Part Two – In this second of a two-part series, Alun Stevens picks up on the issue of fund costs and linked efficiency gains

His commentary derives from Rice Warner’s recently released Superannuation Market Projections 2014 report which explores in-depth Australia’s superannuation sector over the next 15 years.

Fees within the superannuation system have been the subject of much debate and commentary over recent months. The Financial System Inquiry (FSI), and a number of submissions to it, highlight the cost of superannuation in Australia relative to other regions.

The comparisons do not take into account the unique features of the Australian system, including:

• the mandatory nature of life insurance
• choice of fund to almost all members
• choice of investment strategies within funds
• the provision of scalable financial advice.

These characteristics distort any fee comparisons with other regions.

Costs: What the FSI found

However, the FSI also looked at trends in fee levels within Australia over the last decade. It drew attention to the lack of meaningful reductions, despite the growing scale of the market during that period.

The FSI concluded that the current system has inefficiencies which need to be addressed. It recommended that a new formal competitive process be established to allocate new workforce entrants to high-performing funds unless the Stronger Super reforms become effective by 2020. This puts pressure on the industry to demonstrate its efficiency.

The industry is confident that initiatives like Super Stream and MySuper will lead to lower costs and subsequently lower fees for members. And, we know that assets will keep growing for several decades. Will these further scale benefits lead to lower fees for members over the next decade?

Not necessarily to the level anticipated, as there are other forces in play!

Factors affecting future fee levels

One key factor which will lead to higher costs is the shift to retirement accounts as the baby-boomers enter the retirement years. Pension accounts have different characteristics to accumulation accounts. Retirees, who by definition are Choice members, have a one-to-one relationship with their fund. This is different from accumulation accounts where there are significant scale benefits from dealing in bulk via employers.

The level of service demanded by holders of retirement accounts is also much higher than that demanded by accumulation members. Consequently, they are more expensive to service and their fees are higher than for accumulation accounts.

The large numbers of members retiring from the system will have an impact on fees as funds will need to increase their resources to service their members approaching and in retirement (including many working past 60, but using the tax-free earnings of and pension payments from their TTR pensions).

Another factor is the general shrinkage of the number of accounts within funds. The ATO consolidated 265,000 accounts (with balances of $1.3 billion) in the six months to December 2014. In time, consolidation could reduce the accounts from more than 30 million to less than 20 million. This will require super funds and some of their service providers (particularly administrators) to review and change their underlying fee structures. Fees are largely determined by the total number of accounts with the ‘rule of thumb’ model for many funds being a flat $1.50 a week per account.

It is not difficult to see where future (and current) tensions lie. Funds which deploy a flat-fee model and expect to pay for everything within that fairly inflexible pricing structure will be found wanting. As we expect growth in member services and marketing, funds will remain under some cost pressure. In many cases, cost savings will be redeployed to provide enhanced services for members.

This means that any scale benefits coming from increasing asset pools and the aggregation of funds into larger units will be tempered by an increase in costs from individual servicing of demanding retired members and enhanced services for accumulation members.

MySuper costs

Rice Warner does expect downward pressure on MySuper fees as funds pass on some of the scale benefits from their growth. However, the impact of MySuper on overall fees will need to be kept in perspective. Our projections show that while some 24 per cent of the market at 30 June 2014 was invested in MySuper products, only 20 per cent will remain invested in MySuper products 10 years hence.

The projections also show that the Retirement segment will grow from 32 per cent to 36 per cent of assets over the same period.

So while we do expect MySuper fee levels to drop significantly over the next decade, the headline total market fees for funds may not be as low as some commentators expect.

– Alun Stevens, Senior Consultant