Superannuation fund choice: Opening Pandora’s box

Natalie Gallery, University of Sydney

Earlier this year the Federal Government resurrected its policy on choice of superannuation fund after its bill on this issue failed in the Senate in 2001. Presently most employees have to join the superannuation fund specified by their employer or workplace agreement. Choice of fund means that employees will be able to choose which fund they join and have the freedom to switch to another fund later if they choose. The Government expects that greater freedom of choice will increase competition between funds, which in turn will reduce fund costs, increase returns, and so maximise members’ benefits (SSCS 1998). Informed choice is essential for the choice of fund objectives to be met but significant barriers to informed choice presently exist. These barriers include an absence of relevant information disclosures by superannuation funds and the greater problem of members who are unable or are unwilling to exercise choice. While the first barrier could be overcome by establishing standardised measures of fund performance, the potential problem of large numbers of workers not exercising choice requires rethinking the default option. A possible solution is the establishment of a universal default fund.

Barriers to Achieving Informed Choice

The Government first flagged its intention to introduce choice of fund during the 1996 election campaign. After several iterations between the House of Representatives and the Senate, the bill ultimately failed on the vote of the Australian Democrats who supported the choice bill but sought to trade off their support on that bill in exchange for the Government addressing the unrelated issue of same-sex couple rights to access of superannuation benefits. The Government declined the Democrats’ ‘deal’ and the choice issue was shelved.

After vigorously opposing the Government’s choice of fund proposals for many years, the Labor Party is also now canvassing the choice issue in a policy options paper (see Sherry 2002). Now that choice of fund is firmly back on the agenda, no doubt the same issues that arose during the six-year battle over the choice bill will be debated again. Although all agreed that informed choice is an essential prerequisite for a choice-of-fund system to work effectively, the question of how informed choice might be achieved was not fully explored. Disclosure and education were flagged as two key factors impacting informed choice. To exercise informed choice, superannuation fund members first need access to relevant and reliable information, and second, they need to have the capacity and motivation to use that information. Effective disclosure is controlled by superannuation funds and through regulation. The capacity and motivation to use information are internal to individual members, and can be influenced by education programs.

Significant barriers to informed choice presently exist.

Before choice is widely introduced, problems with both fund disclosure practices and members’ capacity and willingness to exercise choice need to be addressed. If not, Australians might experience the same sorts of problems as members of superannuation funds in the United Kingdom in the 1990s, where billions of pounds of retirement savings were lost through mis-selling when choice was introduced in 1988. Legislation gave employees greater choice by allowing them to transfer from their employer-sponsored pension plans to a personal pension product offered by insurance companies (Select Committee on Treasury 1998). Many employees were lured away from sound company pension plans by unrealistic promises made by insurance companies and independent financial advisers, to their ‘considerable financial detriment’ (SSCS 1998, para. 11.4). By the early 1990s mis-selling became clear and regulators stepped in to stop the practices and seek compensation for losses. A recent estimate of the total amount that insurance companies are likely to pay out in compensation is A$27 billion (McIlwrath 2000). An important lesson from the U.K. experience is that most of those affected had reasonable levels of education; many were highly trained professionals such as academics and teachers. Clearly even the well educated are susceptible to making poor pension plan choices (Kennedy 1998).

Active choice involves the risk of making wrong decisions, but members who are unable or unwilling to exercise choice pose an even larger problem. Under a choice-of-fund regime their employers will direct these members’ contributions to a default fund, which under present proposals is likely to be the major fund operating in each workplace. The Senate Select Committee on Superannuation (1998 para. 8.24) highlighted the importance of ensuring that ‘default funds protect the interests of employees who are unable to protect their own long-term interests’ and the need for greater regulation of default funds. However, industry representatives argued against increasing regulation of default funds because it would work against underlying competitive pressures (SSCS 1998, para. 8.16). This apparent conflict between the two objectives of protecting the interests of members in default funds and market competition requires rethinking the default fund option.

Disclosure of Comparable and Understandable Information

The Financial Services Reform (FSR) Act recently expanded superannuation disclosure requirements. However, have reforms delivered on their specific aim of providing comparable and understandable information? The Australian accounting conceptual framework includes these two characteristics of comparability and understandability as essential for financial information to be useful for decision-making. However, the characteristics of ‘relevance’ and ‘reliability’ are pre-eminent (SAC 3): to be useful, information needs to be relevant to the decision at hand; to be reliable, information faithfully represents, without undue bias or error, the substance of the transactions and events that it purports to represent.

Present industry guidelines on calculation of performance ratios are not reliable.

