This article was written by Ruth Stringer and Phil Logan.
The Productivity Commission’s Draft Report has today been released for further public consultation and input, after which a final report will be issued. The Draft Report aims to provide an overall assessment of the superannuation system and recommend policy changes, and is complemented by the Commission’s inquiry into the broader Australian financial system.
Here are some highlights:
- The Federal Government pre-empted some of the recommendations contained in the Productivity Commission’s Draft Report in its recent Budget measures relating to small balances and insurance arrangements for younger members and those with small or inactive accounts. There are nonetheless many more recommendations in the draft Report for the Government to ponder, some of which could have a dramatic impact on the superannuation landscape in years to come, if adopted.
- The most significant proposed change would see a further diminution of the role of employers, with default funds being selected by or for employees independently of the employment relationship. This is predicated on a process to identify 10 “best in show” default funds that would be presented to the employee by way of limited choice on the basis that if no choice is made, a fund would be arbitrarily allocated to the member from this menu.
- The general thrust of the Draft Report is that rather than relying on members to vote with their feet, more needs to be done to nudge people into better performing funds (and away from under performers). Despite this, the draft Report also recommends that the disclosure regime be enhanced by requiring funds to publish a new and improved one page product dashboard and for these to be made available centrally to all employees for all funds on the menu, to encourage active choice.
- The Draft Report recommends further improvements to governance and while not recommending a requirement for independent directors on superannuation trustee boards does recommend that it be made easier to appoint independent directors.
- The authors of the Draft Report are sceptical about the Comprehensive Income for Retirement (CIPR) (or “MyRetirement”) reforms – they conclude there is no need for the system to mandate default retirement income products, arguing that no one product will be suitable for all.
Below we summarise the key findings and recommendations of the Draft Report. The Commission will be holding public hearings in June and submissions on the Draft Report may be made by 13 July 2018.
The draft Report contains a large number of findings and recommendations. The following points are the key themes:
The Commission’s key concerns with the current system are what it sees as the failure to place members in the best performing default products, the proliferation of unintended multiple accounts (including duplicate insurance) and the resulting impact on each of these on member benefits.
The Commission’s recommendations include a complete overhaul of the current arrangements for placement of members in default products and significant changes affecting lost member accounts and their consolidation.
The Commission’s view is that in the default sector there are high regulatory barriers (including being listed in a modern award) and an absence of competition.
The Commission recommends there be a single shortlist of up to 10 superannuation products for all members who are new to the workforce (or do not have a superannuation account), from which they can choose a product. A member who fails to make a choice should default to one of the products. An independent expert panel would be established to run a competitive process for listing products on the shortlist.
The Commission is also concerned about erosion of account balances by insurance premiums and the suitability of default insurance arrangements.
The Commission recommends legislation to require that premiums for members under age 25 should only be deducted with their consent, and to require trustees to cease insurance cover where no contributions have been made for 13 months unless member consent is given. A formal independent review of insurance in superannuation is also recommended.
The Commission is also concerned about both the voluntary nature of the Code and its strength.
The Commission recommends adoption of the Insurance Code be a mandatory requirement to obtain or retain MySuper authorisation and establishment of an ASIC/APRA taskforce to advance the Insurance Code and maximise its benefits in improving member outcomes. The Insurance Code should be strengthened and made binding and enforceable on signatories.
Trustee board governance
The Commission is also concerned about trustee board governance.
The Commission recommends legislation to require trustees to use and disclose a process to assess, at least annually, board performance and the performance of individual directors, and require all trustee boards to maintain a skills matrix and annually publish a consolidated summary of it, along with the skills of each director.
Summary of the draft Report
Broadly, the Commission’s draft findings, recommendations and information requests include:
- APRA regulated funds – a significant variation of performance, with not-for-profit funds as a group systematically outperforming for-profit funds, and retail funds dominating the “tail” of underperformance but with some corporate and industry funds also in that group.
- Self managed funds – funds with balances under $1 million have delivered materially lower returns on average than larger funds.
