The Productivity Commission has released the report of its inquiry into the efficiency and competitiveness of the superannuation system and if new ways to allocate default funds are needed. The report recommends new workers are allocated to a default fund once – after being shown a list of up to 10 top funds. Other recommendations include changes to advice around SMSF.
The Productivity Commission has given its report on the efficiency and competitiveness of superannuation to the Government. Though it might not be released before the next Federal election.
Update: The Government has released the Productivity Commission report, but is waiting for the final report of the Banking Royal Commission before giving its response to the recommendations.
The Productivity Commission says it handed the final report of its inquiry into the efficiency and competitiveness of Australia’s superannuation system to the Government on 21 December 2018.
The Productivity Commission has been releasing research as part of its inquiry into the efficiency and competitiveness of the superannuation system. The latest paper is on economies of scale.
The paper finds that “large cost savings can still be realised, especially from further consolidation”. It “conservatively” estimates that merging the 50 highest cost APRA-regulated super funds with the 10 lowest cost funds would save at least $1.8 billion a year.
“Even modest economies can materially reduce costs. A one basis point reduction in administration expense ratios for funds with more than $10 billion in assets would result in annual savings of around $130 million.”
Passing on the median cost savings, of around 10 basis points (0.1%), on to all members as lower fees and holding all other costs the same would leave the average super fund member about $22,000 better off at retirement.
The Commission found that there have been “significant scale benefits” realised over recent years, of $4.5 billion between 2004 and 2017. Though there is “little evidence” that these savings have been “systematically” passed on to members through lower fees
“Despite the realisation of economies of scale since 2004, the reduction in fees charged to members by the median fund did not fall. Though some funds have likely passed through at least some of the scale gains.”
The Commission says the savings may have been used to increase operational reserves, improving member services or spent on new compliance and regulatory requirements. But issues with data make it difficult to reach a conclusion.
Some super funds – in particularly not-for-profit funds – may have used the savings to increase investments in unlisted assets which boosted returns for members,.
“It is also possible that data limitations (including under-reporting of expenses and patchy fee data) are muddying the analysis.”
The Productivity Commission is due to give its final report on efficiency and competitiveness in the super system to the Government in late December 2018.
Class says that a “like-for-like” Return On Assets (ROA) calculation shows an average 5.59% return for SMSFs compared to 4.98% for APRA funds over a 10 year period.
On a Rate Of Return (ROR) basis SMSFs averaged 6.71% versus 5.58% for APRA funds.
The methodology used in comparing the returns of SMSF and APRA funds in the draft report by the Productivity Commission on the efficiency and competitiveness of the super system has been criticised by Class Limited and other organisations. Class says this does not reflect on the quality of the Commission’s work, but is a “poor performance” by APRA and the ATO in being unable to agree how to report performance in the super industry.
“The competing approaches used to report super performance deliver significant differences and given the dual regulators are responsible for an industry worth over $2.5 trillion, it’s time for APRA and the ATO to agree on a consistent approach to fund performance reporting,” said Class CEO Kevin Bungard.
Class says the ROA formula used by the ATO is “conservative” and will always produce a worse result than APRA’s ROR formula. In part this is because contribution tax and insurance is not treated as an expense in APRA’s calculations, but they are by the ATO’s formula.
The Productivity Commission recently released a supplementary analysis of super fund investment performance, which takes on board these concerns.
“For the 10-year period the Commission’s Report covers, on average, SMSFs outperformed APRA funds on a like-for-like basis regardless of whether ROA or ROR is used,” said Class, in its latest Benchmark report.
Since the Productivity Commission released its draft report the ATO has provided ‘revised’ ROR figures, but some issues remain.
Class is encouraging the ATO to also perform long-term analysis on the performance date of SMSFs to help answer questions about the expenses and returns of small SMSFs.
There has been growing concern that the Productivity Commission may recommend a minimum balance in order to have an SMSF, driven by seemingly high costs.
However BGL says the Productivity Commission is using “outdated and incorrect data”.
BGL extracted data from its Simple Fund 360 database – which includes over 165,000 SMSFs – and found that costs for SMSFs are competitive.
BGL Managing Director Ron Lesh said the data used by the Productivity Commission is “simply flawed”.
“Our data clearly shows the administration cost for funds with balances of less than $200,000 is around 1% and as fund balances grows this percentage drops significantly,” he said.
Data from BGL was also used by the SMSF Association in its Productivity Commission submission, which criticised the methodology used by the Commission.
