Building a more efficient and robust superannuation system

The Final Report has highlighted the importance of an efficient and resilient superannuation system but has called out the need for key changes in order for the system to operate to its full potential.

In recognition of the impact that an ageing population will have on the future fiscal demands on government, the FSI Final Report highlights the importance of an efficient and resilient superannuation system and makes 5 key recommendations designed to significantly enhance it.

The Report delivers a fairly mediocre report card to the superannuation system with a clear message that “it can do better”. In citing a lack of strong price-based competition, inefficient design features and poor options for retirement incomes, it delivers the clear message that the superannuation system is just too important for the Australian population and economy for it to be left to continue to operate in its current form.

The Report’s recommendations are directed to three areas where change is needed:

  • Superannuation needs bipartisan political support with a clear objective enshrined in law to stabilise future policy settings and initiatives.
  • Operational efficiency and competition in the accumulation phase of the superannuation cycle must improve. It is not clear whether the Stronger Super reforms will deliver all of this given their infancy. If a review by 2020 concludes that these reforms have not delivered the efficiencies as promised, the FSI recommends a formal competitive process be implemented to allocate new default members to MySuper products.
  • There must be a focus on the retirement phase of the superannuation system. There is a lack of product innovation and a need for greater focus on the management of longevity risk. The FSI is confident that as a result of the other significant improvements mentioned, these will help to boost the retirement income for the average Australian superannuation member. Enabling retirees to have a higher and more enduring income in retirement and greater confidence in spending is considered to be an important outcome or benefit of these proposed reforms for the broader economy.

The Report’s recommendations are appropriately outcome-focussed and principled-based. This should be commended. It remains to be seen how much of this will be adopted by Government, and if so, the devil will be in the detailed design and implementation of these recommendations. There is always a risk that an inability to agree process and a lack of political will and inertia may delay or dilute the benefits of these proposed reform changes.

The Report recommends a significant role for Government in this sector.  In our view, this is the most significant of the reforms suggested by the Report and we hope there is strong political will to act on the recommendations.

A closer look at the recommendations

“To provide income in retirement to substitute or supplement the Age Pension.”1

The Report notes that currently the superannuation system does not have a consistent set of policies directed to achieving common objectives. There is an imbalance with a much greater focus on the accumulation phase as opposed to the retirement phase.

The Report identifies that government needs to articulate the objectives of the superannuation system. This will set the framework for future enhancements and is expected to make the system more efficient as a result. A suggested first step is a joint parliamentary inquiry to consider the proposed objectives and make recommendations to parliament to be enshrined in law.  The Report also recommends that a publicly funded independent body be formed to assess the superannuation system’s performance and report on superannuation policy changes.

We agree this is a critical step in helping to restore confidence in the long term stability of the superannuation system.

“A major concern of the Inquiry, shared by the Super System Review, is that the Australian system as a whole has been unable to realise the benefits of scale.”2 

The second group of recommendations are directed towards improving the efficiencies of the accumulation phase. Evidence suggests that Australian superannuation fees and charges are still high by international comparison even after taking into account the availability of choice and the feature-rich benefit designs of our system. All of this comes at a cost: lower net returns and retirement incomes for individuals.

The confluence of market fragmentation, high use of active investment strategies, weak member-driven competition and complexity are said to fuel the higher costs and fees and lack of price based competition in our market. The evidence is clear that while increases in scale and the introduction of default MySuper products have reduced fees and costs, these overall savings have not been as high as anticipated. The Report finds that government intervention in the superannuation system is warranted to improve the system’s efficiency in the accumulation phase.

In our view, the FSI have acted reasonably in not recommending any significant reform to this phase of the superannuation system until after the MySuper implementation is complete in 2017. However the FSI has thrown down the gauntlet to the superannuation industry to take charge now and implement steps to be able to demonstrate that greater efficiencies can and will be achieved as a result of the Stronger Super reforms before 2020. If not, the industry will face further reform.

That reform is currently in the guise of a competitive process to be introduced for the selection of default funds for new superannuation members. The Report is scant on the detail as to what this competitive process may look like and how it would operate within the existing system however the recommendations suggest that increasing competition between funds to have to compete for new members would release much greater savings in costs and have a flow-on effect across the broader superannuation sector beyond MySuper members. Of course, the risk of such a process is that the focus becomes only about costs but the Report contends that this risk is manageable and should be actively considered as part of the design and implementation considerations of any such competitive process.

The Report recommends that the Productivity Commission (PC) start preliminary work on the design of this competitive process in 2015 and consider as part of its review into superannuation system efficiency and competitiveness whether implementing a formal competitive process would deliver net benefits.

“To better meet the needs of retirement …”

Both the Report and the Interim Report identified that the retirement phase of the Australian superannuation system is significantly underdeveloped in contrast to the accumulation phase and much could be done to improve this area. Retirees are faced with making a binary decision - account based pension or lump sum payment which leaves little option to effectively manage longevity risk management and can lead to sub optimal retirement outcomes. Further there is very little choice in retirement products. In recognition of this, the government released a discussion paper in July 2014: Review of retirement income stream regulation. The paper acknowledges the regulatory barriers restricting the availability of income stream products in Australia and calls for comments on various questions relating to product options, deferred lifetime annuities and minimum payment amounts for account based income streams.

The Report’s recommendations are focused on trying to simplify and improve the superannuation outcomes for retirees.  Improving efficiencies of the accumulation phase are also expected to result in real savings and higher member balances in the long run which will improve retirement outcomes.

Firstly, it recommends that super trustees be required to pre-select for all members (not just MySuper) a comprehensive income product for retirement (oddly named a “CIPR”). This pre-selection is not intended to inhibit choice as at the start of retirement, members could elect to continue with the pre-selected CIPR or take their benefits in some other way. However, the default selection is designed to simplify choices particularly for disengaged members.

The Report suggests that the CIPR features be mandated by government and include a regular and stable income stream, longevity risk management and flexibility. It is expected that these features may need to be provided by a range of products and it is recognised that there would need to be changes to regulatory barriers and tax policy settings to facilitate the development of these types of products. It recommends that the Tax White Paper consider the taxation of contributions and earnings in superannuation for the best alignment of the earnings tax rate across those 2 phases and how better to target the superannuation tax concessions which currently accrue to the top 20% of income earners.

The Report does not endorse the mandating of specific retirement income products and considers that freedom and choice should be preserved. However it does suggest that if introducing CIPR’s does not achieve its intended objectives, government consider the forms of default product that commence automatically on retirement.

While these are the primary recommendations, the Report does list some other important recommendations for the superannuation sector:

  • All employees should have the ability to choose the fund into which their SG contributions are paid. Presently for approximately 20% of Australian employees, their award or workplace determination mandates their superannuation fund;
  • There should be a majority of independent trustees on the boards of corporate trustees of public offer super funds consistent with international best practice on corporate governance. Further, the director penalty regime for superannuation directors should be aligned with that applicable to directors of managed investment schemes under the Corporations Act. This would also mean super trustee directors would be subject to criminal and civil penalties; and
  • Improve consumers’ engagement with saving for retirement by giving them retirement income projections on their member statements.

The Report presents a real opportunity for engagement and action in the superannuation sector and provides a broad map of key focus areas to help improve efficiencies and competitiveness and build a robust system to meet the needs of an ageing population and increasing number of retirees in Australia.

The recommendations will require a disciplined and coordinated response from the sector and bipartisan government support to implement. Let’s hope this does not become a missed opportunity.