- Default funds – a wide variation in performance, suggesting that many members being defaulted into underperforming products could be doing better.
- Choice funds - a wide variation in performance, meaning that many members could be doing better.
The Commission requests information on whether its assumptions on benchmark portfolios are sound and what factors, other than administration fees, asset allocation and tax, may explain differences in investment performance within the superannuation system, including what evidence is available to test the influence of such factors.
Fees and costs
- Fees and costs reporting - there are significant gaps and inconsistencies, harming members by making fee comparability difficult and rendering cost-based competition largely elusive.
- Fee levels – higher in Australia than in many other OECD countries, although a downward trend since 2010. Fees have fallen markedly for retail funds, although they remain higher (at least for choice products) than for industry funds (for which fees are largely unchanged). The MySuper and SuperStream reforms have likely reduced fees but there is a persistent “tail” of relatively high fee (mainly for –profit) choice products.
- Self managed funds – reported fees have increased over recent years although for funds with over $1 million, fees are broadly comparable to APRA-regulated funds. For low balance funds, fees are significantly higher than for APRA-regulated funds and are the primary cause of poor net returns. However, the number of new funds with balances under $100,000 fell between 2010 and 2016.
- Lower net returns – there is significant potential to lift retirement balances overall by members moving, or being allocated, to a lower fee and better performing fund.
- Member satisfaction – qualitative judgments by members suggest that a small number are dissatisfied with the overall performance of their fund and many more indicate that fund performance, including service quality, has improved over time than those who feel performance has flagged.
- Comparability – many members find it difficult to make comparisons between available superannuation products. A “no frills” product with low fees allocated to a balanced (or balanced growth) portfolio is likely to meet the needs of most members in the accumulation phase. A better designed and modernised default allocation could act as a trusted benchmark for better member decision making.
- Life cycle products – their inclusion in MySuper products is questionable and they are better suited to choice products, because they are mostly suited to members wanting to “lock in” a lump sum for some immediate purchase after retirement, whereas for other members maintaining a balanced portfolio before and after retirement would maximise income.
- MyRetirement default product – such a product is not warranted because of the diversity in household preferences, incomes and other assets. The most important task remaining is to improve the quality of financial advice to members.
- Use of data – funds make insufficient use of data to develop and price products, including insurance, which is problematic for designing products for the retirement and transition to retirement stages, when different strategies have the biggest payoffs for members.
The Commission requests information on whether life-cycle products should be allowed as part of MySuper, and if so, do they require redesign to better cater for varying circumstances of members nearing retirement and how should that be achieved and what information is needed about members to develop a product better suited to managing sequencing risk.
- Engagement is low on average – engagement tends to be higher among those approaching retirement, those with higher balances and members of self managed funds. While only about 30% of members have low financial literacy, many lack the detailed understanding necessary for effective engagement.
- Demand-side pressure is weak – an estimated 1 million members are barred from exercising choice and most members in the accumulation phase are default members, at least when entering the workforce, and modest rates of fund switching suggest a lack of material competitive pressure on funds. Proposed legislative changes to prohibit restrictive clauses in workplace agreements on choice of fund are much needed.
- Dashboards – should be the prime mechanism to allow for product comparison and need to be salient, simple and accessible, but most are not.
- Financial advice – the quality of advice to some members is questionable, including those with self managed funds. Knowledge of the guidance and supports available to pre-retirees is generally lacking and as members retire with higher balances and the diversity of options expands, the need for tailored advice will grow.
Erosion of member balances
- Superannuation Guarantee compliance – compliance will be promoted by policy changes, being extension of single touch payroll to small employers, at least monthly reporting by funds to the ATO of contributions, and strengthening of ATO powers to penalise breaches and recover unpaid contributions.
- Current policy – does not minimise erosion, which is substantial in size and regressive, and recent initiatives are making slow progress by treating the symptoms and not the structural cause. Unintended multiple accounts are the main problem, along with Superannuation Guarantee non-compliance and grandfathered trailing commissions.
