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Productivity Commission – Complacent super industry about to be squeezed?

Productivity Commission – Complacent super industry about to be squeezed?

  • On 03/08/2016
  • commission, financial system, mySuper, superannuation

The Australian superannuation industry is large but fragmented. Costs have fallen with the introduction of MySuper and they will fall further once SuperStream is complete. However, there remain critics who claim that the system needs a shake-up and that further economies of scale can be realised.

In its final report (November 2014), the Financial System Inquiry noted that “the superannuation system is not operating efficiently due to a lack of strong price-based competition“.

Amongst several significant recommendations for change in the superannuation industry, it gave notice that more efficiency is needed or a new system of allocating new default fund members into MySuper products would be required – “unless a review by 2020 concludes that the Stronger Super reforms have been effective in significantly improving competition and efficiency in the superannuation system“.

Clearly, it is important to develop a sound mechanism for measuring both competition and efficiency or this review cannot be undertaken objectively. Consequently, in February this year, the Treasurer commissioned the Productivity Commission (‘Commission’) to conduct a study in two parts, namely:

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

The analysis will be done in two stages and yesterday (2 August), the Commission released its draft report on the first part – How to Assess the Competitiveness and Efficiency of the Superannuation System.  The industry will respond on this draft report by 9 September before the final report is released later this year.

The FSI recommended developing criteria to assess different types of efficiency:

  • Operational efficiency – where products and services are delivered in a way that minimises cost and maximises value.
  • Allocative efficiency –where the system allocates resources to the most productive use and optimal balance between consumption and savings over time.
  • Dynamic efficiency – (including services to members) where the system encourages optimum behaviour on behalf of consumers.

The Commission has set out its own system-level objectives which it wants measured for competitiveness and efficiency:

  • Maximising net returns on contributions and balances over the long-term.
  • Meeting member preferences and needs, in relation to information, products and risk management, over that member’s lifetime.
  • Providing insurance that meets members’ needs at least cost.
  • Complementing a stable financial system and not impeding long-term improvements in efficiency.
  • Competition that drives efficient outcomes for members.

In order to test performance against these benchmarks, the Commission will rely heavily on benchmarks over time – elements of the benchmarks may be an issue for superannuation funds of all types and sizes. The Commission rightly identifies the key matters for members to be investment returns and fees and its emphasis will be on measuring these with a view to put pressure for improving outcomes in these areas. We expect that many small funds will find the scrutiny here to be uncomfortable.

In contrast, the Commission noted that product proliferation, high advertising expenditure, competition on non-price (non-fee) aspects and high search costs are signs of unhealthy competition, something more commonly seen with the larger funds.

As most funds spend money in some of these ‘unhealthy’ areas, often with the view of building their brand, it will be interesting to see how this will be treated when benchmarking efficiency. Funds may be forced to pay more attention to ‘value for money’ for members when they develop their budgets.

It also raises the perennial issue – given superannuation is mandatory, can funds justify spending money belonging to default members to pay for attracting Choice members? Successful funds can as the resultant economies of scale more than pay back this type of investment in the fund’s growth. However, many funds have spent heavily for growth which has never come.

The industry has moved away from simply providing transactions towards one of improving engagement with members. Many funds are now spending more on a range of services including intra-fund advice. Perhaps funds should start showing the cost of these additional services separately so members can more clearly see where their fees are being spent, and the Commission could ensure that benchmarking of different funds is performed on a like-for-like basis.

Another important area is life insurance. Group insurance has led to much wider coverage of life insurance in the community and is generally cheap compared to similar cover held outside of superannuation. However, there is still much to be done to make the group market efficient particularly in relation to the management of data, policy terms and conditions as well as claims management and underwriting. The Commission defines success in this area as providing insurance “that meets members’ needs at least cost”. This suggests simpler products with cheap universal coverage rather than complex products which might be more suitable outside superannuation.

One of the most difficult benchmarking exercises will be that of comparing ‘net returns’. This needs to be done over a reasonable timeframe and it will involve components such as fees, investment risk and asset allocation. Amongst other things, this will raise the perennial issue of active versus passive portfolios in listed markets.

The significant revamp of some products with the introduction of MySuper means that several products do not have a measurable track record for assessing past long term performance. We will need to find a way to measure investment strategies, governance and processes as those funds which do this well will end up with the best long term outcomes for members. It will also lead to questions about suitable asset allocation in both the accumulation and pension phases.

The superannuation industry is complex. It will be useful to see the development of robust measures of efficiency. This should lead to some rationalisation as the funds delivering poorer performance will be taken over.

It would be a good sign if industry wide fees started to plateau even as the asset base rises. Then, all members would get better for value for money.

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