the super iceberg · 2.3 self-managed superannuation funds 15 2.4 increasing issues as choice grows...

The super iceberg What’s beneath the surface of Choice?

October 2008

The super iceberg What’s beneath the surface of Choice?

Contents

Clarifying “Choice” 3

Foreword from InvestmentLink 4

Essence of this report 5

Executive summary 6

1. Choice and the fundamentals it has changed 101.1 The foundation of superannuation 111.2 Choice has led to a paradigm shift in relationships 11

2. The growth in Choice take-up 122.1 Where is Choice today? 132.2 How will Choice grow? 132.3 Self-managed superannuation funds 152.4 Increasing issues as Choice grows 15

3. The challenges and cost of Choice 163.1 The key challenges resulting from Choice 173.2 Misaligned stakeholder interests 173.3 What is Choice costing? 183.4 Small and medium-sized employers suffer (and cause) the most pain 193.5 Who should pay for Choice? 19

4. An administrative scenario for 2020 204.1 Three elements to improve Choice administration 214.2 Impact of these changes 224.3 Fixing Choice requires changes to the Super system 224.4 Stakeholder interests must be addressed 22

5. A central collection infrastructure as driver for change? 245.1 Collection infrastructure internationally 255.2 Criteria for success of a central collection infrastructure 265.3 Call for action 27

6. Conclusion and the need for change 28

AppendicesA Stakeholdersurveys–detailedfindings 30B Keyimplicationsalongthevaluecharts 36

2 The super iceberg What’s beneath the surface of Choice?

3The super iceberg What’s beneath the surface of Choice?

Clarifying “Choice”

The Superannuation Legislation Amendment (Choice of Funds) Act 2004 (Act) changed the Australian superannuation landscape from 1 July 2005. The Act allowed employees to choose how to allocate their compulsory superannuation guarantee contributions and, ultimately, better manage their retirement savings.

The Choice system introduced two key new concepts:

About this reportErnst & Young has performed significant research for this report. We have combined findings from desktop research with stakeholder interviews and online surveys. Specifically, we draw conclusions from the following sources:

Structured interviews with •superannuation fund executives and fund administrators that cover more than two thirds of the industry; retail funds that offer corporate superannuation products based on volume of CoF transactions; and a substantial number of large corporate funds

A recent survey of 200 payroll •officers performed by The Australian Payroll Association (TAPS) in cooperation with SuperChoice, a subsidiary of InvestmentLink Pty Ltd (InvestmentLink)

Twenty structured follow-up •interviews with large employers that participated in the TAPS survey

An online survey of 100 employers •with less than 20 employees

An online survey of 100 employees •who changed jobs in the last four months

Almost three years of anonymous •transaction data from one of the main superannuation clearing house providers, SuperChoice

1. Choice of fund (CoF)

The Act allows most employees to choose a complying fund to receive Superannuation Guarantee (SG) contributions from their employer. If an employee does not nominate a complying fund, their employer selects a default fund. Any employee not contributing to the employer default fund is a Choice member.

2. Portability

In certain circumstances employees may transfer their superannuation account balance to another fund, while working for the same employer.

AcknowledgementsErnst & Young is deeply grateful to the people who have made this report possible: the stakeholders around Australia, who participated in our surveys and structured interviews. We would especially like to thank the following superannuation funds and fund administrators for their time and valuable insights: AAS, AMP, Asgard, Australian Super, Aviva, Axa, CitiStreet, Colonial FirstState, ING, Mercer, MLC, REST, IBM/Russell and SunSuper.

We would particularly like to acknowledge and express our appreciation to InvestmentLink for their encouragement to commence this piece of research. Without their time, insights and initiative this report would have not been possible.

The difference between CoF and Portability

CoF relates to employees directing future superannuation payments into a nominated fund; portability is about switching existing balances between funds.

Choice is different from ‘investment choice’

In this report, the term Choice refers to both CoF and Portability, but does not refer to ‘investment choice’. Investment choice is where members build their own investment portfolio by selecting how much money they want invested in different investment options. Superannuation funds have been offering investment choice for some time, giving members greater control over their superannuation investments.


Foreword from InvestmentLink

We have seen for some time that Choice is creating some fundamental changes in the Australian superannuation industry that will have substantial impacts for funds, employers and members over the next decade.

However, the take-up and impact of Choice has been wrongly dismissed by some in the industry and within the media as a non-event, largely because the problem is so broad and there lack of solid data to help quantify the extent of the problems.

It is for this reason that we decided some time ago that a broad-based research study was required to address this information gap. We were keen for the industry to have a well considered and unbiased view as to what the impact of Choice had been on the cost of contribution processing to funds, employers and members.

To that end, InvestmentLink SuperChoice asked Ernst & Young to undertake the study that resulted in this document. This project has resulted in hundreds of hours of research over the last four months that has drawn not only on our substantial database but also exhaustive interviews with superannuation funds, employers and members. We believe the resulting conclusions represent nothing less than a call to action for our industry to create a more efficient and effective superannuation framework for the benefit of all stakeholders.

This paper does not offer up solutions, but rather we hope that the questions and implications raised by the data will spur debate and we are particularly interested in helping to guide this process with stakeholders and government. I would like to thank Ernst & Young for their belief in this project and for the many hours of work put into producing a document which I believe will serve as a benchmark in guiding the current discussion on Choice.

I commend this report to you and welcome the opportunity it brings to consider these important issues that could have long-term impacts on our industry.

Peter Philip Chief Executive Officer

InvestmentLink Pty Limited / SuperChoice


Essence of this report

Choice overall is a success and can deliver better retirement outcomes for members

Our research shows 10% of Australians already exercise Choice.•

Choice allows members to choose a fund to suit their individual needs•

Choice reduces inefficiencies caused by multiple accounts and lost members•

Choice promotes competition between providers•

Choice changes fundamentals and makes relationships more complex

Post-Choice: Many members deal with one employer who deals with many super funds•

Focus has changed from employer-centric to member-centric, shifting the power • to make decisions

This necessary change exposes underlying weaknesses in the way superannuation is • administered in Australia

Mis-aligned interests create inefficiencies Choice in isolation is not a problem but it highlights inefficiencies in key • parts of the superannuation system for all stakeholders

Stakeholders have few incentives to work together to resolve these systemic issues•

The burning platform grows as the cost of Choice administration is revealed

Inefficiencies impact retirement outcomes for members•

The impact of Choice is still small and the pain is spread among many, but 10% of members • already create up to 25% of super administration costs

Choice grows steadily with some funds losing members•

Only a few funds have done a detailed impact analysis, but growth will result in more challenges•

Our call for action The intertwined nature of processes and infrastructure of Choice and Default require a wider • industry transformation

An industry transformation requires stakeholder commitment •

A shared vision for 2020 and a feasible roadmap will provide guidance for the change process•

Only a concerted effort of Government and industry can create and maintain • sufficient momentum

The outcome will underpin Australia’s world leading position and benefit retirement savings•

Some useful numbers2

ASFA statistics (2006) on Choice eligibility

APRA statistics (March 2008) on administration costs and assumptions for cost estimates

Number of Australians eligible for Choice as of 1 July 2005

5,300,000

Current administration fees of all funds excl. Retail and Public Sector

$ 488m

Estimated percentage of administration fees allocated to collections and member administration

50%

Informed estimated Choice percentage of administration fee of relevant total administration fees

25%

Total Australian working population contributing to Super

9,460,000

Current administration fees of Retail funds

$ 980m

Retail fund administration fees for Retail Super (= 67% of $980m)

$ 657m

Relevant administration fees for Corporate Super of relevant funds that deal with Choice

$ 811m

Relevant total administration fees basis $ 406m

Number of Australians eligible for Choice as of 1 July 2008

6,300,000

Relevant administration fees for Corporate Super of relevant funds that deal with Choice

$ 811m

Relevant total administration fees basis $ 406m

Top down estimate of the cost of Choice for Funds

$ 101m

+ - =

x

x

=

=


Executive summary


The introduction and merits of Choice were debated for many years in the superannuation industry and the political sphere. Since its introduction in 2005, many would argue that Choice has not significantly impacted the way Australians save for their retirement and significant changes in fund membership have not occurred. Notwithstanding these perceptions, there is increasing evidence that Choice is starting to bite, both positively and negatively, on key stakeholders.

Choice has changed fundamentals There is no doubt that Choice fundamentally changed the structure of the industry and the way that members interact with employers and their funds.

The simplistic model before choice was typically:

many employees: to one employer: •to one fund

By contrast, the post-Choice model is:

many employees: to one employer: •to many funds

This is an inherently more complex and dynamic structure. Moreover, this complexity is constantly compounded by new funds, fund portability and employee churn.

