The Productivity Commission final report on superannuation is a weighty tome covering the diverse aspects that make up the world of super.
We’ve extracted the key issues and findings for the SuperGuide readers that would like to dive deep.
These were the major issues raised in the final report:
- Balances are eroded by fees and insurance
- Persistently underperforming funds and products
- Poor investment performance for some default members
- Poor outcomes in the choice segment
- Members do not always end up in the right products
- Member engagement is often low
- Financial advice is expensive or conflicted
- Insurance is not delivering value for money for all members
- Poor conduct by fund trustees
- Absence of strategic conduct regulation
These have been expanded on in the 46 key findings below.
46 key findings from the Productivity Commission Report on Superannuation
The Commission’s funds survey suggests that superannuation funds on average outperformed a market index benchmark in most individual asset classes over the 10 years to 2017. Not for profit funds outperformed retail funds on average within most major asset classes over this period.
However, these survey results are positively biased due to missing data for funds that have exited the system (survivor bias) and that did not provide the requested data (selection bias).
While international comparisons add further data issues, compared with large pension funds in other developed countries, Australian superannuation funds appear to have achieved comparable returns on individual asset classes.
APRA regulated funds have delivered investment returns to members over the past 21 years (net of all fees and taxes) of 5.9 per cent a year, on average. The majority of members and assets in the system are in products that have performed reasonably well. But there is significant variation in performance within and across segments of the system that is not fully explained by differences in asset allocation.
Not for profit funds, as a group, have systematically outperformed retail funds. This outperformance cannot be fully explained by asset allocation, tax or expenses. Much of it is likely due to differences in asset selection (within asset classes) between the segments.
There is wide variation in performance at the fund level. About 5 million member accounts and $270 billion in assets are in 29 funds that underperformed conservative benchmarks tailored to each fund’s own asset allocation over the 13 years to 2017. About 77 per cent of member accounts and 72 per cent of assets in underperforming funds were in retail funds, even though retail funds represented just 9 of the underperforming funds. Of the other underperforming funds, 14 are industry funds, 3 are corporate funds and 3 are public sector funds.
While asset allocation is the largest determinant of returns at the fund level, most of the variation across funds cannot be explained by asset allocation, tax or expenses. Rather, it is most likely primarily due to differences in asset selection (within asset classes) between funds.
There is wide variation in performance in the default segment. About 1.6 million member accounts and $57 billion in assets are in MySuper products that underperformed conservative benchmarks tailored to each product’s own asset allocation over the 11 years to 2018. This suggests that many members are currently being defaulted into underperforming products and could be doing better.
If all members in bottom quartile MySuper products received the median return from a top quartile MySuper product, they would collectively be $1.2 billion a year better off. Being in the median bottom quartile product means that, on retirement, a typical worker (starting work today) is projected to have a balance 45 per cent lower (or $502 000 less to retire with).
There is wide variation in performance in the choice segment that is not fully explained by differences in asset allocation. Almost $25 billion in assets are in investment options that underperformed conservative benchmarks over the 13 years to 2017. Many choice members could be doing a lot better.
The SMSF segment has delivered broadly comparable investment performance to the APRA regulated segment, but many smaller SMSFs (those with balances under $500 000) have delivered materially lower returns on average than larger SMSFs.
Fees and costs
Superannuation fees in Australia are higher than those observed in other OECD countries. This may be partly because Australian funds face higher expenses. While international comparisons are not straightforward, there is evidence (by asset class) that Australian investment management costs are generally high by international standards, including for significant asset classes (such as equities and international fixed income).
In aggregate, total fees in APRA regulated funds (for administration and investment management services) have been trending down as a proportion of assets over the past decade, from 1.3 per cent in 2008 to 1.1 per cent in 2017.
Fees have fallen for retail funds, albeit remaining higher (for choice products) than the (largely unchanged) fees for industry funds.
Among APRA regulated funds, the MySuper and SuperStream reforms have likely acted to reduce fees (including some possible competitive spillover to choice products), although this is difficult to attribute directly given the impact of other fee drivers.
