It's decision time

Imagine for a moment that there is an A$650bn pot of money up for grabs. This thought is generating considerable excitement - and concern - as individual Australian employees are for the first time being given a say about where their compulsory retirement savings will accumulate. Janine Mace reports

Choice of pension (or superannuation as it is called in Australia) fund was first mooted around eight years ago, but has had a long and contentious legislative road to travel before it finally arrives in July this year.

Traditionally, the fund holding an Australian employee's compulsory superannuation contributions was selected by the employer, who usually chose one fund for its entire workforce.

Under the new rules, most employees will now be able to choose to which fund their contributions are directed.

Offering choice is opening the door to a whole new world of marketing by financial services providers eager to win a small slice of all those billions. But it is also generating fears that while product providers will benefit, some individual employees could lose out.

Model system

Unlike many other developed nations, Australia has a well-developed - and well-funded - three-pillar retirement income system that consists of a means-tested age pension, compulsory employer contributions and voluntary employee savings.

Despite some shortcomings, in recent years the system has been held up by the World Bank as a possible model for other countries struggling with the thorny issues of under-funded employer funds and overstretched government coffers trying to live up to past pension promises.

Whilst Australian employees have always had choice in relation to their voluntary retirement savings, they have not been able to select the destination for the compulsory contributions made on their behalf by their employer. These are held in a range of different funds depending on the employer and industry.

Australian retirement funds vary from traditional public sector schemes through to retail and small self managed funds, as well as individual company funds. In some cases, the destination for employer contributions is determined by industry-wide employment conditions or awards that direct the contributions into non-profit industry-based funds.

Freeing up the destination of employer contributions will have major ramifications in the Australian market given the size of the dollars involved, and that ongoing contributions are legislated at 9% of salary.

New research by the peak industry body, the Association of Superannuation Funds of Australia (ASFA), suggests that around 7.5% of the total A$648.9bn in Australian superannuation assets is likely to move following the introduction of choice of fund in July. The new rules are likely to see 5.7m Australians having a statutory right to choose their own superannuation fund and, of those, ASFA expects 8% or some 456,000 to exercise choice.

Fund managers and the banking sector have long been pushing for the introduction of choice in the hope of snaring more of the billions flowing into superannuation funds.

Richard Gilbert, head of the Investment & Financial Services Association (which represents the retail and wholesale funds management and life insurance industries), reiterated the pro-choice view when the legislation finally passed through parliament. 'Given that, for most people, super savings are the biggest financial investment decision they will have to make after buying a house, it is vital that consumers have sovereignty over their retirement savings investments,' he said.

Switching concerns

Despite Gilbert's belief that choice 'will further increase competition in the industry and lead to downward pressure on fees and charges', there are ongoing concerns about the advertising and marketing costs likely to result from choice, as well as the need to avoid the mistakes that occurred elsewhere.

For a number of years, the choice legislation was held political captive to arguments about the need for tight member protection to avoid the UK pension mis-selling debacle - with its subsequent expensive compensation bill - and the excessive member churning that took place in Chile.

The financial services regulator, the Australian Securities and Investments Commission (ASIC), is particularly concerned about ensuring there is no repeat of the UK debacle.

'ASIC will be vigilant in monitoring compliance with advice obligations, particularly in a Choice of Fund environment, because superannuation is an important aspect of the retirement savings plans of Australian consumers,' explains ASIC's executive director of financial services regulation, Ian Johnston.

According to ASFA, there are already anecdotal reports of mis-selling occurring in the run-up to the July implementation, but the association believes the problem is not likely to be as large as in the UK due to regulatory and structural differences between the two countries.

Unlike many developed nations, Australia's retirement system has moved rapidly away from traditional defined benefit (DB) or average final salary style retirement schemes to newer accumulation or defined contribution style funds.

ASFA believes this means there will be fewer individuals with large accrued benefits likely to be tempted to transfer out of good defined benefit funds by fast-talking salesmen. Most Australian DB schemes are in the public sector and are largely exempt from choice.

Few private sector employers still offer pure DB schemes, most having moved to limit their liabilities by shifting to cheaper accumulation schemes. Problems may also be avoided as the bulk of members in accumulation funds do not yet have account balances worth poaching.

Educating the public

Despite these structural differences, concern remains about the potential for mis-selling.

'The biggest risk appears to be advisers mis-selling people into SMSF (self managed super fund) arrangements where the client involved doesn't have the skills, time or adequate savings to make this viable,' says Philippa Smith, ASFA's chief executive officer. 'Fortunately most instances of mis-selling so far seem to be isolated cases driven by individual advisers, not co-ordinated marketing campaigns by financial institutions.'

In the run-up to the introduction of choice, many superannuation industry participants have been very vocal in demanding a well-funded public education on choice.

While the Australian Government has allocated A$16m to an education campaign through the Australian Taxation Office, this is unlikely to have much impact on a largely disinterested population confused by the complexity of the current system. Research shows Australians frequently have low levels of financial literacy and constant legislative tinkering has further reduced interest levels.

Regulatory enforcement

Although public education is likely to be patchy, the regulatory regime in Australia is robust and there is high awareness of the problems that have occurred in other countries.

ASIC is stepping into the breach to ensure there is no wide scale repeat of the UK scandal. In December, the regulator announced it was undertaking a surveillance campaign to assess how financial advisers were complying with their obligations in relation to advice to switch financial products.

The requirements came into effect as part of the new Financial Services Reform (FSR) Act, which has created a much tighter regulatory environment for consumer advice and the sale of financial products in Australia.

Publicly, ASIC claimed that the aim of the campaign was to test the level of compliance with the new switching obligations and to determine if there was 'room for improvement' in the prelude to choice. However, most industry participants believe the campaign was also designed as a 'shot across the bows' to ensure everyone knew the regulator was serious about coming down hard on any inappropriate behaviour, with clear warnings about future enforcement action.

Explaining the rationale for the campaign, Johnston pinpointed the key role of financial advisers, noting that they will 'potentially play a crucial role in guiding choices of superannuation fund - in particular, where a change of fund is being recommended.'

Under the FSR Act, advisers are required to disclose clearly conflicts of interest, adviser remuneration and any limitations that affect their recommendations. When it comes to switching superannuation funds, they must also compare the existing fund with the recommended one; specifically disclose the costs, loss of benefits and other significant consequences likely to occur; and ensure the recommendation is appropriate and not misleading.

The regulator has indicated that it intends to monitor closely the reporting of fees and costs in the next few years to ensure fund members are able to make informed decisions.

Despite this, groups such as ASFA are urging fund members to take care and think carefully before moving their superannuation assets.

'Consumers would be best advised to 'look in the fridge before you go shopping'. Weigh up the benefits of what you have in your current fund against what is offered, and ask plenty of questions until you are satisfied,' Smith says.

Janine Mace is an Australian freelance finance and business journalist.