Choice take-up is likely to growWhile Choice take-up has failed to meet some expectations, the majority of our interviewees, as well as market experts, agree that it will grow. Ten percent of members, being nearly one million people, have exercised Choice. We have modelled some scenarios based on the range of interviewees’ views, which range

from 15% take-up, or nearly 1.5 million Choice members, to 35% take-up, or nearly 3.4 million members by 2013.

Increasing employee mobility, greater education about superannuation and a poor current investment environment, which may lead to more rigorous member scrutiny of fund performance, will all drive greater Choice take-up.

Choice highlights inefficiencies in the superannuation systemWe have researched the impact of these structural changes on key stakeholders - employees, employers, funds and superannuation administrators. From our research it is apparent that the full benefits of Choice are yet to be realised and all stakeholders are plagued with inefficiencies:

Members are overwhelmed by the •complexity of information about their super fund.

Employers are struggling to keep on •top of their regulatory responsibilities and the varied administrative requirements of different funds.

Funds are wasting resources on dealing •with manual transactions, incomplete or incorrect information from members and employers, and manually processing cheques.

In addition, infrastructure, such as the Superannuation Product Identifier Number, is not uniformly applied and an industry-wide clearing infrastructure for superannuation - that many other countries have - has not been developed.

Even a conservative growth estimate in Choice take-up would mean significant additional challenges for the superannuation industry.

“We are in the 20th year of the compulsory system…..I do think it’s an appropriate time to have a long, hard look at the operation, structure and cost of our compulsory super system.” Hon Senator Nick Sherry


What is Choice costing its stakeholders?While it is difficult to assess the total administration cost of Choice, as most funds do not capture such information, our research indicates that the annual cost of Choice is at least $130m.

Costs result from inefficiencies for employers and funds in administration, including:

Manual processing, reconciliations and •handling of cheques

Error handling•

Keeping up with regulatory obligations•

For members, time lags in processing are resulting in lost investment performance.

Cost of Choice could increase to $450m by 2013Can these costs be elimiated only through more efficient administration? It is unlikely. As the pain is spread among many, it may be acceptable to some stakeholders that 10% of members already create up to 25% of the cost, but to ignore these costs would be reckless as all industry participants that we interviewed expect Choice take-up to increase. If such increases do occur, there must be changes to structure or technology to help stakeholders interact or, our research suggests, the cost to the industry could be as high as $450 million by 2013.

Who should pay for Choice?While this question may seem academic, it has great relevance because:

All stakeholders already incur costs •due to Choice.

Choice members are cross-subsidised •by default fund members because they are not charged for the extra administration required.

Large employers are receiving •additional benefits from funds such as training and free clearing services that are not offered to smaller employers, but it is costing smaller employers the most per employee to comply with fund requirements.

If Choice take-up increases, the •additional costs will also increase.

Everybody agrees that Choice creates additional costs. We recommend that all stakeholders embark on a formal debate about who pays for Choice.

Fixing Choice requires enhancing SuperOur research indicates that enhancing Choice requires enhancing the overall superannuation system. A detailed look at the underlying business processes such as collections and member administration, as well as supporting technology infrastructure, reveals that fixing Choice in isolation will be difficult and, arguably, a missed opportunity.

A wider focus on industry transformation could address other industry challenges such as rollovers or lost super, which will take the Super and Choice systems to the next level of efficiency and effectiveness.

Some useful research findings►Employees/members are often •confused by Choice and, for a range of reasons, choose the default fund selected by the employer

►Members are most likely to instigate •a Choice decision when changing employers. Given the mobility of the Australian workforce this is likely to significantly increase Choice over time, with our modelling estimating Choice take up being anywhere from 15% - 35% by the year 2013

►Large employers appear to be •coping reasonably well with Choice, but small employers are struggling with their legal and administrative requirements

►Choice has already benefited •some funds over others by winning new members

►Funds and their administrators are •incurring significant costs, both directly and indirectly, in managing Choice transactions. While Choice may only be a small percentage of some funds transactions, the cost burden is not insignificant

►There is considerable opportunity to •enhance the effectiveness and efficiency of superannuation fund administration with increasing electronic commerce and servicing standards to transfer data and cash.


A central collection and clearing infrastructure as a driver for changeThe government has proposed setting up a national clearing house as one way to address current challenges in the superannuation industry. Our research indicates that a central clearing agent and infrastructure can drive economies of scale and industry efficiency.

A central collection infrastructure of some sort could well be a catalyst for industry transformation.

Our call for actionAn industry transformation will help to bring down the overall cost of superannuation and Choice to world class levels. It will require a concerted effort of all stakeholders to achieve this objective. Only a clear vision with a feasible roadmap and commitment from all stakeholders will ensure success.

The challenge is laid out for the industry and the government. This is a challenge that we are confident the industry will grasp, as it is evident that the true costs of superannuation exceed what appears “above the surface”. The true cost for the industry includes those significant direct and indirect costs, along with the opportunity costs, which lie below the surface for employees, employers and funds.

We believe that the introduction of a superannuation clearing house, as outlined in the recent Federal Budget, may be a catalyst for change to proactively address these challenges. This in effect is a government driven solution; however an alternate approach would be for the industry to take proactive and comprehensive action to address the challenges caused by CoF and the broader inefficiencies in the superannuation market.

It is evident from our research that many, if not all, in the industry are passionate about ensuring Australia has an efficient and effective superannuation system. With our research suggesting demand for Choice will increase, failing to act now would be a missed opportunity and will ultimately cost all stakeholders significantly in the future.

Seven elements that need to be included to resolve the major challenges that Choice faces:

► Alignment of stakeholder interests•

► Financial literacy and member •inertia

►Business process efficiency•

Regulatory red tape•

Communication between all •stakeholders including elements such as PDSs

Collection process and service •standardisation

Central collection infrastructure for •superannuation


1. Choice and the fundamentals it has changed


1.1 The foundation of superannuationIn his address to the Conference of Major Superannuation Funds in March 20083, Senator Nick Sherry outlined the following principles the Government has consistently strived for regarding superannuation:

Simplicity - each fund member should be able to understand at least the general features of the operation of the system and the particular features of their own fund.

Choice and competition - the provision of a level of choice so that individuals can have input into selecting superannuation options that best suit their particular needs for retirement, whether it be a particular fund, investment category, lump sum or pension/annuity, and/or age of retirement.

Affordability - superannuation should be a cost effective savings vehicle with operating costs kept to a minimum.

However, the massive industry changes following the advent of Choice in 2005 and Better Super in 2007 have created issues that threaten these principles. While encouraging choice and competition, our research found these initiatives have significantly increased the complexity and cost for all stakeholders: employees, employers, superannuation funds and fund administrators.

1.2 Choice has led to a paradigm shift in relationshipsChoice has changed the superannuation model profoundly by allowing CoF and Portability. Before Choice, employers directed all superannuation payments to a very limited number of superannuation funds (generally one).

The simplistic model was typically: many employees: to one employer: to one fund

Once infrastructure was established, this processing relationship rarely changed. All parties understood the relationship, expectations were clear and the process was efficient and generally effective.

By contrast, the post-CoF model is many employees: to one employer: to many funds

This is an inherently more complex and dynamic structure. Moreover, this complexity is constantly compounded by new funds, fund portability and employee churn. The following chart depicts the new structure.

In practise this means that some funds now deal with three times the number of employers, and employers sometimes deal with more than 100 funds.

Variations in the new Choice model

Some funds offer large employers a different model, with a central contact point serving as an intermediary to process and distribute employee contributions. This offering is usually part of providing a default fund service. In other words, the fund receives all contributions (both CoF and default) and re-distributes the CoF contributions to the nominated funds. This helps the funds to maintain their default fund status with the large employer, protecting the fund’s market share by removing a burden from the employer.

Multiple employees

Oneemployer

Onefund

Multiple employees

Oneemployer

Multiplefunds

Multiple employees

Oneemployer

Defaultfund as

single faceto employer

and filter

Multiplefunds

The changing nature of superannuation relationships


2. The growth in Choice take-up


2.1 Where is Choice today?Our research indicated that the current level of Choice uptake amongst the 9.5 million Australians that pay superannuation is 10%. However, this percentage is not equally split between large and small employers or between funds.

Principally, employees of small employers are more likely to execute Choice as they are less likely to have an actively chosen default fund. In many cases such employers ask all employees to choose their own funds.

Employees of large employers are less likely to execute Choice because they often have attractive employer-sponsored default funds. Very attractive fee arrangements, generous insurance cover or underwriting arrangements make it less compelling for members to leave those funds. Several interviewees indicated that, as a result, some large employers experience Choice take-up of as little as 1%.

Recent research by ANOP Research4 indicates that only a quarter of those who participate in CoF do so by making a conscious Choice decision. The majority of respondents changed funds because they were changing jobs.