“The suggestion that a SMSF needs a starting balance of $1,000,000 in the AFR this week is simply rubbish,” said Mr Lesh.
“My view has always been you cannot put a minimum cap on how much is needed to set up an SMSF. It is simply not possible.”
“The circumstance of people are all very different. You may have a guy who is 40 years of age, has a balance of $80,000 in an industry fund who decides to move to SMSF. Some people would say – hey that’s not enough to set up an SMSF. But the same guy is then going to make a non-concessional contribution of $100,000 the next year, make his $25,000 concessional contribution and buy a property with an LRBA.”
“Does he now have enough in his SMSF?
“Or the guy may not have $100,000 to put in his SMSF, so he invests the $80,000 plus his $25,000 concessional contributions in listed securities – in Australia and overseas. What’s wrong with that? This likelihood he is would still be better than being in an industry fund – and he would know exactly where his money is invested and exactly to whom he is paying fees.”
BGL will be releasing its BStar SMSF Insights Report in mid August, with an Executive Summary of the report released at the BGL Regtech 2018 | Accountants in BETA conference – which starts today in Sydney, with other cities to follow.
The Productivity Commission’s draft findings include that SMSFs with higher balances were competitive with large super funds, but SMSFs with under $1 million in assets perform “significantly worse” – mainly due to higher average costs.
“Factors such as data problems, investment return calculation methodology and the retirement demographics of SMSFs compared with APRA-regulated funds make it unreasonable for the Commission to conclude from the data they used that SMSFs are not cost-effective with a balance below $1 million,” says the SMSF Association.
The Association’s submission to the Productivity Commission says the ATO’s SMSF statistics are “questionable” – particularly around costs and returns. Issues with the statistics are “exacerbated” by differences in methodology between the ATO and APRA.
The SMSF costs data is also distorted by the inclusion of establishment costs and insurance.
The Association says including SMSF establishment expenses in annual cost calculations is “myopic and distorts SMSF cost and return data”. Including insurance in the operating costs of SMSFs, when it isn’t included for APRA funds, is also distorting.
“Furthermore, another significant issue in comparing investment returns, especially at a sector level, is that SMSFs have a significant proportion of members in retirement phase compared to APRA-regulated funds which can distort comparisons,” says the submission.
The SMSF notes that the Productivity Commission acknowledged in the draft report there are issues in comparing APRA and ATO statistics.
The SMSF Association (SMSFA) also wants the Productivity Commission to consider the “varied motivations” of SMSF members, including increased control and individual retirement goals.
“Simply comparing investment returns between SMSFs and other superannuation funds does not acknowledge or account for the other benefits that SMSF members receive from their funds.”
“We believe that these data problems make it difficult for the Commission to appropriately make a finding that SMSFs are not cost-effective with a balance below $1 million and should not lead to a minimum balance for SMSFs being recommended.”
“The SMSFA does not support the introduction of arbitrary barriers to establishing an SMSF as they would inhibit consumer choice and flexibility within the superannuation system. We believe individuals must be given the ability to engage and manage their retirement savings in ways that suit their retirement goals.”
Class finds “gaps” in Productivity Commission
Class Ltd – which makes Class Super – has also made a submission to the Productivity Commission, finding “gaps” in the draft report.
Class says the Commission’s report is “well researched”, but “fails to hit the mark on SMSF performance”. Though this “isn’t a reflection on the quality of the Commission’s work, however it is a stark reminder of the inherent differences between how APRA and ATO report fund performance”.
As with the SMSF submission, Class points out that the ATO includes contributions tax and insurance in net earnings statistics – which APRA does not.
“Class analysis of SMSF performance across 5 years shows that although funds with smaller balances do generate lower returns, the variance is considerably less than the exaggerated results provided in the draft Report,” says Class, which has released its submission.
“The Productivity Commission notes in numerous places that the ATO’s ROA and APRA’s ROR are not directly comparable – however it then proceeds to do so anyway,” says the submission.
“We do not accept that data collection differences between the ATO and APRA mean that an ROR cannot be calculated and compared for SMSFs,” says Class, setting out a method to do so.
“It should be acknowledged that the ATO and the Commission are largely working with the data they have available, and that the issues we highlight in this submission do not appear to be due to policy or error, but simply due to misunderstandings and/or lack of a full consideration of the impact of some of the choices made, and differences in the methods employed by the ATO and APRA.”