While financial advice can benefit members, excessive advice fees in choice products and all trailing commissions erode member balances. Ten retail funds collected about $1.4 billion of advice fee revenue in 2017, charging their members about $341 per account in that year alone. Separately, members of 11 retail funds identified in data from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry are estimated to have paid in excess of $400 million in (grandfathered) trailing adviser commissions in 2017.
In contrast, advice fees are closely regulated in MySuper products (with funds only permitted to recoup the cost of intrafund advice from fee revenue), thereby protecting members from undue balance erosion. The disparate regulation of fees and costs in the choice and MySuper segments is in part contributing to poor member outcomes in the choice segment.
There is a ‘tail’ of choice products with high fees (exceeding 1.5 per cent of balances), offered by retail funds. This tail accounted for about 17 per cent of assets and 15 per cent of member accounts in APRA regulated funds in 2017. Retail legacy products account for almost half of all products in the high fee tail.
The share of member accounts in the high fee tail has been declining over time, particularly since 2013 and the introduction of MySuper, but today still accounts for an estimated 4 million member accounts holding $275 billion in assets. Further declines are likely to hinge on the effectiveness of regulator efforts to shift members out of retail legacy products.
Despite regulator awareness, there remain significant gaps and inconsistencies in how funds report data on fees and costs. Funds that misreport or underreport fees and costs appear, at times, to have gone unpunished. This harms members by making fee comparability and decision making difficult at best, and thus renders fee based competition largely elusive.
Higher fees are clearly associated with lower net returns over the long term. The material amount of member assets in high fee funds, coupled with persistence in fee levels through time, suggests there is significant potential to lift retirement balances overall by members moving, or being allocated, to a lower fee and better performing fund.
Fees have a significant impact on retirement balances. For example, an increase of just 0.5 per cent a year in fees would reduce the retirement balance of a typical worker (starting work today) by a projected 12 per cent (or $100 000).
Reported costs for SMSFs (relative to assets) have increased over recent years and, for those with over $1 million in assets, are broadly comparable with APRA regulated funds. By contrast, costs for SMSFs under $500 000 in size are particularly high, on average, and significantly more so than for APRA regulated funds.
About 42 per cent of all SMSFs (some 200 000 in 2016, with an estimated 380 000 members) have been under $500 000 in size for at least two years, and appear to persist with high average cost ratios and low average returns. Nevertheless, the proportion of new SMSFs with very low balances (under $100 000) has fallen from 35 per cent of new establishments in 2010 to 23 per cent in 2016.
Qualitative judgments by members of superannuation funds suggest that a small share are dissatisfied with the overall performance of their fund. Members who have a poor understanding of the system and less capacity for accurately gauging the performance of their funds tend to report being much less satisfied. Many more members indicate that the performance of funds, including their service quality, has improved over time than those who feel that performance has flagged.
A sizable minority of members selecting a retirement product express equivocal or negative views about the degree to which funds meet their specific product needs.
Many members find it hard to make comparisons between the large numbers of superannuation products available. The proliferation of tens of thousands of investment options in the choice segment complicates decision making and increases member fees, without boosting net returns.
A low fee product that, over a person’s working life, exposes them to a mix of defensive and growth assets is likely to meet the needs of most Australians during the accumulation phase. A better designed and modernised default allocation mechanism could act as a trusted benchmark for better member decision making across the entire system.
Well designed life cycle products can produce benefits greater than or equivalent to single strategy balanced products, while better addressing sequencing risk for members. There are also good prospects for further personalisation of life cycle products that will better match them to diverse member needs, which would require funds to collect and use more information on their members.
Some current MySuper life cycle products shift members into lower risk assets too early in their working lives, which will not be in the interests of most members.
In the retirement phase, risk pooled lifetime income products may meet some members’ preferences for a predictable income stream and for managing longevity risk. However, the proposed Retirement Income Covenant may nudge many others into products ill suited to their long term needs, may not achieve its desired goal of increasing retirement consumption, and fails to take sufficient account of the diversity in household preferences, incomes and other assets.