However, a higher number of people in the same study indicated they were prepared to exercise Choice.

Why do employees change funds?

2.2 How will Choice grow?

One view on the expected growth of Choice

One of the largest clearing house providers, SuperChoice, which processes contributions for some 1.5 million members, anticipates Choice take-up will rise to 30% of total members.

This graph represents one informed view, but all stakeholders that we interviewed expect Choice take-up to increase - although at different rates.

Growth in Choice take-up

Choice growth - some alternative scenarios

We have modelled some scenarios based on the range of interviewees’ views.Choice take-up: Three scenarios

Changed funds because they changed jobs

Changed to consolidate multiple funds

Chose a new fund as a conscious act of Choice

Changed because their employer changed funds

25% 44%

6%

25%

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Mem

bers

Financial year endingDefault members

Choice members

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

2006

2007

2008

2009

2010

2011

2012

2013

3,000,000

2,500,000

2,000,000

Mem

bers

Financial year ending

1,500,000

1,000,000

500,000

ConservativeCurrent rateLeast conservative

0


The actual numbers for the 2006 to 2008 financial years are based on our research.

Our conservative scenario assumes 1% growth of additional uptake per annum of the relevant Australian working population because:

Member apathy dominates•

Industrial relations awards and •agreements will cover more employees so reducing the number of employees eligible for Choice

Economic climate will reduce the •number of employees changing jobs

Our current state scenario assumes that Choice continues to grow at the average rate of 3.3% additional uptake per annum that we identified for the 2006 to 2008 financial years because:

Changing jobs will continue at a •substantial rate due to skill shortage and the increasingly transient nature of the workforce

Increased focus on Choice will be •compensated by frustration and apathy from members

For our least conservative scenario we assume that Choice growth increases to 5% additional uptake per annum due to:

Increasing member awareness and •financial literacy

Increasing fund balances or poor •investment performance convince members to exercise Choice

Increased advertising by funds to •attract new members

Increasing number of members eligible •for Choice

In our research we found groups of informed stakeholders that support each of these scenarios.

Expected drivers for Choice► Workforce mobility as employees •continue to change jobs

► Increased member awareness as the •result of increased fund advertising – employees switching jobs will be more informed that they can take their existing fund with them

► Growing provision of internal or •external superannuation advice for members

► Growing numbers of small and •medium enterprises (SMEs) - with limited purchasing power. SMEs are more likely to make CoF “compulsory” for everybody, as they are less likely to establish a default fund option

► Increasing numbers of mature aged •workers (65 plus) due to skill shortages. Mature aged workers are likely to channel their contributions to an existing fund

► Poor fund performance. We •envisage an increasing number of members will scrutinize fund performance after the reporting season given poor investment markets, leading to some of them switching funds

► Employers may insist on CoF to •safeguard themselves against disillusioned employees legally challenging fund selection processes. By insisting on CoF employers mitigate the risk of employees attempting to obtain compensation for underperforming (default) funds

► Growth in the popularity of self-•managed superannuation funds


2.3 Self-managed superannuation fundsWe were interested that none of our research participants mentioned self-managed superannuation funds (SMSFs) in the context of Choice. As the fastest growing sector of the superannuation industry, we believe that SMSFs add to the challenges that employers and super funds face.

According to the ATO, SMSFs comprise a significant percentage of the superannuation industry and, at 31 March 2008, had approximately $286 billion in assets under management.5 It is estimated that the number of funds is growing at about 6,000 a quarter.

While super funds are likely to see market share eroded by this growth, employers will also feel the burden of processing member details for these small funds, especially those that employ an older, more educated and investment-aware workforce.

2.4 Increasing issues as Choice growsIrrespective of the final participation rate, superannuation transactions and contributions are set to grow dramatically. As they do, they will place increasing strain on Australia’s superannuation framework.


3.ThechallengesandcostofChoice


3.1 The key challenges resulting from Choice

Challenges Consequences

Members

►

►

►

►Information overload•

Complex, compliance driven • information rather than clear and understandable

Lack of interest, frustration & • procrastination

Multiple member accounts due to • transiency

Inertia to exercise Choice•

Lost super•

Incorrectly completed Choice forms•

Inertia to rectify errors•

Employers

►

►

►

►Difficulty in keeping abreast of • responsibilities

Impact of employee inertia •

Complexity and lack of standards in • fund administration

Organisational weaknesses in HR, • payroll and IT

Lack of support for Choice•

Process inefficiencies•

Funds

►

►

►►

►

►Inconsistent, incomplete or incorrect • information supplied by employees and employers

Employers failing (or refusing) to • adhere to administrative requirements

Preference among many employers • for manual transactions and cheques

Increased error rates•

Cost of manual transactions and • payments

Cost of error rectification•

Decreased customer satisfaction•

3.2 Misaligned stakeholder interestsStakeholders have few incentives to work together to resolve these systemic issues. Our research showed that misaligned stakeholder interests have resulted in an infrastructure that fails to support Choice as outlined on page 20.

Employees

Employees, especially younger ones, often don’t understand the information they’re given on superannuation and have little interest in finding out more. It is simply not a relevant issue. Moreover, the increasing transience of Generation Y is creating multiple low balance funds, which can lead to lost superannuation, higher fees and uneconomic returns.

Employers

Most employers perceive superannuation and CoF as an administrative burden, and some view it as a tax. As one industry expert pointed out, some employers may not have any real interest in the superannuation of their employees, as they act only as a processing filter without direct reward. We can see this lack of interest in recent statistics6 showing employers failing to provide employee tax file numbers in time.

Funds

Funds use the employer as an avenue to secure members and gain efficiencies. However, even though some funds ask for employer registration before accepting CoF contributions, they do not have a contractual relationship with employers. Neither party is obliged to work cooperatively with the other, even though it is mutually beneficial, creating frustration on both sides. Some employers believe funds are not

Our research found that superannuation stakeholders experience a number of key challenges and resulting consequences in managing Choice.

In addition to the challenges specific to stakeholders, the superannuation industry’s lack of core infrastructure presents its own problems.

The Bulk Electronic Clearing System (BECS) limits the volume of information that can be transferred between the sender and receiver of payments. Available workarounds, such as the industry swimEC standards for

contribution payments and the Superannuation Product Identifier Number are not comprehensively or uniformly applied. Thus, a large number of funds are processing contributions by cheques and updating records based on manual notifications, which is time consuming and expensive.

In general, this has increased the cost and time required to allocate and invest employee contributions, raising concerns with the industry’s other stakeholders, namely consumer groups, regulators and government.


responsive to their needs. On the other hand, some funds offer appropriate support and tools to improve efficiency in dealing with employers, only to find employers reluctant to change and refusing tools and support. Some of the tools provided only solve part of the problem and funds have no real incentive to make it easier for their competitors to receive CoF transactions from them.

In some cases, external administrators are remunerated on a fee-per-member basis, rather than a fee-per-transaction basis. This means they may not be able to pass on the additional costs of Choice-related member enquiries, transactions, registration and set up. Thus, the fee-per-member remuneration model offers administrators no direct incentive to resolve issues or innovate to enhance efficiency and effectiveness.

3.3 What is Choice costing?We estimate that the current cost of Choice for the three key stakeholder groups add up to more than $130m per annum. We validated our estimates with fund interviewees and with assumptions from the recent CitiStreet white paper on Choice7, which suggests Choice accounts for 25% of relevant fund administration cost. This indicates that the costs of Choice for funds alone are already more than $100m.

The cost of Choice

Members

Lost investment performance of over •$30m due to a time lag of 15 days between employer deduction of employee contribution and allocation at fund level plus time lag to correctly investigate incorrect transactions and remitted contributions

A large portion of the contributions are •in suspense accounts and earn interest, which gets allocated to all members; the other portion is true leakage

Employers

Spent more than $50m on additional •tasks related to Choice

Cost relate to time spent managing •transactions, handling errors and keeping abreast of regulatory changes, as well as bank charges relating to manual cheques

Funds

Spent more than $50m on additional •tasks related to Choice

Cost relate to time spent handling •errors and keeping abreast of regulatory changes

Growth in Choice take-up will increase cost

Employers“Super is just

a burden”

Transient work force creates low value funds

Complexity of information creates low Choice take-up

No incentive to make �it easier forcompetitors to receive Choice transactions

Lack of contractual relationship and complex

administration does not incentivise despite being a mutually beneficial relationship

Funds“We want

new members”

Employees“It’s too hard – why bother?”

$450m

$130m

Add

itio

nal c

ost

Choice take-up

Senario 2013:35%Currently:10%

True additionalcosts in an efficient environment

Additional costs dueto inefficiencies

?

