Who chooses the super default matters most

The PC has been asked to consider options for a “formal competitive process”, such as an auction or tender. Framing the issue in this manner assumes that it is the mechanism by which the default provider or product is chosen that needs to be addressed. This distracts from what really matters in the default segment: who chooses on the member’s behalf.

Default members, by definition, have accepted the default. Estimates suggest that about 60 to 70 per cent of employees do so. While defaulting is often attributed to disengagement, Centre for International Finance Regulation (CIFR) research suggests that trust combined with lack of skill and confidence to make financial decisions are more important drivers.  In any event, the key point is that most default members are relying on decisions made by others, and trust that the default they are being offered is suitable.

Under these conditions, it is important that those selecting the default provider or product are aligned with members, understand their needs, and have the expertise to identify a suitable offering. It also helps if they have the flexibility to design criteria and choose from a range of providers. This will allow them to tailor to specific needs, and generate competition between providers. Basically, the critical factor is whether those on whom default members rely do a good job at understanding and representing their interests.

The current default arrangements fall short in many respects. Members currently land in a default product as a consequence of their employment relationship. Sometimes the employer selects the default. Sometimes members are directed in accordance with an industrial award. Only in certain situations, such as when an engaged large employer runs a tender for their corporate fund, is an attempt made to match members to a suitable product under conditions of informed decision-making and competitive tension. A minority of employees benefit from such arrangements. In many cases, circumstance or legacy dominates. Often those charged with choosing the provider are not in a position to make a truly informed decision, or may not be primarily concerned with member outcomes.

The Government is clearly contemplating an arrangement under which default members are allocated via a competitive process such as a tender or auction. This outcome is by no means foregone, and much depends on how it might be structured. Nevertheless, focusing on the mechanism of choice draws attention away from the central issue of who chooses. Somebody still has to design a tender, set the criteria, and make the selection. Do they have sufficient expertise and knowledge of member needs? Are they aligned with members, or subject to political or other influences? Are they able to weigh up cost versus benefit, or would they be impelled to focus primarily on cost? Flexibility and the ability to tailor also matter. Members differ, as do the member bases across workplaces. This creates a need for smarter defaults, rather than commoditised solutions.

One way forward is to transfer the responsibility of selecting the default product provider to a new class of specialist entities. These ‘member agents’ would be private sector businesses that are charged with the role of selecting and monitoring providers on behalf of default members. They would possess industry expertise and understanding of member needs, and be charged with a duty to act in the best interests of members. They would have the flexibility to run their own selection process; and would drive competition between default providers at a grass roots level. Establishing member agents would entail requiring the parties involved in the employment arrangement to transfer the responsibility for choosing the default provider or product into the hands of an expert entity that is aligned with members.

Member agents would be far superior to centralised mechanisms that are distant from the members, and likely to deliver commoditised solutions when tailoring is required. It is a market-based approach that would drive the competition that the Government is seeking. Importantly, it would do so under the patronage of informed parties that operate at the coal face, and are primarily concerned with getting the best outcome for the members under their responsibility.

By Dr Geoff Warren, research director for Centre for International Finance and Regulation (CIFR).