Superannuation funds at the crossroads

But isn’t the industry a success story?

Many superannuation industry participants were surprised at the Financial System Inquiry (Murray) arguing that the superannuation system was inefficient and uncompetitive. This confused many within the industry as there are many great achievements – collectively, the industry has delivered:

• A 5% annual real rate of return on investments over 25 years.
• Part closure on the population’s under-insurance gap through group policies.
• A large capital market which has reduced our reliance on foreign investment into Australia – and we have a large pool of assets invested abroad.
• Widespread international recognition of the Australian system as one of the most effective in the world.

Nonetheless, the government agreed and instructed the Productivity Commission to review the industry. It is unsettling to have this come so soon after MySuper and SuperStream. Nonetheless, high impact regulatory changes are inevitable, and will present unprecedented challenges.

At the same time, there are unprecedented opportunities. Superannuation is fast becoming the centre of a family’s financial wealth, and the system is projected to grow to over $4.2 trillion (in 2016 dollars) by 2026¹.   New thinking will be needed to seize these opportunities in an increasingly fluid environment.

Increasing scrutiny

The industry has never faced more scrutiny from regulators, members and competitors

• Smaller funds especially face pressure from APRA and the Productivity Commission because they are, on average, underperforming in their outcomes to members.
• Key person risk is a growing concern, especially for smaller funds.
• Large funds and providers are not immune, as many are not yet accessing the scale benefits available to them, and some are impeded by unresolved legacy issues.
• Funds needs to determine the direction of their own change or risk having change imposed upon them.
• Leaders should use the pressure they are under as a catalyst for action.
• There are a broad set of solutions funds can look at to improve their performance.
• Funds should look at partnership opportunities to create long-term sustainability.

Increasing “stay-in-business” costs

There have also been huge increases in costs with the biggest in recent times coming from heightened governance and compliance activities. The costs of doing business keep rising and this puts pressure on funds to build more resources. This is a challenge for smaller funds as they don’t have the revenue base to do this themselves.

Some will use the analogy that building societies can compete with banks by offering personalised service. That is true, but banking is a transactional business. Once you start providing engagement services, complexity rises and deeper resources are needed.

A fund for life?

A new young person starting work today will already have a bank for transactions and savings. Many will stay with that institution for years, even until they die in perhaps 80 years. There may be events that cause them to move their account but these will be infrequent – typically on marriage or buying a home.

Likewise, that person could be a member of a superannuation fund for 80 years but the chances are lower. Whereas banking is still a transactional service for the most part, superannuation has moved on from that. Funds now offer a range of additional services, which have changed significantly in the last decade:

• Life insurance – 70% of all premiums in the life industry are from group life policies.
• Retirement – more than 30% of all superannuation assets are now in pension phase
• Choice of Fund – SMSFs are now 30% of all FUM – up from 15% 15 years ago.
• Investments – there is more emphasis on tailoring strategies to groups of members.
• Financial advice – everybody needs advice prior to retirement and many retirees will need ongoing advice throughout their life, which preparation for aged care an increasingly important part of this.

Changes in members’ needs over time act as an opportunity for some funds – and a headwind for others. Funds without a compelling retirement solution risk being limited to an incubator role, with members who achieve meaningful balances turning elsewhere for help in converting their retirement benefit into an income.

Decision time

All funds need to review their future direction. In particular, small funds, say those under $2 billion or with less than 100,000 members, should review the business plan they put forward as part of their MySuper application four years ago, and measure whether they are on track. If not, now is the time to review the strategy, and there are several options:

• One is to give up and transfer members and assets into a large fund – few trustees and executives like this option.
• Another is to seek a fund of a similar size and culture and to merge with them. That provides some inorganic growth, buys some time and broadens the range of future options.
• Another option is to review the fund’s objectives and to simplify the structure. Do you need to manage your own investments or should they be outsourced (implemented consulting)? Are you incurring overheads on investment options which are not being used? Reducing the number of investment options might make the fund look less competitive but it can be more focused.
• Another option is to transfer into a big fund but maintain the identity and brand. Few like this option as it means giving up trusteeship but many corporate funds have done this over the last 20 years and their employees have benefited from the change.
• Finally, there is always the option of continuing with a stronger focus on organic growth. This is valid but it may not be achievable for all. Success will require building a competitive advantage in selected niches, focusing on a few core activities, and leveraging off the scale of well-chosen service providers and partners.

Whatever you do, have a strategy and a purpose; otherwise, you could decline and not be in control of your own future.

Michael Rice recently participated in a panel at Mercer’s 2020 Sydney and Melbourne launch of its report Change or be Changed. This Insight contains Michael’s notes based on the theme ‘Change or be changed: how super funds can adapt and thrive in a climate of ongoing uncertainty’.

¹Rice Warner’s Superannuation Market Projections Report 2016