Funds /Administrators

Members

Employers

Over $30m

Over$50m

Over$100m

Over$50m

Estimates based on our stakeholder interviews

CitiStreetestimate

Misaligned stakeholder interest


One-off and indirect costs such as •additional business development resources or marketing and compliance have not been taken into account

Indirect costs such as additional •business development resources or marketing and compliance may increase this number

All stakeholders agree that as Choice grows so, naturally, will the underlying costs. The proceeding chart extrapolates the existing cost based on an uptake of 35% by 2013 used in our least conservative scenario, all things being equal.

3.4 Small and medium-sized employers suffer (and cause) the most painWe found that in general medium -sized employers find Choice administration the most onerous. From a fund perspective, the large number of small and medium employers contribute significantly to fund inefficiencies.

From an employer perspective we found:

The relative cost of Choice is •significantly higher for SMEs

With many SMEs preferring manual •processes and cheque payments, cost per transaction for funds is significantly higher than for large employers where systems are automated and payments are electronic

Medium size employers usually do not •have the bargaining power to convince funds to allow individual processing and tailor automatic systems just for them. This leads to substantial manual transactions, errors and rework

Large employers have often offloaded •the pain to super funds or clearing house providers who are happy to take this on board to maintain their competitive position

Automation reduces manual •transactions and rework for large employers

The following two charts outline the employer and fund perspectives:

Cost of Choice for employers

Cost of Choice for funds

3.5 Who should pay for Choice?The entire debate culminates in the essential question: Who should really pay for Choice?

Members who benefit from Choice •directly?

Employers who need to comply with •their Superannuation Guarantee responsibilities?

Funds who want to secure the •members and inflow of funds?

The Government (which just offered •$16m for a National Clearing House)?

Our research raised a number of issues regarding the questions of who pays for Choice, including:

How do trustees view the fact that by •bearing additional cost for Choice they treat Choice members differently from Default members? It seems in the best interest of Default members not to offer Choice and incur no extra cost because they have to bear part of those extra costs without any benefits.

Is it fair that for larger employers funds •offer specific infrastructure that makes processing transactions more efficient while other employers may not participate in these advantageous arrangements?

Is it compatible with the sole purpose •test for funds to offer this specific infrastructure or clearing services free of charge for some employers?

We can not provide the answer to these questions. However, we believe an intense and open debate amongst all stakeholders is of the essence to avoid member complaints about unfair treatment.

$450m

80% of employers

providing 20 % of members

creating 80 % of costs

$130m

Add

ition

al c

ost

Number of employers

Number of members

Split ofcosts

Largeremployers

Smalleremployers

An aggregated view of Choice from an employer perspective

Employer size< 20 employees > 500 employees

Cost

/pai

n


4.Anadministrativescenariofor2020


Based on stakeholder opinions from our research, global best practice and Ernst & Young’s experience of servicing the domestic and global superannuation and financial services markets, we have identified three areas that would improve the current Choice system. They are solely focussed on operational and infrastructure aspects to improve the way superannuation CoF contributions are administered. They do not cover market dynamics.

4.1 Three elements to improve Choice administration

Stakeholder communication and interaction

Our research revealed strong benefits for funds investing in initial employee and employer education and ongoing quality communication. In 2020, we envisage this becoming industry-wide practice.

The UK Pension Bill (2008) outlines that clear and concise communication between employees, employers and funds help each party to understand their respective expectations and responsibilities. In turn, this reduces complexity, error rates and cost, and increases acceptance.

By 2020, we expect this type of involvement for all employers, not just the larger ones as is currently the case. In addition, we anticipate better and far simpler employer and employee communication.

Simple communication tools (incorporating the legally required information) can make life easier for employees and employers. For example, the current value chain would benefit from simple operational guides for employers and pre-populated CoF forms for employees.

Servicing infrastructure

Electronic commerce environment

Our 2020 vision incorporates the efficiency of an integrated electronic commerce infrastructure. This will enable straight-through processing and limit manual intervention and errors. This may grow into platforms where members can choose their fund and redirect contributions, with an intelligent set of checks and balances to ensure data is validated at the point of entry, thus reducing errors.

Electronic payment infrastructure and business to business payments

The current European initiative of The Single Euro Payments Area (SEPA) is an initiative of the European banking industry that is expected to reduce processing and allocation of all electronic payments across European boarders in a T+1 day timeframe. This may become the benchmark for future superannuation payments in Australia.

In Europe some financial service organisations already use payment systems that allocate 99.5% of incoming contributions to the correct account without human intervention, which could become reality in Australia.

Accompanying SEPA is electronic invoicing or E-Invoicing. E-Invoicing is electronic transfer of invoicing information (billing and payment) between business partners (supplier and buyer). It is an essential part of an efficient financial supply chain that links the internal processes of enterprises to their payment systems. This infrastructure could become a key element in a central superannuation clearing infrastructure and extend to electronic real time exchange and settlement of superannuation contribution schedules and remittance advices.

Servicing and processing standards

Our 2020 vision includes common minimum processing standards. Industries with a significant number of standard transactions between large numbers of stakeholders generally benefit from servicing and processing standards. This enables systematic learning, economies of scale and increased deployment of electronic tools resulting in reduced administration costs.

The Australian superannuation industry processes more than 100 million transactions per annum. If employers and members were offered familiar forms, processes and procedures, it would increase acceptance levels. In turn it would also reduce rework and errors for funds. These measures would lower administration costs and benefit all stakeholders.


4.2 Impact of these changesWhile it is difficult to measure the impact that these changes will have, we expect the following improvements against the American Productivity and Quality Council (APQC) process best practice.

Vision 2020: all Australian superannuation funds accept electronic payments

Time: By 2020, processing Choice should become an integral part of payroll processing. APQC best practice cycle times to process payroll is currently 1.1 days. In Australia, with daily allocation of contributions at the fund level, we suggest clearing payments could be reduced to T + 1 given that this standard already exists in Europe. However, we envisage a lengthy overall process as the underlying Australian electronic payment infrastructure goes beyond the superannuation industry.

Cost: Improving process efficiency, reducing manual transactions by using electronic interfaces, and enhancing servicing standards validations will reduce the impact of the main cost drivers in superannuation administration. These measures would allow a cost benchmark beyond the current discussion of superannuation industry groups and the wider group of superannuation stakeholders of 1%. We suggest that the recently announced total administration costs of 0.3% for the UK’s proposed National Pension Plan should be an aspirational goal for Australia.

Quality: APQC best practice error rates of 0.04% across CoF transactions may be a challenge. However, given some market participants are currently achieving exceptionally low error rates, this may be an achievable stretch target rather than a quantum leap.

4.3 Fixing Choice requires changes to the Super systemA detailed look at the underlying business processes for Choice, including collections and member administration, reveals that just fixing Choice in isolation is not possible. There are many interdependencies including supporting technology infrastructure and call centres that are often used by both business areas. The chart below summarises this.

4.4 Stakeholder interests must be addressedIn our research we found that all major stakeholders are interested in addressing the broader challenges that the wider superannuation market faces.

ASFA has made it part of its official •policy to transform the industry to become easier to do business with.

All funds mutually agreed that a major •industry transformation is necessary to reduce cost, increase member uptake and ultimately benefit members’ retirement provisions.

The current government and Senator •Nick Sherry have several topics on their list to transform superannuation. This includes reducing administration costs, reducing red tape, resolving the lost super issue, making product documents easier to understand for “normal” members and improving financial literacy.

All these measures are important building blocks for a major transformation.

However, a substantial industry transformation requires a clear vision for the future that aligns different stakeholder views. Otherwise misalignment dominates, which results in sub-optimal outcomes for everybody. This is not in the best interest of members or any other stakeholder.

Interdependencies between Choice and Default Super

Intertwined memberperception of super (Choice & Default)

Perception, regulatory and operating environment for

members, employers and funds

Choice

Default

Restrictions in fixing Choice in isolation

Elements in Choice that require attention

Intertwined business processes and infrastructure

at employer end

Intertwined business processes and infrastructure

at fund end

Alignment of stakeholder interests

Communication between all stakeholders including product disclosure statements etc.

Collection process and service

standardisation

Central collection infrastructure

Regulatory red tape

Business process efficiency

Financial literacy and member inertia


We see the three key questions for such a wider transformation:

Are all stakeholders prepared to make •such fundamental and far-reaching changes?

Is there a pragmatic and staged •approach that minimises business disruption?

Who is the driver for such a long term •venture?

A quantum leap requires an independent assessment of how the system can be improved, incorporating lessons learnt from other industries and countries. We suggest that a summit of superannuation stakeholders could form the basis for creating such a vision.