Class CEO Kevin Bungard said: “It appears that the advice the Commission got from the regulators was that it is ‘too hard’ to compare the performance of APRA funds against SMSFs – which is disappointing, given the dual regulators are responsible for an industry worth over $2 trillion. The Class analysis highlights how significant the different approaches to performance reporting really are.”
“It’s time that the two industry regulators start to actively collaborate to deliver accurate insights into like-for-like fund performance.”
Bungard said that Class “wholeheartedly” agrees with recommendation 22 of the draft report – the creation of a superannuation data working group.
The due date for the Productivity Commission’s final report is currently shown, on its website, as “TBA”.
The Productivity Commission has publicly released its draft report into the efficiency and competitiveness of the superannuation system. It finds that the super system needs to adapt to the needs of a modern workforce and increasing numbers of retirees.
The Commission notes that some super funds consistently have high net returns, while a “significant number of products (including some defaults) underperform markedly”.
“Most (but not all) underperforming products are in the retail segment.”
While the default super segment outperforms the super system on average, the way members are allocated to default funds “leaves some exposed to the costly risk of being defaulted into an underperforming fund” – which can erode more than 36% of their balance by retirement.
The draft report recommends that members only be put into a default fund once, when they join the workforce, instead of when they change jobs. Employees would pick a fund from a shortlist – of not more than 10 funds – selected by an independent panel.
“Members should be empowered to choose their own product, and the shortlist should be designed to make this safe and easy to do.”
“No-one would be forced to pick from the shortlist, and members would retain the ability to join any fund they choose.”
The expert panel would compile the list every four years, and the responsible Minister would not have the power to change a decision of the panel.
“It should particularly consider long-term net returns and fees, as well as each applicant’s investment strategy, intrafund advice, governance and track record on identifying and meeting member needs.”
The Commission says this model would likely drive member engagement, with less than 5% of employees likely to not make a choice according to a survey.
The Commission had raised a number of other options to set default funds in earlier consultation documents, including a fee-based auction and multi-criteria tender, but these were “inferior in crucial ways” – including the risk funds would have low-cost strategies at the expense of net returns.
Superannuation fund competition, governance and regulation “inadequate”
The report find that competition, governance and regulation in the sector is “inadequate”. Competition between default super funds is “superficial”, with “signs of unhealthy competition in the choice segment”.
Regulators, and the regulations, “focus too much on funds rather than members”. The data and disclosures to members and regulators are “subpar”, inhibiting accountability.
In addition to the default fund change, the Productivity Commission calls for a higher threshold to be a MySuper fund, more action to make insurance valuable to members (including an enforceable code of practice), stronger governance rules (particularly around board appointments and mergers), and for regulators to “become member champions”.
“Currently, structural flaws – unintended multiple accounts and entrenched underperformers – harm a significant number of members, and regressively so,” says the Commission.
“Fixing these twin problems could benefit members to the tune of $3.9 billion each year.”
The Commission says about a third of super fund accounts are “unintended multiple accounts”, which erode balances by $2.6 billion a year in unnecessary fees and insurance.
“Not all members get value out of insurance in super. Many see their retirement balances eroded — often by over $50,000 — by duplicate or unsuitable (even ‘zombie’) policies.”
The draft report is part of the third, and final, stage of the Productivity Commission’s inquiry into superannuation competitiveness and efficiency and how default super funds should be set. The due date for the final report is currently “TBA”, but likely to be sometime in 2019.
Submissions in response to the draft report are due by 13 July 2018.
Government position on default super as yet unclear
Peter Costello, Chair of the Future Fund, was supportive of a single national administrator of super savings, and suggested the Future Fund could do the job, in a speech to the to the SuperRatings and Lonsec Day of Confrontation 2017 conference.
The Productivity Commission is set to report in 2018 on alternative ways to select default super funds. Its inquiry included looking at models overseas, including ones with a single retirement savings administrator.
Costello, in his speech , said: “Let me say that I believe that, subject to safeguards, people should be able to choose who should manage their superannuation. But the reality in Australia is there is a very large cohort of people that don’t. Their money goes into so-called ‘default funds’ that get allocated to an Industry Fund under an Industrial Award or union agreement, or to a private sector plan by an Employer.”