The requirement that all funds must offer a ‘flagship’ risk pooled product would oblige any fund without a capacity to create such a product to purchase it from a third party — where there are few choices currently on the market. The requirement for a standardised risk pooled product may conflict with trustees’ obligations to act in members’ best interests, and many funds do not want to offer them. Their complexity, limited scope for reversibility and major deficiencies in the credibility, independence and affordability of financial advice for retirement products leaves significant scope for member detriment arising from the requirement to supply risk pooled products.
Superannuation funds make insufficient use of their own (or imputed) data to develop and price products (including insurance). This is particularly problematic for designing products for the retirement and transition to retirement stages, because this is when different strategies can have the biggest payoffs for members.
Across a range of indicators, member engagement remains low on average, though it is not realistic or desirable for members to be engaged all the time. Engagement tends to be higher among those approaching retirement, those with higher balances and owners of SMSFs. Engagement is lowest for the young and those with relatively low balances.
While many Australians have good broad knowledge of the superannuation system, many lack the detailed understanding necessary for effective decision making. Low financial literacy is observed among a sizable minority (about 30 per cent) of members.
Demand side pressure in the superannuation system is weak.
- Most members in the accumulation phase let the default segment make decisions for them, at least when they enter the workforce.
- A significant minority of members (an estimated 1 million) are barred from exercising choice even if they wanted to.
- Fund and investment switching rates are modest, suggesting that active members (or their intermediaries) have not exerted material competitive pressure on funds.
Proposed legislative changes to prohibit restrictive clauses in workplace agreements on members’ choice of fund are much needed.
While there is no shortage of information available to members, it is often overwhelming and complex. Dashboards should be a prime mechanism to allow for product comparison and need to be salient, simple and accessible to be effective — but most are not, and regulators have left this unresolved.
The quality of financial advice provided to some members — including those with SMSFs — is questionable, and often conflicted.
The need for information and affordable, credible and impartial financial advice for retirees will increase as retirement balances grow with a maturing system, and given the rising diversity and complexity of retirement products.
Erosion of member balances
Several proposed policy changes will promote Superannuation Guarantee payment compliance.
- Single Touch Payroll being extended to small employers (with less than 20 employees) from 1 July 2019.
- Funds being required to report contributions to the ATO at least monthly.
- The ATO having stronger powers to penalise non compliant employers and recover unpaid contributions.
The superannuation system, primarily due to its policy settings, does not minimise the unnecessary and undesirable erosion of member balances. This erosion is substantial in size and regressive in impact.
- Structural flaws have led to the absurdity of unintended multiple accounts in a system anchored to the job or the employer, not the member. These unintended multiple accounts (one in three of all accounts) are directly costing members nearly $1.9 billion a year in excess insurance premiums and $690 million in excess administration fees. For an individual member holding just one unintended multiple account throughout their working life, the projected reduction in their balance at retirement is 6 per cent (or $51 000).
- Superannuation Guarantee non compliance is hard to estimate, but may be costing members about $2.8 billion a year.
Recent policy initiatives have improved the situation, but current policy settings are inevitably making slow progress by treating the symptoms and not the structural cause.
Market structure, contestability and behaviour
The market structure of the superannuation system (as distinct from its policy and regulatory settings) is conducive to rivalry. At the retail level, there are many funds and products. At the wholesale level, there is concentration in some service provider markets for outsourcing (like administration). However, a growing ability for larger funds in particular to insource all, or parts, of their service requirements adds to competitive pressure.
While concentration is low in the investment management market, evidence suggests that managers have some market power. As a consequence, smaller funds, in particular, pay higher fees than would be the case if competition was more robust.
Fund level regulation creates a significant cost of entry and some structural features of the system are likely to create challenges for new entrants (including gaining scale by attracting members). However, these are not prohibitive or even high barriers to entry. Nor does the strategic use of integrated business models to gain members stifle contestability in the choice segment.