Five ingredients for successful industry transformation

► Shared business vision and •stakeholder buy-in to the necessary transformation

► Achievable milestones based on a •roadmap that depicts how to achieve the vision

► A regulatory framework that •supports the transformation process by removing regulatory blocks and providing incentives to change

► A set of measures for success•

► A committed driver of the •change process


5. A central collection infrastructure as driver for change?


The government has proposed setting up a national clearing house as one way to address current challenges in the superannuation industry. According to the International Federation of Pension Fund Administrators6, a central clearing agent and infrastructure can drive economies of scale and industry efficiency.

A central collection infrastructure of some sort could well be a catalyst for industry transformation. Below, we consider some examples of other successful central collection agencies and some alternative models for the Australian super industry.

5.1 Collection infrastructure internationallyOnly a very small number of countries (including Australia) lack collection infrastructure for superannuation contributions7. Most countries have a combination of collection mechanisms. They operate mixed systems either directly or indirectly associated with a public service organisation.

Australia can consider a number of models ranging from a centralised system run by a public agency to a decentralised system where collection is the responsibility of each superannuation fund8.

Other industries lead the way

Many of the challenges facing the Australian superannuation industry are not unique. There are two well known examples of industry participants working together to develop common centralised infrastructure. In the banking sector this was done by VISA and an Australian example is the Australian Securities Exchange. Both were established by industry participants to overcome inefficiencies in settling frequent voluminous transactions. They developed an efficient electronic clearing and settlement infrastructure as one major building block to address their objectives.

In Western Europe, many countries have recently added complementary plans based on funded, defined benefit approaches to their traditional schemes. In these schemes, contributions are mainly collected by funds. In contrast, the United States has individual account systems, where employers, employees and the self-employed contribute directly to funds.

Possible variations on any model

Employer coverage: all employers or only SMEs•

Obligation: general compulsion, choice to opt • in, choice to opt out

Range of functions: focus on transacting CoF • contributions, comprehensive financial hub for superannuation including rollovers and lost super.

Potential central collection infrastructure models

Base models Hybrid models

Government owned Operated by the government or partly/fully outsourced to the private sector.

Government owned model outsources the operation to one or more parties or an industry consortium with support from employers

Industry owned The superannuation industry could organise and establish a self-administered central collection agent using an industry body or forming an industry consortium.

Industry owned model or an industry consortium is supported by employers and is supervised and regulated by the government


5.2 Criteria for success of a central collection infrastructureIf a central clearing and collection infrastructure is adopted, transparency will be vital, requiring clear accountabilities and measures of success. Given the diverging objectives of different stakeholders, the clearing infrastructure will need to clearly define and communicate benefits to all stakeholders. In particular, we envisage the need to satisfactorily answer the following questions:

What services will a central collection infrastructure (CCI) offer?

In practise the CCI could be as small as a technology solution that allows employers to capture Choice information and send it efficiently to superannuation funds. On the other hand CCI could become a fully integrated central processing platform for employers and funds to capture and exchange information and process superannuation transactions.

Ultimately, CCI could evolve into a central hub for superannuation for members, employers and funds in Australia. Under this scenario CCI would address other current superannuation challenges.

How will CCI ensure that industry needs are met?

CCI must ensure that it keeps up with the relevant ongoing needs of all superannuation stakeholders. This imposes significant requirements on elements such as technology, business processes and communication.

If a CCI fails to achieve this, large stakeholders may quickly develop alternative solutions. However, a proactive approach focussed on innovation may prove very costly.

We believe that lessons can be learnt from large outsourcing engagements that deal with multiple stakeholders and diverging interests.

Should a CCI be set up only to manage Choice?

Generally, employers do not differentiate between employees that exercise Choice and default members. The same people, systems and technology manage the registration and processing of both types of fund members. We therefore believe that it is important to create a solution from the beginning that integrates all kinds of superannuation transactions to maximise employer acceptance.

How will employers be convinced?

Large employers are critical for success

For a CCI to succeed, it needs to achieve critical mass by securing large employers. These users create economies of scale. However, securing those large employers requires an almost instant time to market with a sophisticated and flexible service infrastructure that suits their needs. In addition, most large employers already receive some form of clearing service free of charge from their superannuation default fund provider. A proposition for a CCI must outline clear benefits for large employers that convince them to change from their current providers and give them the comfort that they will receive similar quality of service from the beginning.

Convincing small employers will require significant investment in marketing

The current level of awareness of the benefits of a central clearing infrastructure is limited, particularly among smaller employers.

SMEs often have existing relationships with payroll providers or accountants to perform payroll or superannuation processing. To secure SMEs as users, each employer will have to be convinced, requiring a significant marketing effort. Engaging trusted advisors, such as accounting firms and payroll providers will be vital, as they play an important role in the decision-making process.

A critical issue in serving small employers is the manual transactions that result from paper-based contribution schedules and payments by cheque, which are extremely costly to process. A central clearing house will need to manage manual processing of paperwork, or change small employer behaviours to avoid it, if it is to succeed.

What governance considerations must be taken into account to enable stakeholder control?

If a CCI is adopted and funds and employers lose the choice of clearing options, they must have sufficient comfort that service spectrum, service quality, pricing and other operational and strategic aspects of a CCI meet their needs. The CCI must respond quickly and appropriately to any industry requests and concerns. Governance and management structures for the CCI must reflect this critical, trusted role.


5.3 Call for actionThe government already aims to address several operational elements necessary to improve the Choice and superannuation systems. It could use a central collection and clearing infrastructure such as the national clearing house as a starting point to do so. Appropriate regulation could, step-by-step, encourage the industry to address administrative issues, lost super, rollover and other inefficiencies.

The government’s independent role enables it to make unpopular decisions for employers and funds to overcome natural resistance to change. Regulatory incentives could make it attractive to invest in necessary central infrastructure or transformation projects.

There are advantages and disadvantages to either the government or industry taking the lead in developing a central collection and clearing infrastructure. Irrespective of the model we believe change is necessary, but we anticipate a wise evolution rather than a revolution with disruptive change.

However, the questions raised here must be considered as alternative models are evaluated.


6.Conclusionandtheneedforchange


The superannuation industry has gone through significant changes and had to address many challenges in recent times.

Despite its many challenges, we firmly believe Choice is in the industry’s best interests. Moreover, it is not only here to stay, but will become more prevalent over time as power shifts from the employers to employees/members.

To sustain its world class reputation, the Australian superannuation industry needs to collaborate to create a system that includes a focus on marketing and communication; attracting and retaining new members; and an overall service focus to cope as Choice grows.

We believe it is now time for the industry to come together to debate our analysis with a common goal of reducing the cost of administering Australia’s retirement savings. The wealth of the nation is too important not to act.

It will take leadership, planning and industry-wide collaboration to address the challenges. A substantial investment in infrastructure solutions is likely to be required to support efficiency improvements, while further investment in continued industry standards, better education and awareness programs will be required to maximise member engagement in making decisions to provide for their retirement.

These steps will move the industry towards an optimal operating model by 2020 to meet the needs of all stakeholders.

All stakeholders have a role to play

It would be misguided to apportion blame to individual stakeholders for many of the issues that lie below the surface. To date, each stakeholder has rationally responded to change by focussing on addressing immediate concerns caused by recent legislative changes. Now it’s time to look towards a vision for 2020 and work together to improve the super system.

Employees are often time poor, unaware and overwhelmed by information. However, they now need to focus and take responsibility for their retirement savings, engage and take an active interest in managing their assets for their future. The government and funds have a role in supporting this, through increased education, better communication and reduced mandatory regulatory information.

Employers have focussed on keeping up with their regulatory requirements as well as ensuring employees are content and motivated in a competitive environment for labour. They are also balancing back office costs in an inflationary business environment. Now they can work closely with funds and clearing house providers to ease administrative costs.

Funds have responded to legislative changes by protecting and retaining their source of revenue and membership to ensure a sustainable business model. Now there is an opportunity to focus on operational efficiencies and service standards to improve business performance, while addressing the structural changes caused by Choice in superannuation.

The government wants the Australian superannuation industry to remain world class and encourage individuals to meet the level of savings required to provide for a certain economic future without placing a burden on the younger generation. The Government has the power to drive change by pulling regulatory levers. However, it must balance this against the need to provide a stable legislative environment.


Appendix A Stakeholder surveys – detailed findings


A.1. Qualitative implications - what does Choice cost?

A.1.1 Employees

We cannot quantify the specific opportunity costs to employees of making superannuation or Choice decisions. However, we can assess some quantitative implications of the current processes on employees and their investment performance.

In our analysis we focused on the opportunity cost of not efficiently deploying funds to generate returns. Specifically, we estimate the annual:

returns lost due to processing time •or the time lag between a contribution being dispatched by an employer to be finally allocated and invested by the fund

investment performance lost due to •the time lag for errors and issues to be resolved

These estimates are based on limited data and should be interpreted as indicators only. We believe however that they are useful for the purposes of stimulating industry discussion on this issue.