Market structure, contestability and behaviour
- Market structure – as distinct from superannuation policy and regulatory settings, market structure is conducive to rivalry, with many funds and products at the retail level. At the wholesale level, there is concentration in some outsourcing markets (such as administration), but a growing ability for larger funds in particular to insource adds to competitive pressure.
- Barriers – fund regulation is a significant cost of entry but this and other challenges for new entrants are not necessarily prohibitive or high barriers. In the default sector there are high regulatory barriers (including being listed in a modern award) and an absence of competition, whereas the choice sector is largely contestable. Barriers to fund mergers frustrate consolidation, at great cost to members.
- Unhealthy competition – competition in the choice sector has not always translated to better outcomes for members, and product proliferation (particularly the number of investment options) and poor comparability are symptomatic of unhealthy competition. In the default sector, the risk of inducements to employers can work against the interests of members.
- Using associated service providers – while vertical integration is not in itself a problem, it raises conflicts of interest which need to be addressed by confident regulators and with greater transparency through disclosure and reporting.
- Economies of scale – the significant savings over the last decade have mainly been from exit of small, high cost funds. It is not evident that funds have been able to realise cost efficiencies as they have grown in size.
The Commission requests information on certain costs of mergers and on passing through of economies of scale to members.
- Premiums and balance erosion – premiums can have a material impact on retirement balances which is highly regressive for members with low incomes and has a larger impact on members with multiple insurance covers or who have intermittent attachment to the labour force.
- Default insurance – in terms of premiums paid, while offering good value for some members, for others it is ill suited to their needs or they may be unable to claim. This is particularly the case for younger members or members with intermittent attachment to the labour force.
- Fiscal effects – these are complex and the net effects are uncertain. Existing estimates overestimate net fiscal benefits as they do not consider the impact of balance erosion on age pension eligibility.
The Commission requests information on the case for bundling life and total and permanent disability insurance and whether, where permitted, members elect for one but not the other. The Commission also requests information on the value for money case for income protection insurance being provided on an-opt out basis.
- Board appointment processes – despite improvements, there is still much room for trustee boards to do better and the use of a skills matrix (informed by external evaluation of board performance, skills, experience and knowledge) should be considered best practice.
- Qualification of directors – best practice for trustee boards would include at least one third of independent directors. However, ensuring there are processes to recruit highly skilled and experienced directors is at least as important.
- Evaluations – many trustee boards fail to require evaluation of board performance and capability by external parties, which is crucial to identifying skills gaps.
- Short termism – mimicking the strategies of rival funds for fear of short term poor relative performance is likely to be at the expense of long term returns to members.
- Proposed “member outcomes” reforms – if enacted, these will improve member outcomes, particularly the MySuper outcomes test (in terms of APRA de-authorising poorly performing products and better promoting fund consolidation) and increased power for APRA to deal with ownership changes.
- Conduct regulation – confusing and opaque arrangements and the overlap between the roles of APRA and ASIC have the potential to lead to poor accountability and lack of strategic conduct regulation.
- Dispute resolution – provided it is adequately resourced, the formation of the Australian Financial Complaints Authority should be a positive reform.
- Borrowing by self managed funds – the current use of limited recourse borrowing arrangements is unlikely to pose a material systemic risk but this needs to be actively monitored.
- Policy changes – while the frequency and pace of recent changes have undoubtedly created real pressures for the superannuation industry, most of the reforms have been overwhelmingly beneficial from a public interest perspective.
The Commission requests certain information on division of responsibilities between APRA and ASIC and better strategic conduct regulation and regulator accountability.
- Substantial dollar benefits – fixing some of the worst of the current problems would bring substantial benefits to members. This includes unintended multiple accounts (and duplicate insurance) and moving members from underperforming MySuper products to 10 top performing MySuper products.
- Needs of members – the superannuation system has not kept pace with member needs, most notably the absurdity of one in every three accounts being unintended, with the system anchored to the job or the employer, and not the member.
