Why picking a superannuation fund isn’t like shopping for groceries
Economists normally assume more choice is a brilliant thing for customers. Whether we're buying groceries, shopping online, or taking out a mortgage, surely it helps to have more businesses fighting for your dollar, right?
But how much is this true for one of the most important financial decisions people have to make – where to put their superannuation?
This question is being thrashed out by the Productivity Commission, which is looking into how billions of dollars in super contributions are managed on behalf of members who don't make an active choice about their fund.
The commission is yet to deliver its final report to the government, but a few things are already pretty clear.
Economists' favourite policy prescription for so many other problems - harnessing the market forces of competition, and greater consumer choice - probably won't work as well in this area.
That is because choosing a retirement saving fund is a very different task from most choices we make everyday as consumers, with potentially much bigger implications.
The commission's inquiry is into "default" super, which refers to $474 billion in retirement savings of people who do not make an active choice about how their money is managed.
Crucially, about two thirds of all super fund members have their money in default accounts.
The precise arrangements for default super are tied up with superannuation's origins in the industrial relations system, so current rules vary across industries, and types of employment.
In its draft report, the commission proposed a few new potential models for new employees who don't already have a fund, and who don't make an active choice. Its aim is to "nudge" people towards making good decisions by limiting their choice to a small subset of high-performing funds. This could include limiting members' options to a shortlist of only four to 10 funds.
Neither the not-for-profit super funds, nor the for-profit funds owned by banks and wealth managers, seem particularly happy with these proposals.
But the for-profit retail funds, in particular, seem worried by the prospect of such a short shortlist. They are keenly talking up the virtues of greater choice.
This is how Financial Services Council chief executive Sally Loane put it to a public hearing on the proposal in May, when the group also argued for a longer shortlist.
"No one gives employers or unions carte blanche to choose their bank accounts, so why do so many allow them to choose their super funds?"
"It's our view that too many people in some parts of the super system assume that young people can't or won't make decisions about their long-term future, that they're chronically disengaged, that they need decisions made for them by a third party who may or may not have their best interests at heart."
The FSC also this month released a report commissioned from Deloitte Access Economics that found members could save $292 million in fees if greater competition was unleashed in default super.
Now, I agree there could be benefits from forcing all super funds to better compete on their costs and performance. That would partly be achieved by forcing funds to compete to get a spot on the shortlist. Members should also be to choose their own fund if they want to.
But beyond that, I'm not convinced more "choice" is a silver bullet here.
Why? Because super is not like other shopping decisions, as explained by Professor Nicholas Barr of the London School of Economics this month after speaking at the Annual Colloquium of Superannuation Researchers in Sydney, in comments reported by the AFR.
Barr, an expert on pension schemes, told me via email why choice and competition are great in many other markets - but not in complicated areas like super.
"Choice and competition work well in a wide range of areas such as smart phones, cars, restaurants, supermarkets, holidays. But they work well for a reason – those are all areas in which consumers are reasonably well-informed," he said.
"They work much less well where consumers are not well-informed, which is particularly the case for complex products."
He draws the comparison with prescription-only drugs, where we all accept there are limits on consumer choice.
"The choice of pension fund is more like pharmaceutical drugs than like smart phones. People make bad choices, for example not understanding the extent to which administrative charges eat into their accumulation," he says.
It's a good point. Super may seem simple enough, but it's financially complex.
The fact two thirds of accounts are in default funds suggests most of us probably don't take a deep interest in our super. In the jargon, we are "disengaged." We probably haven't weighed up the pros and cons of how small variations in fees can affect accumulated savings.
Yet Barr points out how important such details can be. A management fee of one per cent can wiped out 20 per cent of how much you save over a career, he says.
In other words, people who don't want to make an active and informed choice should be protected, by default funds..
Those who want to choose their fund should be able to - but there are strong grounds for keeping this list short, to only include the best and prevent us being conned by marketing tricks.
Thankfully, it's a point the Productivity Commission also appears to recognise.
Its draft report cited research that found when you give people a shortlist with more than 10 funds on it, they're more likely to make no choice at all because of "choice overload."
When quizzing the FSC at a hearing in May, deputy chair Karen Chester said a shortlist of say, more than 60 funds, would be like "choosing ham at a New York deli" or "toothpaste in a toothpaste aisle of Australia, there's just too many to choose from and they can't tell the difference."
There are certainly ways in which more competition in super would help members. However, giving disengaged savers far greater "choice" doesn't look like being one of them.