The bloodletting in Australia’s financial services industry was stepped up on Tuesday as banks, insurers and other providers of retail superannuation products came under fire in a new government-backed report. 

The report, ‘Superannuation: Assessing Efficiency and Competitiveness’, published by the Productivity Commission (PC) after months of detailed analysis, slams the culture of underperformance and a lack of transparency in the management of super funds and the sale of related insurance products.

Encouraged by the government to suggest changes, the commission also proposes a radical reform of the $600 billion default superannuation system.

Australia’s super system has two main structural flaws, the report said: “unintended multiple accounts and entrenched underperformers”.

Fixing these twin problems could benefit members to the tune of A$3.9 billion (US$2.9 billion) each year, it added. “Even a 55 year old today could gain $61 000 by retirement, and lift the balance for a new job entrant today by $407 000 when they retire in 2064.”

The PC report suggests the formation of an independent panel of experts who would create a list of the top-10 superannuation products based on various criteria (performance, fees, number of independent directors). These would then become the default funds for new members, the ones they might automatically be enrolled on to when joining a new employer pension scheme.

One concern expressed about creating a 'best of breed' list is how it impacts on asset allocation. Gordon Noble, director at FenElpi Partners in Melbourne told AsianInvestor there is a risk that passive investment strategies could come to dominate the ASX.

“If cost is a major factor in making it to the list then we face a very real scenario where funds progressively move to passive strategies. This would impact on the potential for funds to allocate to assets such as venture capital, private equity and infrastructure. There are system implications that need to be understood," he said.

Up to two-thirds of workers choose the default fund option when starting a new job, but rather than migrating that fund when they change jobs, a new fund is created.

“Members should only ever be allocated to a default product once, upon entering the workforce,” the report said.

By separating this process from employers and creating a supposedly independent panel, this could create opportunities for foreign fund providers in Australia to compete more effectively with entrenched local bank-owned providers. “Members should be empowered to choose their own product and the shortlist should be designed to make this safe and easy to do,” the PC report said.

According to the PC's analysis, over the past 20 years most institutional super funds (regulated by the Australian Prudential Regulation Authority, or Apra) have delivered solid returns to their members, net of fees and taxes, averaging about 5.7% a year — equivalent to about 3.2% above CPI.

But when viewed over the 12 years to 2016, Apra-regulated funds on average delivered average annual net returns just below the system-wide benchmark

Chart: Superannuation fund returns by segment 2005-2016

Source: Productivity Commission/APRA

As a group, not-for-profit funds delivered returns above the benchmark tailored to their average asset allocation, but retail funds as a group fell below theirs.

WIDE VARIATION

The PC report notes there is wide variation in performance in the default segment that is not fully explained by differences in asset allocation.

"About 1.7 million member accounts and $62 billion in assets are in MySuper products that underperformed conservative benchmarks over the 10 years to 2017. This suggests that many members are currently being defaulted into underperforming products and could be doing better."

In the report, federal treasurer Scott Morrison noted that the superannuation system has accumulated over $2 trillion in assets.

But the report estimates that $2.6 billion in Australian retirement savings has been lost through unnecessary fees.

In a radio interview on Tuesday, financial services minister Kelly O'Dwyer called this “a massive rip-off," and indicated the government would be taking the PC’s reform proposals seriously.

Fees have not fallen by as much as would be expected given the substantial increase in the scale of the superannuation system, in large part due to the absence of consumer-driven competition, particularly in the default fund market, the report said. 

TRANSPARENCY GAP

The failings of the pension fund savings industry in Australia have created such a lack of transparency that even the PC itself was unable to gather investment return data directly from the vast majority of funds.

"While 80% of funds claimed that they regularly undertake performance attribution analysis, relatively few funds provided data to us on net returns by asset class,” the PC report noted. In fact, just five of 117 funds covered actually complied with the data request.

The report blamed Apra and the Australian Securities and Investments Commission (Asic) for encouraging a climate of complacency: "The two greatest disappointments for us in terms of where the regulators are today are the lack of good data for members and the fact that enforcement action relating to bad behaviour is missing in action."

It also denied claims by some inquiry participants that the reform proposals could destabilise Australia's superannuation system.

"It would not," the report countered. "Modelling by the commission, and reviewed by Apra, suggests that even if many members chose to switch to a shortlisted fund, and other funds needed to exit or merge in the first few years, this should be manageable for Apra and would advance (not compromise) members’ interests."

By stopping the creation of new unintended accounts (and insurance policies) and providing a simple list for all members to choose from if they wish, existing members would reap the benefits, the report said.

This latest controversy follows the recent condemnation of Australia's banks for systematic failings in their fee charging practices.

The outcome of these reform proposals is possibly legislation to appear in 2019. Noble said, "My expectation is that we will see a bill in the spring session of the federal parliament that will contain a series of measures focused on both banking and superannuation."

The earliest a bill could pass through parliament would be the Autumn 2019. Noble warned that reforming of the system should be done carefully. "There are governance reforms that are definitely needed, but the federal government needs to ensure that it doesn’t lose the strengths of the superannuation system.”