Free To Choose, As Well As Lose

The Sydney Morning Herald, Sydney, Australia
June 26, 2004

Those taking the plunge into the new choice of fund environment could find themselves in deep water. Photo: Leanne Hartley

Choice of superannuation fund is a nice idea, writes Simon Hoyle, but reality could be quite different.

The term "pension mis-selling" might not mean much to you, but with choice of superannuation fund now a reality it might pay to become familiar with it.

Pension mis-selling describes the situation that arose in Britain between April 29, 1988, and June 30, 1994, after the government decided it would be a good idea to let individuals buy pensions from private-sector providers.

The government was saying people should have the choice of who provided their pension - that it should not necessarily be only their employer - and that they should be allowed to buy, in effect, a retail pension fund.

Many who decided, or were persuaded, to buy a retail fund should have stayed just where they were. High-pressure tactics by commission-based salespeople led to tens of thousands of people being sold products that proved to be entirely unsuitable.

High fees and charges and poor investment returns combined to shrink the retirement savings of these people. 

Many found themselves locked in, and unable to switch to more appropriate products without incurring very high exit fees.

The result was a nightmare for investors, pension providers and the government. As at the end of October last year an estimated £11.5 billion had been paid in compensation for mis-selling.

The British experience serves to illustrate what can go wrong when, even with the best intentions, choice is given to people who are unprepared for it. It also shows how mendacious salespeople can exploit unsuspecting consumers, and how something that starts out as a fine idea can turn into a mess.

In Australia, after seven years of false starts, superannuation fund choice is now a reality. A start date of July 1, 2005, has been set. And as sure as eggs, there will be salespeople out to make a quick buck.

The aim of the choice regime is to allow employees to choose where their compulsory, employer-paid superannuation contributions go. In many cases, employees are presently locked into a single fund, which may or may not be the best one for them.

The Assistant Treasurer, Senator Helen Coonan, says the arguments against choice "just don't stack up".

"We know choice works," Coonan said, in a statement announcing the passage of choice legislation through Parliament.

"Many employers already offer employees choice of fund - a fact backed up by the Association of Superannuation Funds of Australia - and choice has been operating successfully in Western Australia for many years.

"If Labor's scaremongering is true, why is there no evidence of choice being costly for employers or of unscrupulous funds taking advantage of employees?

"A substantial education campaign will support the introduction of choice. It will encourage people to take an interest in their superannuation and carefully consider any decision to change funds."

No one is suggesting that choice is not desirable. In a statement, the chief executive of the Investment and Financial Services Association, Richard Gilbert, said choice had been "a long time coming", and that "this is a good result for consumers".

"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 says.

"IFSA further welcomes the one-year transition period to give industry enough time to adjust to the raft of changes about to be introduced. 

"Super choice of fund legislation will further increase competition in the industry and lead to downward pressure on fees and charges."

Nor is anyone suggesting that problems on the scale of the British pension mis-selling episode will arise here. But there are concerns that parallels exist, and that there will be trouble for a significant number of superannuation fund members who will be persuaded or pressured to switch super funds, against their best interests.

The chief executive of the Australian Institute of Superannuation Trustees, Susan Ryan, says comparing pension mis-selling in Britain to the situation that may arise in Australia is valid. 

The potential implications of poorly exercised superannuation fund choice don't bear thinking about. "We think there are many dangers in this," Ryan says. "There are more dangers than opportunities. Some people may be able to work it all out, but many people, who are in the optimal fund for them, may be seduced out of it.

"In Australia we are a lot further down the track [than the British regime was] in terms of compulsory super, compulsory reporting to members, and our industry is more developed and more friendly.

"But if a person has a considerable accumulation in, say, a big industry fund or a big corporate fund, and they are told they can put it somewhere else, they are going to be the target of marketing."

According to Ryan it wasn't only people with small account balances that made unwise choices in Britain. "People in big public-sector schemes, like teachers and nurses, opted out," she says. "It happened there, it can happen here.

"We've got more to protect members, but we haven't got a guarantee that every member will grasp the significance of what they are doing.

"It's worth referring to [the British] episode, and it's worth referring to the fact that middle-class, well-educated individuals made choices that, when you look back on them, seem incomprehensible. But they made them."

Ryan says the message from super fund trustees to fund members is: Be careful.

"It's your life savings, and if you put it in the wrong spot no one is going to make it up for you."

As consumers, we can arm ourselves against the likely onslaught - and as Ryan notes, we have a lot more information available to us than investors in Britain had. The best defence against making a poor choice or being ripped off by an unscrupulous salesperson is knowledge.

First of all, it is worth considering why we need choice in the first place, apart from the ideological or philosophical position that we all should be free to choose what we want to do and when we want to do it.