Based on our assumptions9, Choice members may lose more than $23 million in investment performance per annum due to the time lag for processing CoF contributions.

In addition, based on our assumptions10, Choice members miss out in excess of $5 million per annum in investment performance due to the time to resolve errors. A large part of this loss is in fact cross-subsidising other members because the contribution is residing in a fund bank account awaiting to be allocated to a member. During this time the fund earns interest which will be allocated to all fund members.

Over the course of a 30 year period for an average fund member, these costs add up to a sizeable amount. Moreover, as the uptake of CoF grows, so will the opportunity cost of un-deployed funds, chipping away at Australia’s potential retirement savings.

A.1.2 Employers

To calculate the time and cost toll these issues take on employers, we used performance benchmarks from payroll processing as a proxy for the efficiency in processing CoF transactions. Based on these assumptions11 and our findings, we estimate handling and resolving errors for CoF transactions costs Australian employers over $50 million per annum.

We believe this estimate is conservative, as it does not include any additional management time or bank fees.

A.1.3 Funds

Few funds have a granular understanding of the implications and costs of Choice. Most funds lack detailed analyses quantifying of time, cost and quality impacts. Similarly, analysis rarely takes into account the implications for call centres, finance departments, client service or business development staff or advisors.

However, the cost of Choice on funds has been significant. Our research found a large number of publications that discuss Choice and general levels of administration costs in the superannuation industry.

Cost to handle errors and resolve issues

Cost to process manual chequesplus external bank fees for cheques

Cost to handle correct transactions

Management time

Cost to keep abreast of regulation

$ pe

r em

ploy

ee p

.a.

Categories of additional administrative cost for employees


For the first time, a recent white paper by CitiStreet12 took a more holistic view of Choice and its implications for funds. The paper calculated that processing CoF contributions is costing the industry an estimated $20-30 million per annum, creating administrative headaches for all participants. CitiStreet concluded the superannuation industry must invest in developing a long term, sustainable solution to facilitate CoF as a whole. This included streamlining money and data flows between all industry participants.

Based on our interviews, we estimate the incremental cost to administer CoF is likely to be even higher than suggested in the excellent CitiStreet paper. Our higher estimate was even before accounting for initial set up costs or the ongoing additional cost of client service and business development focussing solely on Choice.

However, similar to the situation with employers, these costs are not evenly spread across funds. Funds with more electronic transactions and greater resilience for change are faring better than others.

Most market participants agree that if CoF grows as anticipated, the industry will face substantial challenges coping with the additional administrative load. Clearly, the system needs to change.

A.2. Employee survey findings

Who do employees talk to about their super?

Payroll officers or human resources are the main source of advice on the direction of employees’ superannuation payments. In fact, almost half the respondents indicated that work colleagues were the main source of information about superannuation.

Where employees relied on internal advice, there was a higher incidence of joining the default fund.

Fourteen percent of respondents sought external advice from planners, accountants or lawyers. Where external advice was sought by employees, most exercised Choice.

What’s it like completing the paperwork?

Employees are more likely to complete initial documentation in their personal time. However 36% completed at least some of the information on their employer’s time, suggesting there is a cost to employers in addition to monthly administration and processing.

Most employees took up to half an hour to complete superannuation forms. Not surprisingly, they took less time when selecting the default fund and more when exercising CoF.

Employees that exercised CoF found the process time consuming and often confusing.

Eight percent of survey respondents admitted they found the process of completing superannuation documents too hard, ending up choosing their employer’s default fund.

“….too many regulators, too many government authorities, too much tension between industry and retail funds, with no one representing the best interests of the industry and members.”Fund Executive

Key employee survey findingsChoice grows faster than expected •in a transient environment

Human resources is the main source •of general advice and could be used to drive CoF

Complexity and hassle limits •employee’s from exercising Choice

Payroll officers or human resources are the main source of advice on the direction of employees’ superannuation payments

Almost 70% of people who changed jobs in the last four months had exercised choice by redirecting contributions to a fund other than the employer’s default fund


Where is the money?

Sixty percent of employees joined the default fund because it was easier and less time consuming. A further 6% of respondents ended up in the default fund because they didn’t submit the forms or because of a clerical error. Apparently, many individuals are indifferent to active superannuation management.

60% of employees joined the default fund, because it was less hassle.

Almost half of employees in default funds indicated they were “definitely or seriously considering” switching funds. A further 19% said they would switch funds, but either didn’t know how or thought the process was just too hard.

Similarly, half the respondents indicated they would be interested in switching funds in the future, but they didn’t know how, or thought the process was just too hard, or had lost track of their superannuation.

A.3. Employer survey findings

Large employers

The errors, issues and costs in processing superannuation CoF contributions vary substantially between employers. However, our research clearly indicates large employers have fewer challenges to deal with as they have more automated systems to interface electronically. This results in lower error rates.

In addition, most funds have comprehensive business development infrastructure specifically for large employers or the advisers who serve them. Comprehensive training for new schemes, regular policy committees and frequent operational contact allow funds to proactively identify any issues with larger employers. This enables early detection and resolution of any potential issues.

Our research showed:

The average cost of processing CoF •contributions reduces as organisations get larger.

Payroll officers believe process •efficiency, understanding superannuation legislation and establishing a system to better manage Choice are key to resolving inefficiencies.

Two thirds of the respondents said they •were struggling with essentially manual in-house processes, writing out multiple cheques and remittances to funds and experiencing high error rates and refunds.

Employers noted the following as most pressing to improve superannuation Choice processes:

Standardise remittance and reporting •formats for all CoF transactions.

Accept Electronic Funds Transfer (EFT) •as a means of settlement.

Support prompt returns of rejected •payments back to employers.

Remove the employer registration •requirement from the super fund compliance mandate even if it entails a significant amount of subsequent legal ramifications.

“There’s an argument the human resource cost is a sunk cost. But tell that to the payroll managers who get in at 7am and stay back till 7pm to process cheques to 50 super funds with different requirements and formats”Employer

Many employers asked: “If a superannuation fund won’t accept electronic funds transfer, then shouldn’t the employer have the right to reject that employee’s choice?”


Small employers (SMEs)

Last year, a UK study13 demonstrated the smaller the business, the greater the time required to provide monthly information on contributions for each eligible employee and make a monthly payment for pension products.

This research also reported that the additional cost per employee falls quite dramatically for firms with 20 or more employees, which can benefit from economies of scale.

If the government introduced a centralised clearing service that catered for the needs of small business, it would need to invest in education and awareness programs

Our research indicates that most Australian micro businesses, with fewer than five employees, offer all employees CoF arrangements. While the processing burden is relatively costly per employee, it is not significant in absolute terms. This category is more concerned about compliance with their legal obligations.

The real impact of CoF in the small business community is felt by companies employing 5-20 people. This is due to their high number of employees relative

However, funds agree that Choice is here to stay. As it gains momentum, it will have substantial implications for the industry over the next five years. Essentially, funds believe the initial estimates of the impacts of Choice still largely hold true. They will simply be realised over a longer period than first anticipated.

What opportunities does Choice offer to funds?

Funds repeatedly highlighted the major opportunity created by Choice was to build and strengthen relationships with large employers. Most funds view employers with over 200 employees as their priority in the drive for members and funds under management. Large employers are gatekeepers to a significant potential membership base and are therefore highly valued customers.

Choice was the catalyst for many advisors and funds to review arrangements that often had been in place for over ten years. To compete for default fund status, many funds strategically focused on developing all encompassing solutions, including employer and employee education programs, legal, advisory and clearing house services.

They invested heavily in providing legal advice to employers, as well as educating the market through sales and marketing programs. These employer-centric initiatives came at a large cost, with many funds investing a significant amount of time, money and resources.

Because Choice created an additional administrative burden on employers, some funds saw an opportunity to seize a competitive advantage by offering employers outsourced superannuation processing arrangements via software

On legacy systems…“You can’t put cruise control on a 1970 Holden” Fund executive

Estimated additional time per employee in minutes

12.50

5.40

0.800.22

< 5 employees

5 - 49 employees

50 - 249 employees

250 + employees

to internal resources. Such a business might have 15 employees who all exercise CoF. With the proprietors’ time thinly spread, processing super payments at month end is a burden.

Our small business survey indicated in particular that:

85% of small businesses owners •performed the super administration function themselves rather than using a dedicated payroll manager or external bookkeeper or accountant.

Of the 43% of small businesses with a •default fund, the majority of the default funds were industry based funds. Thus, industry funds may deal with a greater percentage of smaller employers, creating more administrative challenges for those funds.

44% of small business employees had •exercised CoF.

Respondents rated overhauling •superannuation administration as important as GST, tax, and employment law reform. Almost all respondents felt that simplifying superannuation was important or extremely important for small business owners.

A.4. Superannuation fund survey findings

What has been the impact of Choice?

