear – indeed there may be a number of good solutions. Would we reach these solutions and have the necessary discovery process if the focus switched to one of pure cost reduction? The opportunity cost of an inefficiently designed system could easily exceed the cost savings of implementing cost efficiencies at too early a point in time. Recent regulatory reviews such as the Super System (‘Cooper’) Review and the Financial System (‘Murray’) Inquiry failed to address key issues which could have guided and accelerated the development of post-retirement solutions (see Has the FSI missed the elephant in the room?). In a report where ‘fees’ and ‘returns’ are mentioned prolifically, ‘mortality’, ‘longevity’ and ‘post-retirement’ are not mentioned once.
- The Grattan Institute focuses on the core services required of super funds in coming to their recommendations. This assumes that all other non-core services are provided effectively and efficiently by either government or the private sector. Consider the example of financial education. Around Australia and the world, financial literacy levels are appallingly low. Australian schools do not have mandated financial literacy programs and question marks remain as to whether the Government has effectively addressed the problem. (In Australia, ASIC has a National Financial Literacy Strategy and with Financial Literacy Australia, they have projects to improve financial literacy, but they announced in late 2014 that the MoneySmart Week initiative will be discontinued). The cost of financial illiteracy is high but difficult to measure: financially illiterate people are much more likely to be liquidity-constrained, overindebted, and poor (see A sombre reflection on financial literacy). Many super funds work hard to improve the financial literacy levels of their members. Yet services such as this are likely to be viewed as not having a direct benefit by Grattan, partly because the undoubted benefits are difficult to measure.
- Nationwide default plans have strong application if all members are generic. This is not the case: for instance members differ by work pattern, wealth path and occupation. A generic plan could have huge opportunity costs on members who are not ‘average’. A simple example is occupation. There exists great dispersion of insurance costs for members across different occupations, yet insurance contracts are typically determined at a fund level. A fund which blends members by occupation may face significant member equity issues associated with cross-subsidisation. This is just one example of the costs of treating individuals generically.
The Grattan Institute strongly challenges the super industry to have a good look at itself and justify the fees and added value provided to members. Unfortunately I think it applies a productivity focus to the superannuation industry in absence of recognition of the crucial stage of development the industry is at (and one which previous regulatory reviews failed to provide the necessary guidance to accelerate). I am not confident that Grattan has considered these challenges sufficiently in its analysis (where not a single mention of the words ‘mortality’, ‘longevity’ and ‘post-retirement’ occurs) and I feel it makes potentially incorrect assumptions that some of the highly valuable services provided by super funds, such as financial literacy, will be adequately provided elsewhere. It is too early, and ultimately damaging, to implement the most impactful recommendation of a default tender process. However there is little a rational person could say against recommendations (2) to (4) above. The prospect of (1) in the future should exist to keep efficiency front of mind for the industry. There will likely be a time when the default process outlined is appropriate, but let’s reconsider that when the crucial issue of post-retirement solutions has been worked through.
David Bell is Chief Investment Officer at AUSCOAL Super. He is working towards a PhD at University of New South Wales. The views contained in this article are those of the author and not AUSCOAL Super.