Ryan says the choice regime as it has come about is not the result of consumer demand. It is the result of players in the financial services industry thinking it would be good if they were given an opportunity to sell their products to members of public-sector, industry and corporate funds, who they otherwise couldn't appeal to as potential customers.

Choice of superannuation fund will only be worthwhile if it is a way of generating more money to live on when we retire. If it does not, or if some people end up with less to live on than if they stay in the fund they are in now, then it is a waste of time and effort.

The thing most super fund members focus on is how much is credited to their accounts each year by way of investment earnings. But this is a net figure; the amount credited is the gross investment return of the fund, minus fees and charges (and other costs, including member protection).

It does not necessarily follow that a high-fee fund will have better services and systems - the fees might serve only to make the fund promoter rich.

"You're likely to get better value in a not-for-profit fund," Ryan says.

"The fees charged to members in a not-for-profit fund are just cost-recovery and beyond that there's no need for the fund to recover or charge more fees.

"If you are in a retail fund, you may want to go into a not-for-profit fund, but you have to look at what you are giving up. You may be giving up investment choice. You will certainly be giving up a lot of marketing material.

"It puts a lot of direct responsibility back on the individual member, but we know that people find these complex [financial] arrangements very daunting. As a result, they often get waylaid."

Ryan says the standards of financial planners, advisers and the financial services industry generally have improved significantly in recent years.

"There's not as much danger as if this had gone through years ago when the government first tried it," she says.

ASFA's chief executive, Philippa Smith, says: "There are still a few more boxes to tick if we are to have informed choice and effective competition.

"Choice is definitely good but, for choice of fund to be effective and beneficial to consumers, we need three essential elements in place: education, disclosure and protection."

Informed choice is key to consumers being better off under the new regime, Smith says.

"There is little point in having a plethora of options to choose from if you don't understand any of them. 

She cites research by ANZ Bank on the low levels of financial literacy in the community, and says the Federal Government's allocation of $14 million over four years to alert people to super choice is a tiny amount when spread over 20 million account holders.

"You also need to be able to compare the price tag. Some steps have been made on the fee-disclosure front, but unfortunately they don't go far enough.

"We don't want a repeat of the mis-selling debacle in the UK following the deregulation of the pension system," Smith says. To ensure that doesn't occur, the Australian Securities and Investments Commission will need to be a vigilant regulator.

The shadow minister for retirement incomes and savings, Senator Nick Sherry, says choice of super fund is a welcome development. "It's great," he says. "But it's got to be done properly."

Sherry says his concerns revolve around the average member's ability to make an informed decision on which fund is best for them.

While a repeat of the British experience isn't on the cards, "I think there will be elements of that here," he says. 

Sherry says there are some features of the Australian market that could make the problems worse, while there are others that could mitigate them.

For example, in Britain only 40 per cent of employees were members of pension funds. In Australia, superannuation is compulsory, with an estimated 90 per cent of employees in a fund. Which means more targets for unscrupulous salespeople.

On the other hand, he says, the industry in Australia argues that in Britain there wasn't disclosure, nor the equivalent of the Financial Services Reform Act to scrutinise financial planners. "That's true; that's accepted," he says. "But those things in themselves do not prevent malpractice in respect of commission-based selling.

"I would argue that some of the safeguards here will actually contribute to the problem."

For instance, the average product disclosure statement for a retail fund can run to 60 or 70 pages. A statement might contain all the information someone needs to make a judgement about a particular fund, but it is just as likely to be so daunting that it encourages them to seek professional advice. Once they are in the hands of an adviser, there is a greater risk they will become a victim.

"That's the irony of it," Sherry says. "There are some things in the Australian system that make the potential problem worse; there are some things that make it better." 

Sherry says the problems in Britain started slowly and snowballed. Once salespeople, in pursuit of commission income, started to switch people from one fund to another (or to "churn" them, to use the industry phrase), the companies that were losing business had to respond.

"Initially most of the industry tried to do the right thing," Sherry says. "But a few people started to churn and the rest just followed, because they had to win back the business that had been churned out of their products.

"The malpractice spread throughout the industry. There was virtually no institution that wasn't involved in the mis-selling."

Sherry says supporters of the choice regime as it has been structured in Australia argue that it is a free market and should be allowed to work as such. The argument is that competition will improve the quality of the product, and lead to lower costs.

But he says superannuation isn't a free market - it's compulsory - so safeguards absolutely have to be built in, and adequate. A market only operates effectively if consumers are empowered to make informed choices.

"I simply say to the proponents of choice: Can you guarantee that everyone's fees and charges will go down? State that, if that's your position. But they are pretty wary about doing that."