Productivity Commission draft report

Productivity Commission draft report


Superannuation: Assessing Efficiency and Competitiveness

There has been an enormous amount of coverage of the Productivity Commission’s draft report since it was released last Tuesday. Much of this has focused on specific aspects of the report or has taken a particular point of view.

The Productivity Commission’s draft report is 549 pages long and is supplemented by seven technical reports, cameos and other material.

This Policy Alert provides a simple, easily digested overview of the report, summarising the key draft finding and draft recommendations in a neutral basis. The views summarised are those of the Productivity Commission, not those of AIST.

AIST issued a media release when the report was released and will be making a substantial submission in response to the draft report. We will be advocating for measures that advance the best interests of members of profit to member funds. AIST is seeking the views of our members. 

Super funds will also be sent another survey by the Commission tomorrow (5 June).

For further information or to provide feedback please contact AIST’s Senior Policy Manager David Haynes at dhaynes@aist.asn.au


What is the Productivity Commission doing?

The Commission sees its role is to address structural flaws of multiple accounts and underperforming funds that harm many super fund members by providing recommendations to the Government.

Overview

  • The Productivity Commission is fulfilling terms of reference given to it by the Federal Government in February 2016.
  • It is required to assess the efficiency and competitiveness of the superannuation system, to improve outcomes for members and system stability.
  • The Commission has highlighted that fixing the twin problems of unintended multiple accounts and entrenched underperformers could benefit members to the tune of $3.9 billion per year.
  • If there were no unintended multiple accounts (and the duplicate insurance that goes with them), members would have been collectively better off by about $2.6 billion a year.
  • If members in underperforming MySuper products had instead been moved to the median of the top-10 performing MySuper products they would collectively have gained an additional $1.3 billion a year.

How are they going about it?

Submissions on this draft report can be made until 13 July, and a final report is likely due later this year. The Commission will be sending super funds another survey tomorrow (5 June) to address gaps from their previous surveys.

  • The Productivity Commission has been inquiring into superannuation since February 2016. 
  • Their first stage report proposing an efficiency framework was published in November 2016.
  • Their second stage report was incorporated into this third stage inquiry.
  • This draft report is the start of their third stage, with the Government asking the Productivity Commission to have focus on fees, default fund allocation about insurance.
  • The timeframe for their Final Report is yet to be announced but is likely to be towards the end of next year.
  • Public hearing will be held in late June, with submissions in response due by Friday 13 July.
  • The Commission is also sending out a further survey to funds tomorrow (4 June) on fund assets, returns and fees by asset class.

Default super fund allocation

New entrants to the workforce will be given the choice of 10 super funds chosen by a new independent expert panel.

Draft findings

  • The default system has ‘on average’ outperformed the system but has not served a sizable minority in under-performing products.
  • Some members cannot choose their own fund.
  • Current default arrangements do not promote member engagement.
  • Research suggests members would choose an existing fund if given the opportunity.
  • A ‘sovereign monopoly default fund’ would not increase competition in the super system and would reduce member engagement.

Recommendations

  • Default accounts should only be created for people entering the workforce.
  • New members should be allowed to choose any fund but also be given the choice of 10 ‘best in show’ super funds (along with clear and comparable information on these funds features).
  • Use of the ATO’s online commencement process being developed should be mandated and used to facilitate this.
  • Any member not making a choice within 60 days should be sequentially allocated to one of the 10 funds.
  • An independent expert panel should be introduced to run the competitive process each four years for the 10 ‘best in show’ funds.

Member account balance erosion

In order to reduce the 10 million unintended multiple accounts, all lost/inactive accounts (and all ERF accounts) should be sent to the ATO, which will be required to transfer these to members’ active accounts. The lost inactive threshold should be reduced from 5 to 2 years.

Draft findings

  • 10 million accounts – 1/3rd of all accounts - are unintended multiple accounts.
  • The ‘absurdity’ of unintended multiple accounts is a consequence of the structural flaw of a system anchored to the workplace.
  • Single Touch Payroll, new fund reporting to the ATO and increased enforcement powers will  increase SG compliance.
  • SG non-compliance may be costing members $2.6 billion pa.
  • Multiple accounts cost members $2.6 billion pa in unnecessary fees and insurance premiums.