Current or potential members’ decisions require information about the income a fund generates and the fees it charges, usually measured as investment returns and management expense ratios (MERs) respectively. When the reporting of these performance ratios is standardised so that all superannuation funds calculate the ratios on the same basis, measures are reliable and comparable because there is greater confidence that the rates of return and MERs of different funds represent the same types of underlying economic events. Present industry guidelines on calculation of MERs and other performance ratios are not reliable, even on the admission of industry insiders, because funds can include or exclude various items with discretion.

An accounting standard prescribing how the ratios should be measured will enhance the reliability of fund performance information, and support improved choice. Indeed, participants in the previous debate on choice of fund expressed concern about the lack of consistency in application of industry guidelines on performance measurement and the absence of enforceable standards. When the (then) Senate Select Committee on Superannuation and Financial Services learned from the Chairman of the Australian Accounting Standards Board in early 2001 that the accounting standard governing the preparation of superannuation fund financial reports (AAS 25) was to be reviewed, they expressed hope that revisions would address the standardisation issue (SSCSFS 2001). However, the draft of the revised accounting standard (ED AAS 25) issued by the Institute of Chartered Accountants in mid-2001 does not address this matter, and to date neither the accounting profession nor the accounting standard setters have publicly proposed further revision. It seems that a valuable opportunity to establish standards to ensure superannuation funds disclose information that is comparable has been lost.

In relation to the second aim of the financial services reforms—for disclosed information to be understandable—two issues arise. First, to make financial information more understandable generally requires simplification of that information (for example, graphical presentation). However, with simplification information is lost, giving rise to a dilemma: if financial information is simplified to make it more understandable, then the loss of detail makes the information less reliable. Such transformations are also open to manipulation in the absence of audit. Given that superannuation information is by nature complex, simplification inevitably leads to disclosure of less reliable, and therefore less useful information.

Capacity and Motivation of Members to Exercise Choice

Even if these significant problems with ensuring disclosure of reliable, comparable, and understandable information were overcome, the issue of whether superannuation fund members have the capacity and/or motivation to use the information to exercise choice remains. With the introduction of choice the government proposes to include an education program for the eight million or so superannuation fund members. However, many simply do not have the capacity to become adequately informed to make choices. ABS statistics show that 46 per cent of Australians have ‘unsatisfactorily low levels of literacy’ and fifteen per cent are ‘functionally illiterate’ (SSCSFS 2000). These statistics suggest that it will not be possible to educate the vast population of superannuation members to adequate levels of financial literacy for them to make informed decisions about their superannuation.

Many do not have the capacity to become adequately informed to make choices.

Further, members suffer ‘emotional disengagement’ from their superannuation. Structural changes in the labour market have exacerbated the problem with the growth of casual jobs increasing the risk of workers losing track of their superannuation entitlements. One recent survey found that up to 50 per cent of workers are unsure as to which fund their superannuation contributions have been directed (Lampe 2001). Another found that 64 per cent of fund members had little or no knowledge of their funds, only a quarter of fund members read some or all of the annual fund report, and only 43 per cent of those were able to recall some information detailed in the report (Kavanagh 1998).

Widespread member disengagement is further demonstrated by the large amounts of money the Australian Taxation Office (ATO) has collected from employers who failed to comply with Superannuation Guarantee (SG) obligations ($100 million represented by 403,000 unredeemed SG vouchers) for which the ATO is trying to find the owners (ANAO 2000). Then there are the lost members, that is, those members with whom superannuation funds have lost contact and have been referred to the ATO Lost Members Register. There are approximately four million accounts with total assets of $5.5 billion on the register, representing about eighteen per cent of total superannuation accounts (Productivity Commission 2001). If large numbers of members presently do not have the ability and/or motivation to keep track of their superannuation entitlements, are they likely to actively exercise choice when it is offered?

Most people agree with the principle of fund choice. The ASSIRT Investor Market Trends survey found that 83 per cent of respondents considered choice-of-fund legislation to be a ‘good’ or ‘great’ idea (Superfunds 2000). However, when choice is actually offered—for example, when funds offer their members investment choice—on average, fewer than ten percent of members actively exercise that choice (SSCSFS 2000). This suggests that many individuals value choice as an option, but are willing to exercise that choice only where the expected benefits exceed risk transfer costs (Brown, Gallery & Gallery 2002). Becoming informed is costly, particularly in relation to complex superannuation issues. The costs include the time taken to acquire, read, and interpret relevant fund reports and other material, to attend training sessions, and to seek professional advice from financial experts. There is also the risk and associated costs of making the wrong decision. If these costs exceed the perceived benefits of choice, then members will rationally avoid the choice decision. Even where members have the capacity to become informed to exercise choice, risk transfer costs are likely explain why they do not do so (Brown, Gallery, Gallery & Guest 2001).

