Employees' choice of superannuation plan: effects of risk transfer costs.

Abstract

Consistent with a worldwide trend away from defined benefits towards accumulation benefits, many Australian employers, who traditionally offered their workers defined superannuation benefits, are closing their defined benefit plans to new members and/or offering existing members the option of transferring to an accumulation plan. There has also been a push to allow members greater choice in terms of both funds and investments. Against this background, the Superannuation Scheme for Australian Universities (SSAU) made an offer to its members in 1998 to transfer from the defined benefit section to an accumulation-style plan. Their position was that the choice of fund for employees should be a matter for the employer and the employees at the workplace or their respective representative organisations. At the conclusion of the offer period only one-third of SSAU members had elected to transfer to the Investment Choice Plan (ICP). This study seeks to explain why the majority of SSAU members chose to remain in the Defined Benefit Plan when offered the option of transferring to the accumulation-style ICP. We propose that 'risk transfer costs' explain the low ICP acceptance rate. Research findings show that both those who chose to stay in the Defined Benefit Plan (DBP) and those who elected to transfer to the ICP were prepared to accept trade-offs in their choice. DBP members were prepared to forego a higher quantum of expected benefits for greater security of benefits expected in the DBP, whereas the ICP members were prepared to forego such security and accepted higher investment risk in return for a higher expected quantum and greater control over their benefits. Differences in financial proficiency and differences across academic disciplines confirm that risk transfer costs were a key reason why the majority of SSAU members rejected the ICP choice. Important implications arising from this study include the need for greater transparency of the risk transfer costs involved in offers of benefit structure change, such as that offered by the SSAU, and the need to incorporate compensation for such costs into the offer. Cognizance also needs to be taken of the major risk transfer cost of becoming informed about superannuation and the consequences of such costs for the government's intentions to mandate superannuation fund choice for all Australian workers.