Competing for default members
- Member placement – the default system fails to ensure members are placed in the best products and places a minority in underperforming products. Some members are denied the opportunity to choose their own product. Default arrangements need to be modernised and recrafted to harness the benefits of competition for default members.
- Member engagement – current default arrangements do not promote engagement. Evidence reveals that when members are provided with a simple and accessible list, only a small minority would not make a choice.
- Sovereign monopoly default fund – while such a fund would be well placed to realise economies of scale, it is not recommended on the basis that it would run counter to the (desirable) absence of an actual or implied government guarantee and would fail to harness the benefits of a competitive process. It would also supplant member engagement.
The Commission requests information on any material impediments to high performing non-incumbent funds participating in a “best in show” selection process, particularly foreign funds or a government owned fund with no prior local track record.
Draft Recommendation 1 - Defaulting only once for new workforce entrants
Default superannuation accounts should only be created for members who are new to the workforce or do not already have a superannuation account (and do not nominate a fund of their own). A centralised online service for members and employers should be established for opening, closing and consolidating accounts, which would also allow the Government to collect information.
Draft Recommendation 2 – “Best in show” shortlist for new members
A single shortlist of up to 10 superannuation products should be presented to all members who are new to the workforce (or do not have a superannuation account), from which they can choose a product. It should include clear and comparable information on key features of each product. A member who fails to make a choice within 60 days should default to one of the products based on a sequential allocation.
Draft Recommendation 3 – Independent expert panel for “Best in show” selection
Establishment of an independent expert panel to run a competitive process for listing superannuation products on the shortlist, to be reconstituted every four years. In order to be submitted for listing, a product must meet the expert panel’s criteria and be judged as delivering the best outcomes for members, with high weighting on investment strategy and performance.
Draft Recommendation 4 – MySuper authorisation
Legislation to allow APRA to apply the MySuper outcomes test. MySuper authorisation rules should be further strengthened to require funds to obtain independent verification (to an audit level standard) of their outcomes test assessment, comparison against other products and determination that members’ best interests are being promoted, at least every three years. Failure to meet these conditions, or underperforming for five or more years an APRA investment benchmark should lead to revocation of authorisation. Every five years, there should be an independent review of the effectiveness of the authorisation rules (including the outcomes test) at meeting their objectives.
Draft Recommendation 5 – Regulation of trustee board directors
- require all trustees to use and disclose a process to assess, at least annually, board performance relative to its objectives and the performance of individual directors;
- require all trustee boards to maintain a skills matrix and annually publish a consolidated summary of it, along with the skills of each trustee director;
- require trustees to have and disclose a process to seek external third party evaluation of the performance of the board (including its committees and individual trustee directors) and capability (against the skills matrix) at least every three years. The evaluation should consider whether the matrix sufficiently captures the skills that the board needs (and will need in the future) to meet its objectives, and highlight any capability gaps. APRA should be provided with the outcomes of such evaluations as soon as they have been completed;
- remove legislative restrictions on the ability of superannuation funds to appoint independent directors to trustee boards (with or without explicit approval from APRA).
Draft Recommendation 6 – Reporting on merger activity
Trustee boards of all APRA regulated funds to disclose to APRA when they enter a memorandum of understanding with another fund in relation to a merger attempt. Where a merger does not proceed, the board should disclose to APRA the reasons and the members’ best interests assessment that informed the decision.
Draft Recommendation 7 – Capital gains tax relief for mergers
Legislation to make permanent the temporary loss relief and asset rollover provisions that provide relief from capital gains tax liabilities to superannuation funds in the event of fund mergers and transfer events.
Draft Recommendation 8 – Cleaning up lost accounts
Legislation to ensure lost accounts are sent to the ATO, empower the ATO to auto consolidate a lost account into an active account unless the member rejects that, allow funds to exempt an account where the member has explicitly signalled that they want to remain in the fund, reduce the “lost inactive” threshold from five to two years, require all ERF accounts to be sent to the ATO and prohibit further accounts being sent to ERFs.