The Way Forward?

With the recent corporate collapses and accounting scandals, much has been said about the need for greater transparency and improved disclosure by corporations. Despite various parliamentary and other reviews expressing concern about super fund disclosure, there has been no concerted effort to remedy the inadequacies of financial disclosure standards and practices. The disclosure problem can be relatively easily overcome by putting in place a set of effective disclosure rules ensuring that trustees are fully accountable to their members, and that members and others have full access to relevant, reliable, and comparable information about the financial position and performance of superannuation funds.

A viable alternative is to establish a universal default fund.

However, establishing and enforcing disclosure standards does not overcome the wider problem of members lacking the skills or motivation to become informed to exercise choice. If choice is introduced when large numbers of fund members are unable or are unwilling to exercise choice, there is a very real danger of exploitation on a massive scale such as that experienced in the United Kingdom. Past experience of low take-up rates where choice is offered suggests that when choice of fund is introduced universally, only a minority of members will actively participate. The Association of Superannuation Funds of Australia estimates that as many as 50 to 70 per cent of workers will not make an active choice.

Given arguments that increased regulation of default funds will work against competition in the superannuation industry, a viable alternative is to establish a universal default fund (UDF), as suggested by Brown et al. (2002). It would be more efficient to more closely regulate a single UDF than multiple default funds, and the UDF would still be subject to competitive market pressures, because members of the UDF would still have a choice to join another fund. Thus, a government-regulated UDF would cater for those members who are unable or unwilling to make informed choices and ensure their retirement savings are not frittered away by poor fund choices or exploitation. While such a move is likely to be unpalatable to both major political parties and the superannuation industry, it nevertheless presents a solution to a widespread problem. In an industry worth over $500 billion, there is huge potential for vast sums of retirement moneys to be misallocated or lost. There is clearly a need to address existing problems in the superannuation system before the Pandora’s Box of choice-of-fund is opened.


Australian National Audit Office 2000, Superannuation Guarantee, Australian Taxation Office, Audit Report No. 16 1999–2000, Performance Audit, Canberra.

Brown, K., Gallery, G. & Gallery, N. 2002, ‘Informed superannuation choice: constraints and policy resolutions’, Economic Analysis & Policy, vol. 32, no. 1, pp. 71–90.

Brown, K., Gallery, G., Gallery, N. & Guest, R. 2001, ‘Defined Benefit or Accumulation Plan? Superannuation Choices of Australian Academics’, paper presented at the Ninth Annual Colloquium of Superannuation Researchers, University of New South Wales, 9–10 July.

Kavanagh, J. 1998, ‘Start Delay Won’t Spoil Super Choice’, The Weekend Australian, 11–12 April, p. 3.

Kennedy, R. 1998, ‘Focus will be on understanding choice’, Superfunds, April, p. 13.

Lampe, A. 2001, ‘Super a Mystery for Most Workers’, The Sydney Morning Herald, 16 May, p. 3.

McIlwraith, J. 2000, ‘UK pension nightmare a lesson for us’ Superfunds, April, 54–56.

Productivity Commission 2001, Superannuation Industry (Supervision) Act 1993 and Certain Other Superannuation Legislation, Report No. 18, Ausinfo, Canberra.

Select Committee on Treasury 1998, Ninth Report, House of Commons, United Kingdom.

SSCS (Senate Select Committee on Superannuation) 1998, Choice of Fund, 28th Report, Parliament of the Commonwealth of Australia, Canberra.

SSCSFS (Senate Select Committee on Superannuation and Financial Services) 2000, Roundtable on Choice of Superannuation Funds, Commonwealth of Australia, Canberra, March.

SSCSFS (Senate Select Committee on Superannuation and Financial Services) 2001, Prudential Supervision and Consumer Protection for Superannuation, Banking and Financial Services, First Report, Commonwealth of Australia, Canberra, August.

Sherry, N. 2002, Superannuation Policy Paper A: ‘Broader Choice, Stronger Protection and Fairer Tax’, August.

Statement of Accounting Concepts SAC 3 ‘Qualitative Characteristics of Financial Information’.

Superfunds, ‘Investors endorse choice of fund’, June 2000, p.5.

Dr Natalie Gallery is Senior Lecturer in Accounting at the University of Sydney.