Recommendations

  • The Government should legislate for all ‘lost’ accounts (other than those specifically exempted by a member) to be sent to the ATO, and for the ATO to transfer these to a member’s active account.
  • ‘Lost inactive’ threshold should be reduced from five to two years.
  • All accounts in Eligible Rollover Funds should be sent to the ATO, and further ERFing should be prohibited.

Insurance in superannuation

Adoption of the super industry Insurance Code should be a condition for holding a MySuper licence.  The Code should be improved and become enforceable. Cessation of cover after 13 months and opt-in insurance for under 25 year olds should be introduced.

Draft findings

  • Around half of all life insurance is distributed via super, and the large share of low risk members in the pool acts to keep premiums down.
  • Insurance in super is good value for many members, but less so for young, casually-employed and low-income members.
  • The problem of balance erosion by premiums is most pronounced for low-income and casual members, and for those with multiple account balances.
  • Unsuitable and unclaimable insurance must be addressed at a structural level.
  • The economic benefits of insurance in super are overstated.
  • The Insurance in Superannuation Code will herald modest improvements but is unenforceable.

Recommendations

  • Funds should be required to immediately adopt the Insurance in Superannuation Code of Practice to obtain (or retain) MySuper authorisation.
  • The Code should be improved over the next two years, become enforceable and be oversighted by ASIC.
  • Members aged under 25 should only be provided insurance on an opt-in basis.
  • Insurance cover should cease for members with no contribution in the past 13 months.
  • Funds should be required to articulate their insurance cover/balance erosion trade off, and the rationale for default premiums and cover.
  • The Government should undertake an independent review of insurance in super within the next few year, including whether insurance should be opt-in or opt-out.

Super fund governance

Super funds should have at least 1/3rd independent directors and be externally evaluated. MySuper rules should be extended to include minimum long term-investment performance and switching disclosure.

Draft findings

  • Trustee board appointment processes need to be improved, despite recent developments.
  • Fund boards should comprise at least one-third independent directors to meet best practice governance.
  • Processes to recruit skilled and experienced directors are at least as important as independent directors.
  • External evaluation of board performance is crucial in identifying skill gaps.
  • Short-termism driven by inter-fund rivalry is likely to be at the expense of long-term returns.

Recommendations

  • Funds should be required to assess their performance at least annually, including external evaluation and capability against a skills matrix.
  • Authorisation rules for MySuper should include a requirement for minimum long-term investment performance, external evaluation of board performance and reporting on switching to higher-fee choice products in the fund.
  • Failure to meet the above test or the outcomes assessment test should result in loss of MySuper authorisation.
  • The MySuper authorisation rules should be independently reviewed every five years.
  • Legislative restrictions on the appointment of independent directors should be removed.
  • Funds should be required to advise APRA when they enter a MoU with another fund about a possible merger.
  • Capital Gains Tax relief for fund mergers should be made permanent.

Fees and costs

Trailing commissions grand-parented by FOFA should be clearly disclosed to members, and all exit and switch fees should be clearly disclosed.

Draft findings

  • Fees are too high, although not-for-profit funds charge fees well below retail funds.
  • Higher fees are clearly associated with lower net returns over the long term and have a significant impact on retirement outcomes.
  • Fee comparability and cost-based competition is limited.
  • While MySuper and SuperStream may have reduced fees, fees remain higher than in other OECD countries.
  • While retail choice fund fees are trending down, they remain higher than industry fund fees.
  • SMSFs generally have fee levels similar to APRA-regulated funds but SMSFs with low account balances have much higher costs.

Recommendations

  • MySuper limitation on exit and switching fees to cost-recovery should be extended to all new members and products.
  • All members paying trailing fees should advised on this, the amount involved, and the fact that they are now illegal for new members.
  • Funds should be required to disclose number and value of trailing commissions

Investment performance

Not-for-profit super funds have systematically outperformed for-profit super funds, and feature overwhelmingly in the top-rating MySuper products.