“Instead of the Government arbitrating between Industry Funds and private funds, there is a fair argument that this compulsory payment should be allocated to a national safety net administrator – let us call it the Super Guarantee Agency – a not for profit agency, which could then either set up its own CPPIB-like [Canada Pension Plan Investment Board] Investment Board – the SGIA-or contract it out – the Future Fund Management Agency could do it.”
Costello there would be “huge economies of scale”, fees would be reduced and it would “end the fight between the Industry and the profit sector over who gets the benefit of the default funds”.
However the Association of Superannuation Funds of Australia (ASFA) said such a proposal would put retirement savings at risk.
“In the context of the broader public debate around the efficiency and competitiveness of the superannuation system, it is almost inconceivable that anyone would countenance a government monopoly delivering the best retirement outcomes for Australians,” said ASFA CEO Dr Martin Fahy.
“What is being proposed is in essence the nationalisation of private, individual superannuation savings,” he said.
Dr Fahy said the Future Fund lacks the governance framework and administrative capabilities it would need to manage superannuation.
“It would also require faith that government could deliver more efficient, effective and reliable administration services than the private sector.”
“The reality is that transferring administration functions to a government body would create single-point-of-failure risk for members.”
The SMSF Association says that the lack of stability in the superannuation system is impeding the efficient deliver of retirement savings outcomes to members.
“The system needs a sustained period of stability free from significant changes, especially changes to taxation settings, to allow members to have confidence in the system and make long-term savings plans,” said SMSF Association CEO John Maroney.
Mr Maroney said it’s imperative for the Government to get industry consensus on the objective of superannuation – a Bill for which is still before the Parliament – and remove superannuation from the annual budget policy cycle.
SMSFA has been calling for superannuation policy to be removed from the budget cycle for some time, instead recommending it be reviewed every five years.
“Superannuation policy changes can then potentially be undertaken through a review of superannuation settings linked to the Intergenerational Report which is required under the Charter of Budget Honesty Act 1998 to be completed every five years and released by the Treasurer at the time,” said Mr Maroney.
“Having the Intergenerational Report released once every five years will allow the Government, industry and consumers to take a ‘health check’ on the superannuation system to see whether it is attaining its goals and whether any adjustments/changes to policy settings are required.”
The SMSFA has told the Productivity Commission, in a submission to the inquiry into the competitiveness and efficiency of the super system, that the political instability and ongoing changes to superannuation law has created a level of distrust and instability in the system.
“When superannuation changes occur at the whim of budget policy and when consistent tinkering occurs, these activities affect the public trust in superannuation that can lead to individuals becoming disengaged with the system.”
“They may withhold from making contributions and managing their superannuation savings in the most appropriate way for them (either in an SMSF or APRA-regulated fund) to maximise their retirement benefits.”
Maroney points to research released by the Association which shows that legislative change, and surrounding speculation, has resulted in many Australians losing confidence in the super system and reducing their super contributions.
“We think there is a clear message in these reports. Constant changes to the superannuation system undermine confidence and will hinder the system achieving its primary objective – to provide income in retirement to substitute or supplement the age pension, delivering a financially secure and dignified retirement for Australians,” he said.
The figure comes from the Financial Services Council (FSC), which says Fair Work Commission’s default super fund selection process is leaving up to 1.7 million people worse off in retirement.
Analysis by the FSC found there are 33 super funds listed under modern awards which each manage less than $10 billion. The average performance of the 33 funds over 10 years was “just” 4.50% per annum, which was 0.80% lower than the average of all ‘growth’ super fund options.
The FSC calculates that this performance gap could leave consumers $170,000 worse off by retirement.
“If this many Australian workers were enabled by law to languish in poorly paying jobs with working conditions way below their peers, for as long as 40 years, there’d be outrage across the entire community,” said FSC CEO Sally Loane.
“So we shouldn’t tolerate a system which leaves people in superannuation funds delivering significantly poor returns, for years and years. Many can’t change funds because of the current industrial laws governing default super, and many are chronically disengaged and disinterested. Either way, the system needs to change if the policy is going to work for all Australians.”
“The prevalence of subscale funds in the default system is a major public policy issue which needs to be addressed given they have such a negative impact on consumers’ financial outcomes,” Ms Loane said.
The FSC, which represents a number of large financial institutions, has been campaigning for greater access for the funds operated by its members to the default super system.
The Productivity Commission conducted an inquiry into alternative models for selecting default super funds, which was due to be given to the Government in August 2017. However this final report will now be incorporated into report into the competitiveness and efficiency of the superannuation system, due in June 2018.