- On March 22, 2018
The superannuation industry is busy dealing with several significant inquiries, including:
- The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
- The continuing Productivity Commission review of the efficiency of the superannuation system.
- The Parliamentary Joint Committee inquiry into life insurance as well as implementation of the code of practice for life insurance within superannuation.
If that were not enough, APRA has put forward several Discussion Papers about Strengthening Member Outcomes. This followed the release (August last year), of APRA’s letter to the trustees of superannuation funds¹ informing them of its newly developed member outcome tests, which are focused on fund sustainability and the quality of member outcomes.
These tests are intended to replace the scale test and revolve around 4 metrics:
- Net cashflow ratio patterns over the last three years
- Cost per member vs MySuper net returns over three years
- Operating expenses vs current cashflow ratio
- Change in membership and active member ratios
APRA anticipates that its new tests will require improvements and remediation activities for a subset of funds in the short term. However, its objective in proposing the prudential framework changes is to drive long-term improvements in industry-wide practices.
Viewed in isolation, many superannuation funds will appear to be performing quite well according to many internal and external metrics. However, these same funds could still be identified as performing poorly according to APRA’s member outcomes analysis. In this context, Trustees will need to be able to articulate where a fund sits in relation to the identified member outcomes, and why. As appropriate, it might also be required to provide an explanation as to what it is doing about its position.
Rice Warner has undertaken analysis of the APRA cashflow statistics. It reveals a fascinating picture – 119 of the 175 funds with data experienced a declining net cashflow ratio over the past 3 years. These funds are represented by the purple bubbles below the dotted diagonal line in Graph 1 below. Funds with the largest decline in net cashflow ratio are the furthest below this line.
Graph 1. Net cashflow ratio in 2016 vs 3-year average net cashflow ratio
Of note are the funds below the line and in the top right quadrant of the Graph 1. These funds are cashflow positive but still ranked as ‘poorly performing’ funds under this part of the APRA member outcomes test, which measures the most recent 12 months cashflow against the 3-year average. From the perspective of the member outcomes test, this might be interpreted by APRA as the funds having declining cashflows.
Plotting the change in member accounts against the active member ratio paints a similar picture. The shaded area in Graph 2 below represent funds that lost more than 5% of their accounts in 2016. Further refining this for those funds with an active member ratio of less than 80%, we can see that approximately 60% of funds are classed as performing poorly on this metric.
Graph 2. Change in member accounts vs active member ratio 2016
Of course, the APRA tests are blanket measures designed to give APRA a high-level perspective. Being blanket measures, there are several issues with the metrics. These include:
- With underlying wage inflation growing at an average rate of around 2-3% and most funds returning 6-8% p.a., many funds will always have a declining net cashflow ratio if contributions are the primary source of cashflow. The only way to reverse this is to have a strong inflow of new members or a sustained campaign on consolidation from existing members;
- The measures don’t look retrospectively at events that may skew results. For example, a past merger may have caused cashflow ratios to spike temporarily, and compulsory transfer of small lost accounts to the ATO may be driving a decline in the number of member accounts;
- Fees are double counted when analysing costs per member vs MySuper net returns, since the cost per member is inclusive of investment expenses.
With the continued growth of the Australian superannuation industry, regulatory oversight and the demand for greater transparency will only increase. All superannuation funds will need to adapt to this new environment.
While the outcomes tests will place many funds in APRA’s crosshairs, demonstrating that the fund is delivering positive outcomes to members will relieve the pressure.
Those funds that consistently perform poorly against several of the member outcomes tests will need to be able to justify why APRA should not consider them to be poorly performing. For many funds, there will be justification for their position. For others, they will need to demonstrate that they are acting on the evidence to improve the proposition.
As part of these enhanced powers, if APRA is not convinced of a fund’s sustainability and/or its ability to deliver quality of member outcomes, it could impose conditions on the licence or issue directions related to particular matters. This could even see a fund being directed to in relation to its operations, including potential wind-up options.
This further dials up the pressure on struggling funds to improve their value proposition to members. This may be achieved through pursuing more aggressive growth strategies – it is likely that these strategies will incorporate a combination of complementary organic and inorganic activities.