Published (and amended) in The New Zealand Herald, 10th. September 2022
The recent furore over the proposal to charge GST on KiwiSaver management fees shows three things. Firstly, tax remains a treacherous area for policy debate in New Zealand.
Secondly, KiwiSaver has built a strong and thriving industry of financial advisers and managers who are now in a strong position to protect their interests.
Thirdly, we now learn something that all retirement savers should have emblazoned on their accounts – that a small, early addition of cost in their retirement portfolio can translate over time, and through the magic of compound interest, into a very considerable depletion of their final savings balance.
The Financial Markets Authority (FMA), the ostensible regulator of the sector, helpfully provided modelling to support the case. It forecast that requiring all fund managers to pay 15 per cent GST on managed fund fees would see the value of the country’s KiwiSaver investments fall by 5 per cent by 2070.
This is a revealing statistic because it highlights the impact of KiwiSaver fund fees. Average fees (management and administration) on the country’s KiwiSaver balances amount to 0.8%, according to the FMA.
A Grattan Institute study in Australia found that over 40 years, a 1 per cent fee would reduce one’s retirement savings by a fifth. This assumes annual wage growth of 1.8 per cent and portfolio returns of 5 per cent (see figure below).
A fee of 1.5 per cent – which is is probably top of the range in New Zealand – would reduce one’s retirement balance by a third over 40 years.
At the other end of the scale, I have a retirement portfolio I started before KiwiSaver with a “no frills” non-metro investment outfit. This has grown eightfold in value in as many years, provides returns that match those of insurance industry benchmarks, and costs me 0.3 per cent annually, inclusive of GST at 15 per cent.
There is at least one KiwiSaver provider that charges at this low level (albeit without having to absorb the full level of GST).
The remarkable thing is that, according to FMA research, there is no relationship between fees and returns. In other words, the great majority of KiwiSavers are paying fees that greatly reduce their final balances, forego significant reinvestment of returns, and provide them with no apparent advantage over low-cost providers.
Other research by the FMA shows that New Zealand fees are not internationally competitive. The closest comparator to ours is the auto-enrolment retirement system in the United Kingdom. Indeed, it was largely modelled on ours. Our provider fees are anything between 30 to 75 per cent higher.
There is almost no competitive pressure on fees in New Zealand. Yes, the providers compete on advertising and offerings, but not on fees.
When a certain provider advertised their low fees as an attraction to new clients they were admonished by the FMA on the basis that there was no certainty that these fees would retain their competitive edge, and thus deliver a better retirement income over a full life cycle of saving. Also, the provider’s assumptions were not prominently disclosed.
The FMA has asked providers to reduce their fees if they are seen to be “unreasonable”. But the real pressure has come from the government’s tendering of default providers to favour those offering lower fees.
While the Australian system of contributory private provision is compulsory, they have come across a similar set of problems. Their fees are even more uncompetitive than New Zealand’s, and they have asked their Productivity Commission to consider ways of getting better value for money for superannuation clients, including compulsory tendering, underperformance tests, and merging of providers.
It is not as if the government is without leverage. It contributes almost a billion dollars a year to KiwiSaver balances. One wonders why this is not used more judiciously to encourage the ratcheting down of fees; after all, agencies like Treasury, MBIE and FMA follow an orthodox analytical model, they are cautious, and they are probably too close to the industry to do anything of this kind.
The government also has a moral obligation. The New Zealand system was – when it was established in 2007 – and still is, in many respects, world leading. Among other things, it was a pioneer in using the insights of “nudge” philosophy and behavioural economics to gain high levels of enrolment by making the system “opt out” rather than “opt in”, and having a centralised system via Inland Revenue of following clients as they cycle through different jobs.
There are ethical arguments about whether the “nudge” approach is manipulative as it shapes choices in such a way as to make enrolment almost universal. But it could be argued that the cause – saving for retirement – justifies this approach and avoids having to enforce a mandate.
Nevertheless, once people are in the system, the predominant economic model is of the rational, informed user in a competitive and fully informational market. But the reality is very different. The relationship is asymmetric and opaque to the average user, and providers are not under pressure to reduce their fees in any meaningful way.
Therefore, we need to move away from the orthodox approach of “caveat emptor” to one that takes greater care to re-balance the system in the client’s favour, particularly for low-income savers.
The government could tender for default KiwiSaver providers more frequently. It could use its contributions to the scheme to incentivise providers to lower fees. The Super Fund could even join the market to provide more competition. And savers could be offered better chances to switch.
Peter Davis, Emeritus Professor in Population Health and Social Science, University of Auckland.