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Raking over the ashes

Sonia Speedy continues her round-the-world tour of some of the pension models being touted for the UK by visiting Australia, land of compulsory contributions, where concerns are growing that recent changes on fund choice could bring widespread misselling

Australia has had a compulsory pension regime since 1992 but it is only in the past five months the bulk of investors have had the right to choose how and where their nest egg is invested.

With five million people now considering who to trust with their financial future, there is concern that Australia could be set for a repeat of the misselling debacle that marred the liberalisation of the UK pension regime.

Before 1992, private pensions were limited mainly to defined-benefit schemes for public service professions, although some private employers used pensions as a means to attract staff, particularly in upper echelons. Those without the good fortune to fall into either of those categories typically had a retirement plan that went no further than paying off their mortgage before finishing work and then relying on the state pension until they died.

A few invested in life insurance but it was seldom enough to provide adequate support while the wealthy relied on rental income from property, still the most popular form of investment.

But the government eventually realised it was facing the same demographic timebomb as elsewhere in the developed world so it was decided to introduce compulsory pensions, or superannuation as they are known in Australia, in 1992, with the Labour government doing a deal with the unions to swap pay rises for a secure retirement.

Employers were now required to pay the equivalent of 3 per cent of a worker’s salary or wages into a pension fund. This has since been raised in steady increments to 9 per cent. Workers can also make additional contributions out of their pre-tax income, paying only 15 per cent tax rather than the marginal rate of up to 47 per cent.

This was augmented last year by the introduction of a co-contribution scheme under which the government would match voluntary contributions up to a limit of $A1500 a year for workers earning less than $A58,000 a year.

But despite the compulsion to save and the tax incentives to save more, the decision on where the funds were invested was largely left up to employers.

Some bigger companies ran their own funds while others outsourced to specialist commercial managers. But one of the biggest portions of the savings stream was directed to union-owned vehicles, the so-called industry funds.

Unlike employer or commercial funds, industry funds had the advantage of being portable, so workers changing jobs but remaining in the same sector and still being covered by the same union were able to continue making payments into the same account.

This, along with their low fees and not-for-profit business model, helped industry funds build up a 15 per cent share of the $A742bn in pension funds under management at the end of June.

A desire to crimp the unions’ power over Australian capital led the now Conservative government to this year bring in an election promise dating back to 1996 when prime minister John Howard won power from Labour PM Paul Keating.

Super Choice, as it is known, allows all workers to specify how their pension will be invested, regardless of where they work. With $A70bn a year pouring into super funds, product providers and financial advisers are thrilled to at last be given access to investors previously locked away.

Employers must still choose a “default” fund in which to park contributions for staff who do not specify a preference. However, regulations were tightened in 2004 requiring trustees to be licensed and for super funds to be managed as financial product, greatly increasing the burden of paperwork associated with running a fund. This has led many employers which previously ran their own pension schemes to outsource to master trusts.

The market share of corporate funds slipped from 9.4 per cent in June 2004 to 8.8 per cent in June 2005.

Master trusts that target big employers can offer discounts to compete with the fees charged by industry funds but these discounts are typically not retained for workers who decide to stay with the trust when they switch employers, resulting in sharp increases in fees. Industry funds have retained their portability.

So far, there are no figures to indicate how investors are repositioning in the wake of Super Choice’s introduction, but anecdotal evidence suggests that retail and industry funds have received a boost.

Consumer advocates and industry figures alike warned of the potential for advisers – 70 per cent of whom are directly employed by fund providers – to exploit the new regime by selling inappropriate products to maximise their commission.

The fears were not without basis as a surveillance campaign carried out this year by the corporate regulator, the Australian Securities and Investments Commission, found that, in 90 per cent of cases, advisers recommending that clients switch pension funds recommended a fund supplied by their employer, regardless of its suitability.

This was coupled with limited investigation of investors’ existing funds, poor disclosure of costs and benefits lost by changing funds, and clear misselling of life products.

The results were all the more alarming as they came after the introduction of higher educational standards and increased disclosure rules in 2004 which prompted up to 10 per cent of advisers – presumed at the time to be the poorest-qualified and most conflicted – to leave the industry.

Asic’s study found that there were still plenty of bad apples left in the barrel.

As the Asic study predated the Super Choice changes, there was some consternation that things would only get worse once the more liberal regime was introduced.

But with Asic now pursuing legal action against 13 of the 15 firms involved in the campaign, a high-profile crackdown on adviser standards could be just what is needed to ensure Australian investors do not suffer the same fate as their UK counterparts.

Another consequence, one that would dismay the Conservative government as it prepares to hit unions further with legislation that will effectively wipe out collective bargaining, could be to push investors away from the commercial product providers and back to the industry funds.

Other beneficiaries are likely to be the raft of “no-nonsense” product providers that UK investors are already familiar with – Virgin Money launched a range of index-tracker products with easy-to-understand fee structures in July while St Andrews, the investment arm of HBOS, has decided to bypass advisers altogether with a pension product that is sold directly to consumers.

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