From a funds perspective, Choice has not had the immediate impact the industry anticipated. Some funds were expecting uptake rates of all Australian employees as high as 50%, resulting in a major reallocation of money in the system. Yet, following much hype and uncertainty, the reality has been slower than expected - for some almost a non-event. One fund drew comparison between Choice and Y2K.


solutions and clearing house services. These funds believe such initiatives increased their market share by growing their volume of CoF contributions.

For many funds, Choice provided an opportunity to offer other products and services, such as insurance. Some funds even suggested Choice gave them the opportunity to segment their operations between advisory and default fund services.

These tactics have created an uneven service model, where large employers receive superior service, benefits and attention and smaller employers miss out.

Taking a longer term view, some funds believe Choice will lead to market rationalisation. They believe some funds will be forced into talks with competitors as they lose members and capital, while others will use the situation to gain further scale.

What difficulties have funds experienced in implementing Choice?

Funds were clear that Choice in all instances has created extra complexity and cost, the biggest being administrative problems. Many funds zeroed in on the increased paperwork and manual handling. One executive claimed they were overloaded by “cubic metres” of documents.

Lack of uniform payment methods

The most significant challenge is the lack of uniform payment methods. Cheque payments significantly increase manual processing time, resulting in higher costs. Some funds suggested they may cease to accept contributions by cheque.

Limited EFT transaction data

Where funds receive EFT contributions, many complained of issues with limited transactional data. This means they spend an enormous amount of time manually allocating money to the right product and the right member account. This increases the propensity for confusion and errors, a situation compounded by the limitations of legacy computer systems. Some funds reported error rates more than doubling since the introduction of Choice. Others have had to employ dedicated full time staff to deal specifically with errors.

Record maintenance

Many funds also had a great deal of difficulty keeping track and maintaining records of the proliferation of employers they transact with. This was particularly prevalent in industry and retail funds, which are more likely to gain members from small employers. One industry fund reported transacting with an average 1,000 new employers a month.

These challenges are making it difficult and costly to maintain servicing standards. Funds are putting on extra call centre staff to handle the resulting increase in member enquiries. Despite this, to date, the superannuation industry has been very much focused on its distribution model while back office operational issues have been lower down on the agenda.

For funds dealing with large employers, electronic interfaces between systems and intense ongoing employer contact result in substantially lower error rates.

Nearly all funds are different in the way they operate, the information they require and the forms they use. Some fund administrators have standardised selected areas of processing. However, most trustees or funds respond to some organisational or compliance requirements slightly differently and insist on their way of marketing and processing.

To help analyse the challenges Choice presents to its stakeholders, we have applied the key steps in the underlying business process which is often referred to as the value chain. The diagram represents the steps14 required to process CoF superannuation contributions.


Appendix B Key implications along the value chain

B.1. Instruction origination: the issues start upfrontThe process of completing and submitting the employee’s CoF form is currently posing challenges. Success requires: employers clearly understanding their responsibilities under the superannuation regime; and employees being aware of Choice and understanding fund communication to make informed decisions about where to put their retirement savings.

Employers have significant CoF obligations

Employers are responsible for giving eligible employees the standard CoF form. Employer obligations under the CoF laws are to:

Determine which employees are •eligible to exercise CoF

Give each eligible employee a standard •CoF form within 28 days of the employee starting work, with the employer part of the form completed

Identify if the employee exercises CoF •by completing, signing and returning their employee part of the standard CoF form

If the employee makes a valid choice, •act on that choice within two months and pay the 9% obligation into the appropriate fund

Avoid influencing the employee’s CoF •

The onus is on the employee to correctly complete a standard CoF form

An employee does not have to exercise CoF. The employee is free to do nothing, thereby accepting the fund specified by the employer in the standard CoF form. There is no time limit on the employee deciding whether to nominate a fund of their choice. To properly complete the standard CoF form, the employee must provide the employer with details of the proposed fund and confirmation from the fund that it can accept payments from the employer on behalf of that employee. Many employees and members have difficulties with this step.

Fund administration is complex

Employer registration is inconsistent

Under the Choice system, some funds can refuse to accept contributions unless the employer registers their details. However, many employers object to registering with funds to avoid a perceived increase of future marketing and additional paperwork. Moreover, they are under no obligation to register. In these circumstances, contributions return to the employer and/or the employer advises the employee to select an alternate fund. This practice undermines the principle of Choice.

Information from superannuation funds can be voluminous and complex

Many employees are overwhelmed by superannuation fund information. People struggle to identify the essential information and requirements in comprehensive Product Disclosure Statements and other complex legal documents. This confusion results in a large number of incomplete or inaccurate standard CoF forms. In general, employers filter a large portion of these issues and rectify them before they enter the contribution system. However, employees frequently start down the path of exercising CoF, but end up in the employers default fund because it is simply easier and less hassle.

Advice/fund

selection

Instructionorigination

Captureand

validate

Balancecheckand

accounts

Settlementof

messagesand funds

Accountallocation

and reconciliations

Compliance and remittance management

Investingnew

funds


B.2. Capture and validate: getting it rightIncorrect data amplifies costs later in the value chain, as transactions are processed based on the content of master data files. Thus, capturing and validating accurate information is a critical step in making the value chain efficient. The current challenges in the system are:

Master data is dynamic not static

Changes to member master data, such as name and address, can be performed independently by different stakeholders at different points in the value chain. For example a change of payroll information by human resources; manual changes to remittance forms to superannuation funds; change at superannuation fund level via employers; or changes at superannuation fund level via a member request. These independent changes result in reconciliation issues and errors.

Information gets sent to the wrong address and can have the wrong payee details

Employers and clearing houses face the challenge of keeping up to date with processing administrative changes. The significant number of cheques going through the traditional mail system highlights the importance of this issue. Getting the payee and postal address right is critical.

Administrators change over time

There are challenges when funds or products within one fund change administrators. Most administrator changes are notified well in advance. However, if communication between funds and employers breaks down, errors are likely to occur.

Privacy laws limit data sharing

Privacy law sometimes restricts employers and clearing houses from reporting changes to employees’ master data to superannuation funds. In these cases, employers have to ask employees to make the appropriate changes with the funds directly. Employee inertia, or lack of understanding, may cause errors, rejections and delays in allocating contributions correctly.

B.3. Balance checks and accounts Closed accounts are the largest cause of contributions that require further investigation to correctly identify and return to employees. Most cases of closed accounts relate to poor communication between the employer, employee and fund, or between the corporate and retail areas within one fund. On some occasions, the account has simply been withdrawn or the member has exited the fund. In others, the member may have transferred to another product or fund after changing jobs. Many of these cases relate to employer-sponsored funds where the employee chooses an account they held through a former employer. However, once that former employer notifies the fund the employee has ceased employment, the account is usually transferred.

In addition, errors may result from invalid bank account details or member accounts that have not been set up on time.

As the majority of these cases relate to a member changing employers, this issue requires urgent attention because of Australia’s growing levels of employee mobility.

B.4. Settlement of information and fundsParties exchange information and money electronically, by paper or a mixture of both methods. Inefficiencies arise when a large number of the transactions require significant manual intervention and re-keying of data. Improving efficiency will require changes to the existing IT infrastructure, as well as settlement frameworks and key parameters such as information and service standards. The key issues are:

Cheque contributions

A large number of employers, particularly smaller employers, prefer to transfer contributions by cheque. Hence, some funds receive more than 75% of their contributions (Default and Choice) by cheque. In fact, some funds actually require cheque payments for contributions. This leads to substantial volumes of manual transactions and reconciling items. As a result, most funds concerned have had to implement costly control systems to detect errors in manual processing.

Limited information on electronic payment systems

According to the “swimEC15 CoFs payment group”,16 there are major constraints on the exchange of electronic information with the existing Bulk Electronic Clearing System (BECS).17

These limitations currently reduce the ability of employers and funds to communicate electronically and exchange contribution and payment instructions efficiently and reliably. This drives complexity and manual processing, which increases error rates and costs.


Electronic commerce standards are not uniformly applied

Several industry groups recommended standardising the approach for processing superannuation contribution payments to assist employers with implementing the CoF legislation.

While some stakeholders adhere to these standards, uptake has generally been poor. This significantly limits acceptance by an employer.

B.5. Account allocation and reconciliationAllocating contributions to the right fund product and ultimately to the correct member account is complex and challenging. It often involves performing reconciliations as part of the allocation process. Issues include:

Legacy systems preventing pan-industry unique product identifiers

In an environment with more than 700 relevant products, funds and trustees, the financial services industry uses Superannuation Product Identification Numbers (SPIN)18 to uniquely identify superannuation products. SPIN is recognised by many key participants19.