In the default segment, regulatory settings limit access to the market (including difficulty being listed in a modern award), competition for the market is absent, and competition in the market is muted.
There is a high propensity for funds in the system (particularly retail funds) to report using associated (or related) service providers — a form of vertical integration. Use of related parties is associated with higher costs, and weaknesses in contract review processes suggest some funds are outsourcing to related parties ahead of more efficient (but unrelated) service providers — constraining contestability and likely at the expense of member outcomes.
Evidence of economies of scale is compelling — larger fund size is strongly associated with lower average costs in the Australian superannuation system.
Significant economies of scale have been realised over the past 13 years, particularly on the administration side. Holding constant other cost drivers, ‘marginal’ (or incremental) gains in system savings (accruing from increases in scale in any year) totalled an estimated $4.5 billion between 2004 and 2017. Data limitations rule out estimation of realised ‘cumulative’ savings (scale benefits that persist beyond the year in which gains are first realised), but no doubt they have also been material.
Significant unrealised economies of scale remain. For example, annual cost savings of at least $1.8 billion could be realised if the 50 highest cost funds merged with the 10 lowest cost funds. And a 0.01 percentage point reduction in administration expense ratios for funds with more than $10 billion in assets could result in annual savings of about $130 million. The presence of these potential gains, particularly from further consolidation, reflects a lack of effective competition in the system.
Scale benefits also manifest through increasing returns to scale. Net returns are positively related to size for not for profit funds. (No corresponding correlation was found for retail funds.) Stronger net returns among larger not for profit funds might be due to higher exposure to unlisted asset classes, but data limitations rule out strong conclusions. Larger funds do appear, however, to make better investment decisions within asset classes.
There is little evidence that realised economies of scale have systematically been passed through to members in the form of lower fees. Scale benefits may have been passed through in the form of member services or increases in reserves, or offset by the costs of meeting new regulatory requirements. And not for profit funds, on average, might have passed through some scale economies by investing more heavily in (higher cost) unlisted assets and obtaining higher returns. Data limitations preclude firm conclusions about the form of pass through of economies of scale, and thus how members are actually benefitting and whether they are benefitting in a form they value.
The deduction of insurance premiums can have a material impact on member balances at retirement.
This balance erosion is more costly to members with low incomes. It also has a larger impact on members with intermittent attachment to the labour force, and those with multiple superannuation accounts with insurance (the latter comprise about 17 per cent of members).
Balance erosion for low income members due to insurance could reach a projected 14 per cent of retirement balances in many cases, and in extreme cases (for low income members with intermittent work patterns and with multiple income protection policies) could be well over a quarter of a member’s retirement balance.
In terms of premiums paid, default insurance in superannuation offers good value for many, but not for all, members. For some members, insurance in superannuation is of little or no value — either because it is ill suited to their needs or because they are not able to claim against the policy. Income protection insurance and unintended multiple insurance policies are the main culprits for policies of low or no value to members.
Younger members and those with intermittent labour force attachment — groups which commonly have lower incomes — are more likely to have policies of low or no value to them.
The fiscal impact of insurance in superannuation is complex and multifaceted. The effect on Age Pension outlays of the erosion of superannuation balances by insurance premiums is not trivial, and could materially offset any savings to government in social security outlays (that would otherwise have been paid to members that become insurance payout recipients).
Board processes to recruit highly skilled and experienced directors, and to effectively evaluate board performance and capability, are an essential prerequisite for best practice governance. Although there have been improvements to trustee board processes to better ensure boards have the necessary skills and experience, there is still much room to do better. Many boards are not employing effective assessment processes.
Use of a skills matrix (informed by external evaluation of board performance, skills, experience and knowledge) to guide the appointment process should be considered best practice by superannuation trustee boards. A focus on skills would likely lead to more independent directors as boards recruit from a wider ‘gene pool’.
