Bill Buttler wonders whether the Stronger Super framework will lead us to a better and more efficient business model.
Somewhere across the sea, in another part of the world, lies the magical Land of Oz. Politically, economically and culturally, the Oz lifestyle is not so different from ours. What sets Oz apart from its neighbours is the ability of its citizens to make rational decisions about major political questions without too much fuss.
One fine day, the head of the Oz Treasury department approached the Treasurer with a new report.
“Our research shows that we are heading into some long-term challenges requiring us to manage an ageing population. I am afraid that we won’t be able to meet people’s retirement expectations without big increases in taxes for those still working,” said the head of the Oz Treasury department.
“This is not going to happen for another 20 years, but we need to start planning now”.
“Ok”, said the Treasurer,“What does your department suggest?”
“Well, we are proposing that the government of Oz should mandate a compulsory retirement scheme, fully funded by employer contributions of (say) 10 per cent of all wages. We can gradually make the current government pension means-tested, so the pressure is taken off the Oz Budget as people start to retire with their own retirement account. Our projections show that, if we start now, we should be able to minimise the future budgetary impact. If we delay much longer, it will be too late to act.”
“Hmm …,” said the Treasurer. “But how are we going to manage the accumulated funds? It will require a whole new bureaucracy.”
“We are not suggesting that the government should manage the new scheme,” said the head of the Oz Treasury department.
“If you hand management over to the private sector, you will be able to get the benefits and efficiencies of competition among fund managers. The managers will drive prices down as they compete for the huge amounts of cash this system will generate. Plus, does your government really want to run the risk of being blamed if money is lost or investments perform poorly?”
“You are right,” said the Treasurer.“As a government, we are committed to the principle of private enterprise – especially if it helps us avoid losing office! However, I still have a question – how are we going to decide which fund managers will get the job? Surely we will just be opening ourselves up to the same risk if we select particular managers?”
Leave it to the market
At this point, the assistant to the department head piped up: “That’s easy – we just leave it to individuals to pick their own fund from the range of approved funds available on the existing market. You will probably want to set up a regulatory framework to keep out crooks and incompetent managers, but otherwise you can leave it to the market.”
“That’s all very well for you to say,” said the Treasurer, “but we have young people starting their first jobs, not to mention plenty of people with little financial knowledge. How are they going to be able to understand what is on offer, much less make a choice? We at least have to provide a ‘default’ fund for those who can’t be bothered – and I suspect that will be most of them!”
“Perhaps we could get the employers to nominate a default fund?” said the assistant.
“No, that won’t work,” said his boss brusquely. “What qualifications do employers have to evaluate investment strategies? Why would they want to accept the liability for making a bad choice? And anyway, we would be creating a monster – every time someone changed jobs, they would get a new account with their new employer’s default fund. And I bet most of them will never get around to transferring their old account to their new fund. Before you know it, we will have more retirement accounts than we have people in the workforce.”
“How about getting the employers and trade unions together to make a decision on an industry by industry basis?” said the Treasurer.
“At least that will limit the number of new accounts generated by employees changing jobs.”
Arcane demarcation
“Same problems,” said the department head. “We will get new accounts created every time an employee moves from one industry to another. Have you seen our arcane demarcation rules? And anyway, why do you think the trade unions and bosses are any better qualified to make a professional assessment of different investment strategies? If anything, the system would be even more open to decisions on the basis of industrial relations politicking. Why should the quality of an individual’s retirement fund be dependent on a lottery based on the industry he happens to work in?”
“Hmm …,” said the Treasurer again. “This is harder than I expected”. She was lost in thought for a few moments, and then her face brightened. “This is what we will do …
“First, we will create a new financial entity – let’s call it a platform. The job of platforms will be to receive retirement contributions, pretty much the same way as employees nominate a bank account for their salaries to be paid into. I expect the banks will all want to be platform providers, since it lines up with their normal banking services. It will be just as easy for new employees to choose a platform as it is for them to nominate a bank account, because the only features to assess will be the fees they pay and access to branch offices and online services.
“To handle investing the contribu- tions,” the Treasurer went on,“we will create an entity called a YourSuper option. YourSuper options will be ‘default’ investment strategies built around a typical growth-oriented profile suitable for long-term investors. To protect investors, we will create a regulatory environment around YourSuper and any alternative options the fund managers want to offer. Every platform will have to offer at least one YourSuper option, but we expect they will all want to offer a full range if they want to protect their customer base from day-to-day performance variations.”
Shift the problem
“Doesn’t this just shift the problem of selecting a default strategy back to the platforms?” asked the assistant Treasury head.
“Sure,” said his boss, “but at least the platform managers have or can buy in the skills to evaluate different investment strategies. It will be in their commercial interests to choose a good default YourSuper option, and to monitor performance. Moreover, our actuaries have cal- culated that the actual rate of investment return over the first 10 years of a person’s career has relatively little influence on the eventual retirement outcome. By the time employees have built up an account that matters, they will be closer to retirement and more engaged, so they will probably want to seek professional advice anyway.”
“And that brings me to the last component of our new system,” said the Treasurer.
“We will need to establish a framework for quality independent advice, separate from the fund management business. I don’t mind if the platform providers want to provide advice as part of the package, so long as their advisers are not remunerated by the fund manag- ers.”
“Hmm …,” said the department head, “that could be difficult …”
POSTSCRIPT
The Land of Oz is of course a fantasy world, and like all such idealist visions, from Plato’s Republic to Thomas More’s Utopia, retirement planning in Oz would probably end up as a totalitarian nightmare. However, the story does serve to highlight a few truths about Australia’s superannuation system:
• Whilst the award-based default fund system has served us well in getting a universal scheme up and running, it has largely been responsible for creating an inefficient proliferation of small accounts, which now has to be cleaned up via some form of auto-consolidation program;
• FoFA was inevitable – commercial funds could hardly expect to be given default fund status without removal of the conflicts involved in commission-based advice;
• The principle cuts both ways – “not-for-profit” status on its own cannot and should not be an adequate criterion for default fund status. Consequently, MySuper was inevitable as well;
• The open-platform model should have been tailor-made to deliver a portable superannuation account for many Australians. The inability of commercial operators to come up with a simple cost-effective product enabled industry funds and self-managed super fund promoters to build market share at their expense. Nevertheless, there is still an opportunity for the banks to re-enter the market with the right products.
Time will tell whether the new Stronger Super framework will lead us down the Yellow Brick Road to a better and more efficient business model.
