The FSI Super recommendations

Last week’s formal response to David Murray’s Financial System Inquiry (FSI) raised barely a whisper of objection to a comprehensive list of reform recommendations.

But a primary response by the new Treasurer Scott Morrison – to refer the framing of competition within default superannuation to the Productivity Commission – has shades of policy endeavours past.

Does this seemingly innocuous review signal a fast-track reform to tidy up the industry’s shortcomings?

Firstly, let’s deal with the definitions. The Turnbull government has thrown its support behind the FSI recommendation to set an agreed objective for the superannuation system.

For its part, the FSI recommended that the primary goal of superannuation should be to provide income in retirement to substitute or supplement the Age Pension.

Should the government leave this definition unchanged, it may finally confirm that super should be used for a definitive purpose – and not as a ‘slush’ fund to assist in other areas of social need such as housing deposits, health costs or aged care requirements.

And while the government endorsed most of the FSI recommendations (except the suggestion that borrowing or leverage be banned within self-managed super funds) it has also tasked the Productivity Commission to develop:

• alternative models for a formal competitive process for allocating default members to products,
• criteria to assess the efficiency and competitiveness of the superannuation system

The first item instils an eerie sense of déjà vu.  The Productivity Commission completed a similar review in 2012 which was generally well thought out and gave a balanced view of some of the complexities associated with altering the Modern Award system.

In particular, the draft report raised a number of issues that are relevant to the current debate:

• how could we increase competition of default business without putting undue upward pressure on costs through increased intermediation?
• how could we ensure that funds operate on a level playing field in terms of access to awards but also enforce strongly any ban on illegal inducements that may be offered to employers?
• the importance of ensuring employers do not have too much choice, by limiting the number of funds that may be listed in an award (e.g. 5-10 although potentially all MySuper products could apply to be on an award)
• protecting members by ensuring that they are not ‘flipped’ into higher cost divisions

Unfortunately, the 2012 draft report was too controversial for Labor and the final report led to the current Fair Work legislation which is messy and has been thwarted by the government. The decision to open up the whole workforce to Choice of Fund might change the distribution emphasis with the industry towards employees.

Any change to the default arrangements needs to take into account the potential impact on the efficiency and competitive forces of the system.  The ongoing review into default arrangements and industry efficiency, together with the change in governance to allow more independent trustees, will provide a wake-up call to the industry.

Although the FSI changed much of the public discourse to focus on fees and retirement innovation, the upcoming Productivity Commission review will now put a time limit on the period within which the industry can act on its perceived shortcomings, or risk having control of its own destiny taken away.  Rice Warner expects many corporate funds and smaller industry funds to wind up, and many larger funds to merge to remain competitive.

In its response, the government has stated that more needs to be done (1) to reduce fees and (2) to increase after-tax returns for fund members.  This would be better expressed as improving (long-term) returns after fees and taxes as the two objectives are not always correlated.  We need a strong system which encourages innovation and flexibility; we must avoid an exclusive focus on fees alone or we will end up with a system unlikely to maximise retirement incomes.

The government has agreed to support the development of comprehensive income products for retirement, which can be pre-selected as a default retirement option for members.  It states that the current range of products at retirement is narrow, and does not always meet individuals’ needs and preferences.  Rice Warner concurs that the industry needs better solutions to provide longevity protection as well as developing a focus on maximising retirement incomes within the pension phase.

The government claims it has a strategy for superannuation to improve the operation and efficiency of the system and in doing so boost retirement incomes.  The next phase in the post FSI environment will be interesting to see how exactly – and how quickly – this might be achieved.