Contract management processes, along with disclosure and reporting, need much improvement. While vertical integration is not a problem per se, conflicts of interest raised by the use of related parties need to be better managed by trustees and, where left poorly managed, redressed decisively by confident regulators.
A better definition of the term independent director is needed. Trustee directors are not independent if they are affiliated with parties related to a fund.
Many funds mimic (at least to some degree) the investment strategy of rival funds for fear they will otherwise exhibit poor short term performance relative to their peers (‘peer risk’). This short termism is likely to be at the expense of long term returns to members.
Robust and independently assessed performance attribution is needed for a trustee board to satisfy itself that it has acted in members’ best interests. But trustees have considerable room for improvement in the use of performance attribution. Indeed, some even appear to have ‘outsourced’ their best interests duty for members using platforms and wrap accounts to financial advisers and product providers.
Benefits provided to employers by some funds unduly influence some employers’ choice of default fund.
Considerable evidence of trustees acting in ways that are inconsistent with members’ best interests suggests that trustees and regulators adopt a broad and at times inappropriate interpretation of members’ best interests.
The package of reforms contained in the Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation) Bill 2017 would improve member outcomes if legislated.
In particular, the proposed MySuper outcomes test (a good first step) should better enable APRA to de authorise poorly performing products and better promote fund consolidation. But the test needs to be strengthened, extended to choice investment options and then fully and transparently enforced by APRA.
Introducing civil and criminal penalties for trustee directors, and giving APRA more power to deal with ownership changes of superannuation funds, are policy ‘must haves’ to better protect members.
Conduct regulation arrangements for the superannuation system are confusing and opaque, with significant overlap between the roles of APRA and ASIC. These arrangements inevitably lead to poor accountability and contribute to the lack of strategic conduct regulation, especially public deterrence through enforcement action, with poor outcomes for members.
The formation of the new Australian Financial Complaints Authority should be a positive reform for members, provided it is adequately resourced to deal with the level of complaints received.
The relatively small number of SMSFs with some form of limited recourse borrowing arrangement (about 7 per cent of SMSFs representing 5 per cent of SMSF assets) means such borrowing does not currently pose a material systemic risk. However, active monitoring (along with public reporting and discussion by the Council of Financial Regulators) is warranted to ensure that SMSF borrowing does not have the potential to generate systemic risks in the future.
Concerns about SMSF borrowing arrangements being utilised by members that lack the requisite financial literacy to properly understand the risks associated with them (or for whom such arrangements are unsuitable for other reasons) are best dealt with through measures to improve the quality of SMSF related advice.
The frequency and pace of policy change undoubtedly create real pressures for participants in the superannuation system. However, most of the recent major reforms (such as MySuper and SuperStream) have been overwhelmingly beneficial from a public interest perspective.
Fixing some of the worst problems in the current superannuation system would bring substantial benefits. 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 bottom quartile MySuper products had instead been in the median of the top quartile performing MySuper products they would collectively have gained an additional $1.2 billion a year.
Competing for default members
While the default segment has on average provided better outcomes for members than the system as a whole, it fails to ensure members are placed in the very best funds and places a sizeable minority in funds delivering poor outcomes. For example, focusing on investment performance (an important aspect of member outcomes), products that performed above their benchmark generated a median return of 5.5 per cent a year in the 11 years to 2018, whereas the 17 underperformers generated a median return of 3.8 per cent a year (and represented about 1.6 million member accounts and $57 billion in assets).
Current arrangements also lead to unnecessary account proliferation, rely heavily on third party decision making and deny some members any ability to choose their own funds. Default arrangements need to be modernised and recrafted to harness the benefits of competition for default members. The interests of members (not funds) should be paramount.
Current default arrangements do not promote member engagement. Survey evidence reveals that when members are provided with a simple and accessible list of superannuation funds, only a small minority would not choose their own fund. This evidence aligns with the lessons of behavioural economics.
Source: Productivity Commission 2018, Superannuation: Assessing Efficiency and Competitiveness, Report no. 91, Canberra.