Draft findings

  • Investment returns are the most important element in members’ retirement outcomes.
  • Most products have performed ‘reasonably well’, with not-for-profit funds ‘systematically’ outperforming for-profit funds.
  • In the decade to 2017, the top 10 MySuper products (or pre-2013 equivalent) were all in not-for-profit funds.
  • SMSFs generally perform as well as APRA-regulated funds but SMSFs with less than $1 million have underperformed.
  • Retail funds dominate the tail of underperforming funds, although there are some not-for-profit funds in this group.  
  • The outperformance of not-for-profit funds cannot be explained by fund size or asset allocation – there is a performance gap.
  • If members in underperforming default funds received the median return of the top 10 MySuper products, they would collectively be $1.3 billion pa better off and have 36% more in retirement.

Members’ needs and member engagement

Many members lack the financial literacy to understand overwhelming and complex super information. Product dashboards for all super products should be published by super funds, ASIC and ATO Online.

Draft findings -Members’ needs

  • Members find it hard to compare super funds.
  • A simple ‘no frills’ product with low fees would meet the retirement needs of most Australians.
  • A better designed default system would be a benchmark for better decision making.
  • The inclusion of life-cycle products within MySuper is questionable given the extent of their foregone returns.
  • A ‘MyRetirement’ default is not warranted given the diversity of member needs in retirement.
  • Super funds don’t undertake sufficient data analysis in pricing products.

Draft findings- member engagement

  • About 30% of members have low financial literacy, and many lack the knowledge needed for effective engagement.
  • Much superannuation information is overwhelming and complex, and there should be more emphasis on dashboards.
  • Most members let the default process make decisions for them, and few members switch investment options or funds. 
  • 1 million members are prevented from being able to exercise choice.
  • The quality of some financial advice (including to SMSF members) is questionable.

Recommendations

  • Funds should be required to publish a simple product dashboard for all superannuation products.
  • ASIC should review all product dashboards and require implementation of choice product dashboards by 1 July 2019.
  • All product dashboards should be published on a single ASIC website.
  • A member should be able to see the product dashboards along with their account information on ATO online.
  • Members seeking to switch from a MySuper products should be provided with the product dashboard for the MySuper product and the destination product.
  • The ATO should provide pre-retirement information to members when they turn 55.

Market structure

The super system should deliver good member outcomes over time, with significant scale benefits realised over the past decade. The large tail of small funds suggests further scale economies can be realised.

Draft findings

  • The market structure, aided by trends such as insourcing, supports competition in the system.
  • Meeting regulatory requirements is a barrier to new funds entering the super system, especially in the default fund segment.
  • Competition has been ineffective because of product proliferation and poor comparability.
  • Inducements to employers are a concern and can work against the interests of members.
  • Economies of scale have generally been achieved by the exit of small, high-cost funds.

System governance

Regulators should be given additional powers to pursue super fund consolidation, improve disclosure, and improve collection and use of data.

Draft findings

  • The overlap between APRA and ASIC could lead to poor accountability and strategic conduct regulation.
  • The formation of the Australian Financial Complaints Authority (AFCA) is supported provided it is properly resourced.

Recommendations

  • The MySuper outcomes test should be legislated to allow APRA to better pursue fund consolidation.
  • Funds should be required to undertake due diligence of their outsourcing arrangements at least every three years.
  • APRA should
    • report to the Council of Financial Regulators at least every three years about implementation of the MySuper scale test and the outcomes test.
    • assess the cost of legacy products, and if appropriate, promote rationalisation of these.
    • produce product-level reporting as soon as practicable in the next 18 months.
  • ASIC should:
    • set standards for product and insurance disclosure
    • require disclosure of proportion of costs paid to related party service providers
    • investigate mergers that did not go ahead
    • review exit and switching fees paid by existing members
  • A Superannuation Data Working Group of government agencies should be established to:
    • improve scope and collection of data collection and release
    • evaluate costs and benefits of reporting changes
    • recommend changes to support better data collection
    • report annually to CFR, including on data capabilities