Draft Recommendation 9 – A member-friendly dashboard for all products
Publication of simple, single page dashboards to be required for all superannuation products. ASIC to prioritise implementation of choice product dashboards by 1 July 2019, revise those dashboards by end of 2019 and publish all MySuper and choice product dashboards on a single website.
Draft Recommendation 10 – Delivering dashboards to members
The ATO to present the relevant product dashboard for a member’s existing account(s) on the centralised online service. Trustees to provide members who request a switch from a MySuper product to a choice product within a fund with the relevant product dashboards.
Draft Recommendation 11 – Guidance for pre retirees
The ATO to guide members reaching age 55 to specified website material relevant to retirees.
Draft Recommendation 12 – Exit fees at cost-recovery levels
Legislation to extend to all new members and new accumulation and retirement products the MySuper regulations limiting exit fees and switching fees to cost recovery levels.
Draft Recommendation 13 – Disclosure of trailing commissions
Funds should be required to clearly inform affected members on an annual basis of the amount of any trailing commissions and that they are now illegal for new members, and also disclose the extent of trailing commissions and the number of affected members in their annual reports and provide the information to ASIC.
Draft Recommendation 14 – Opt-in insurance for members under 25
Legislation to require that premiums for members under age 25 should only be deducted with their express consent.
Draft Recommendation 15 – Cease insurance on accounts without contributions
Legislation to require trustees to cease insurance cover where no contributions have been made for 13 months, unless member consent otherwise is given.
Draft Recommendation 16 – Insurance balance erosion trade offs
APRA to require trustees of APRA regulated funds to articulate and quantify the balance erosion trade off determination they have made for group insurance, and make it available on their website annually. Trustees should also provide on their websites a simple calculator for members to estimate the impact of premiums on balances at retirement and articulate in annual reports why default cover and premiums are in members’ best interests.
Draft Recommendation 17 – Insurance Code to be a MySuper condition
Adoption of the Insurance in Superannuation Voluntary Code of Practice (“Insurance Code”) should be a mandatory requirement to obtain or retain MySuper authorisation.
Draft Recommendation 18 – Insurance Code taskforce
Establish an ASIC/APRA taskforce to advance the Insurance Code and maximise its benefits in improving member outcomes, to report annually on progress. The Insurance Code must be strengthened and made binding and enforceable on signatories within two years before further regulatory intervention is considered.
Draft Recommendation 19 – Independent review of insurance in super
A formal independent review to evaluate the effectiveness of initiatives to date, examine the costs and benefits of retaining insurance arrangements on an opt-out (as opposed to an opt-in) basis, and consider if further regulatory intervention or policy change is required. The independent review should be initiated within four years of completion of the Commission’s report, or earlier if the strengthened Insurance Code is not made enforceable within two years.
Draft Recommendation 20 – Australian Prudential Regulation Authority
APRA to impose new requirements on trustees including requiring trustees to conduct formal due diligence of outsourcing arrangements at least every three years to ensure they provide value for money and provide their assessment to APRA; to report annually on progress from application of the MySuper scale test (and outcomes test, when legislated) in bringing about fund mergers; to undertake a systematic assessment of the costs of legacy products and if necessary further refine trustees’ obligations for member transfers so products can be rationalised. APRA to also embed product level reporting within its reporting framework as soon as practicable (no later than 18 months) to enhance visibility of actual member outcomes across funds and bring reporting for the choice sector into line with the MySuper sector, and expedite efforts to address inconsistencies in reporting practices.
Draft Recommendation 21 – Australian Securities and Investments Commission
ASIC to set and enforce disclosure standards (additional to the recommended simpler product dashboards), require disclosure to current and prospective members of the proportion of costs paid to related party service providers, investigate stalled or failed mergers, and review exit and switching fees with a focus on whether they relate to underlying performance of the product or unreasonably impede a member switching products.
Draft Recommendation 22 – Superannuation data working group
Establish a superannuation data working group to address consistency and scope of data release, costs and benefits of reporting changes, necessary legislative or regulatory changes, with annual reporting of the group’s progress.