Approximately three quarters of all superannuation funds and products across Australia have a SPIN. However, restructuring and consolidation in the industry has severely complicated the classification system, making it difficult for a layperson to understand. Moreover, SPIN is not and cannot be used as a unique identifier for contribution transactions20. Many funds use multiple legacy systems to process transactions.

These legacy systems do not facilitate the consistent identification of products using one unique identifier across the industry.

No industry service standards for collecting and administering CoF contributions

Superannuation funds and intra-fund products often have separate policies, processes and procedures for administering CoF contributions. Additionally, each individual fund may have unique forms and data requirements.

This means, for every additional employee exercising CoF, employers may need to familiarise themselves with the detailed, non-uniform requirements of a potentially different fund or product. Inconsistently applied standards complicate this. Diligent employers cannot rely on fundamental industry practices, such as funds accepting CoF contributions without employer registration.

Employers interviewed reported these inconsistencies are causing major frustrations for payroll officers, increased effort and cost to keep up with the operational procedures of each fund and sometimes even ignorance and non-compliance with specific fund requirements.

As a result, some employers are rejecting an employee’s CoF request for funds that do not accommodate the employers’ requirements.

Most aforementioned issues are also relevant for clearing houses and those default funds that act as single contact points for employers channelling CoF contributions to other funds.


Footnotes

1 Association of Superannuation Funds of Australia (ASFA) projections, February 20062 CitiStreet in their recent white paper that the costs to administer Choice represent 25% of the overall

administration costs.3 Senator the Hon Nick Sherry, 19 March 2008, Super and the New Government: Speech to the

Conference of Major Superannuation Funds, Commonwealth of Australia4 Cameron, R & Gibbs, M, November 2007, Lessons from the latest Super Industry Research, ANOP

Research Services Pty Ltd.5 Self managed superannuation fund statistical report 17 July 2008, Australian Tax Office website, 22 September 2008 (http://www.ato.gov.au/super/content.

asp?doc=/content/00100435.htm&pc=001/007/130&mnu=37324&mfp=001/007&st=&cy=1) 6 Australian Financial Review, p.21, 26 June 20087 CitiStreet, Choice of Superannuation Fund in Australia: What’s the Real Cost to Industry? Sydney,

March 2008.8 International Federation of Pension Fund Administrators, Collection costs in Pension Fund Systems,

Santiago,9 Ross, S G, June 2004, Collection of social contributions: current practice and critical issues,

International Social Security Association10 Rofman, R, and Demarco, G, February 1999, Collecting and Transferring Pension Contributions,

World Bank11 This is based on a total of $70bn superannuation contributions and a CoF ratio of 10%. We applied an

annual short term investment performance of 8% for an average period of 14 days.12 Our analysis of InvestmentLink data indicated an average time lag of one month between an

employer sending CoF contributions and funds returning the money due to underlying errors. Based on the HR benchmarking data we assume an average 15 days to clarify the error plus additional 15 days for re-sending the contributions and the correct allocation.

13 Assumptions used in calculating costs to employers

The American Productivity and Quality Council (APQC) maintains payroll efficiency performance benchmarks. According to the APQC’s benchmarks the most efficient payroll processors correctly first time process 99.6% of all payroll transactions. The worst performers have a rate of 85.3% and the average is 98.9%. We mapped CoF transaction and error data from clearing house providers and employers against benchmarks from The American Productivity and Quality Council (APQC). In addition we grossed up the effective error rate by a rate of perceived errors that require some attention before they can be resolved without creating a return of contributions. Our analysis assumes the Australian economy and key stakeholders currently deal with between 500,000 errors and issues that require attention annually based on 1.3 million Choice members and 10 million CoF transactions per annum. Based on assumptions used we estimate that the Australian market has an average error rate of 5% for processing CoF contribution transactions. This comprises errors that become resolved before they reach the funds for processing and errors that result in refunds. Our analysis gives a range in performance for processing CoF contributions; best practice is a 0.3% error rate while the worst performers have an error rate exceeding 10% of transactions processed. Based on the sample of employers and clearing houses that we interviewed, the average error takes 2 hours to resolve. Current employment market studies give and an average salary cost of $75,000 per payroll FTE involved in resolving the issues and errors who works 1,700 hours per annum.

14 CitiStreet, Choice of Superannuation Fund in Australia: What’s the Real Cost to Industry? Sydney, March 2008.

15 The Department for Work and Pensions, Anticipated administrative burdens on businesses of proposed personal accounts arrangements, United Kingdom, September 2007

16 Value chain steps

Instruction and origination - often the first interaction between an employee and employer. The employer must clearly understand their responsibilities under the superannuation regime. The employee should be aware of their rights to direct their retirement savings.

Capture and validation - where employers capture employees’ decisions and updates. It involves physically processing and storing information and extends to maintaining master data Balance check and accounts - where employers regularly transfer contributions and perform all associated finance activities.


Settlement of messages and funds - where employers, funds and fund administrators or clearing houses exchange information and money. This “technical” exchange and settlement of contribution schedules and payments can be done electronically, by paper or a mixture of both methods.

Account allocation and reconciliations - where the fund or administrator allocates money to the correct member’s account. This requires allocating contributions to the right fund product. It often involves performing reconciliations, as both part of the allocation process and as an internal control mechanism.

17 swimEC program

The swimEC program is an amalgamation of the:

SuperEC program - from the Australian superannuation industry. It aims to deliver industry-wide • cost reductions and efficiency gains by promoting industry message standards for electronic commerce.

MFundEC program - from the Australian managed funds industry. It aims to deliver industry-wide • cost reductions and efficiency gains by promoting industry message standards for electronic commerce for the Australian Managed Funds System.

The swimEC program aims to;

Create the standards, relationships and processes for the automated exchange of superannuation • and managed funds information across all industry stakeholders

Assist members to roll out the finalised standards into production.• 18 swimEC, Overview of current approaches for issuing superannuation payments, 200519 Constraints with Bulk electronic Clearing System (BECS)

Only a few fields are available to the “sending” user to specify the details of a payment•

Structural limitations within the BECS Direct Credit file, i.e., field size constraints•

The system does not pass all of these fields through its entirety•

At certain application entry points, only some of the fields are available to users• 20 SPIN was developed by the SuperEC Programme, which recognised the need to be able to uniquely

identify superannuation products offered within a fund. 21 SPIN is recognised by Treasury, the Australian Taxation Office (ATO), the Australian Securities and

Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA).22 Issues with unique superannuation identifying numbers

Through its analysis, the SuperEC Rollover Special Interest Group found that:

The Superannuation Fund Number (SFN) or Australian Business Number (ABN) is used to identify • the legal structure of a superannuation fund. The provider of a fund is usually the trustee of that fund. The provider (or trustee) has also been described as the responsible entity for that fund. Each provider needs to be uniquely identified by a consistent identifier.

A provider may be the provider for more than one fund so that there maybe multiple SFNs/ABNs • associated with the same provider.

A provider may also offer more than one product to the market within a fund so that there may be • multiple product offerings under the one SFN or ABN.

The Product Identification Code is not confined to a specific level for superannuation purposes and • may relate to the investment option, the product level and the fund level.

There may be several investment options associated with a product.•

External transactions are undertaken at the product level, while subsequent allocation of monies • to member fund balances occurs at the investment choice level. These external transactions include rollovers, contributions, payments and surcharge reporting.

The superannuation industry is one of the fastest growing market segments in Australia, creating challenges and opportunities for all participants including industry, corporate, retail, self-managed, and public sector funds, third party service providers, employers and individuals.

Given the complex and constantly changing superannuation regime, we have a specialised team that works with employers, trustees and superannuation executives to identify and implement solutions for emerging issues.

For more information about our services, please contact a member of our superannuation team:

Insurance Industry LeaderGraeme McKenzieTel: +61 2 9248 [email protected]

Adelaide Chris Sharpley Tel: +61 8 8417 1685 [email protected]

Brisbane/Gold Coast Ian Burgess Tel: +61 7 3243 3711 [email protected]

Mike Reid Tel: +61 7 3243 3696 [email protected]

Canberra Andrew McCrossin Tel: +61 2 6267 3946 [email protected]

Melbourne Stephen HuppertTel: +61 3 9288 [email protected]

Dennis Connors Tel: +61 3 8650 7232 [email protected]

Denis Thorn Tel: +61 3 8650 7637 [email protected]

Perth Grant Burgess Tel: +61 8 9429 2298 [email protected]

Tim Dachs Tel: +61 8 9429 2111 [email protected]

Sydney Antoinette Elias +61 2 8295 6251 [email protected]

David Jewell +61 2 9248 5803 [email protected]

Josef Pilger+61 2 9248 [email protected]

John Shipp +61 2 8295 [email protected]

Contacts

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© 2008 Ernst & Young Australia. SCORE Retrieval File No. AU00000217

This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk.

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