The interim report of the Financial Inquiry headed by former Commonwealth Bank chief, David Murray, has given the Australian financial system a big tick, with no significant changes suggested for the structure and nature of the system, but one theme comes in for special and extensive comment and calls for more advice – the three interlinked areas of superannuation, retirement incomes policies and financial advice.
The report, which was released this morning, calls for more submissions and discussion of a series of key issues. While the traditional areas of the banks and insurers won’t be much impacted by the inquiry, judging by the interim report, the superannuation sector looks like taking much of the changes that could emerge from the final report when its finished later this year.
One of the major areas is the cost of superannuation (an issue close to all of our super accounts).
The inquiry has accepted the contention of the Reserve Bank and others that "Notwithstanding the difficulties in comparing fees and costs across funds, Australia’s superannuation sector has some of the highest operating costs among Organisation for Economic Co-operation and Development countries."
"The decline in fees over the past decade is modest, given the economies of scale that the sector has achieved. That said, high allocations to growth and alternative assets contribute to these costs, but they can also deliver higher after-fee returns to members," the inquiry observes.
"In general, competition has led to feature-rich, but more costly, superannuation products, in part reflecting that many consumers are not fee sensitive. It is too early to assess the effect of recent reforms to default arrangements (MySuper) on fees.
"There is an opportunity for fees to fall significantly over time, with further expected increases in scale and increased competition for MySuper products.
"High demand for liquidity from superannuation funds may be reducing after-fee returns to members. The mandatory inter-fund portability timeframe of three days is contributing to higher allocations to liquid assets than the system requires.
"It remains unclear whether funds are chasing short-term returns and, if so, whether this is contributing to lower after-fee returns, as well as to what extent more individual tailoring of asset allocations would produce net benefits to members."
Another section looks at the emerging trend for super funds to have higher leverage (or gearing and therefore debt). The inquiry says the ‘general lack of leverage’ in the super system is a ‘major strength of the financial system’. Although direct leverage in superannuation is small, the inquiry says, "the current ability to borrow directly may, over time, erode this strength and create new risks to the financial system."
The inquiry said it was seeking views on the costs/benefits and analysis of restoring "the general prohibition on direct leverage in superannuation on a prospective basis"
"Constant change in superannuation and retirement income policy settings imposes costs on superannuation funds, which are ultimately paid by members. As superannuation is a long-term savings vehicle, change can also undermine confidence and trust in the system.
"To ensure policy stability, the system needs to achieve, and be seen to achieve, its objectives efficiently and equitably, and the fiscal cost needs to be sustainable. Some evidence casts doubt over whether current policy settings will stand the test of time," the report said.
It said it was seeking further information and advice on the following areas in superannuation.
Mechanisms to drive down fee, vertical integration, tailoring asset allocation and the focus on short-term returns, active asset management, pricing of member investment switching, liquidity management, trust structure, self-managed superannuation fund operating costs and establishment.
And looking at the end part of the superannuation industry – retirement – the inquiry finds a number of significant problems. The inquiry observes "The retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees."
"Over the coming decades, Australia will confront a number of continuing trends as well as new drivers of change for the financial system, creating both opportunities and risks. These changes include our ageing population, technological change and Australia’s international integration. To varying degrees, these trends are already manifesting themselves.
"The superannuation drawdown phase of Australia’s retirement income system provides limited choice for managing risk in retirement. It also gives little guidance to retirees in navigating complex and important financial decisions. Retirees do not efficiently convert superannuation benefits into income streams in retirement.
"During the accumulation phase, employers make Superannuation Guarantee contributions automatically on behalf of employees, with defaults applying to those who are less engaged with the system. This framework to guide individuals ceases at retirement. Retirees make critical, once-in-a-lifetime decisions regarding when and how to draw down their savings over the remainder of their lives, and how to manage the investment, inflation and longevity risks involved. Many retirees are unprepared for these decisions.
"Risk management is a major weakness of the drawdown phase. Although individuals are concerned about outliving their savings, few retirees use income stream products with longevity risk protection, and there a limited choice of these products. Australia is unusual in not encouraging its citizens to use income streams with longevity protection in retirement. Also, the Government bears significant longevity risk by providing the Age Pension."
And there’s a big hint that the inquiry is concerned at vertical integration in superannuations (i.e. the linking of super funds, planners and others all in the one group).
