The government released the Super System Review panel’s final report on 5 July 2010.
The final report (commonly referred to as the Cooper Review report) is in two parts totalling approximately 500 pages and includes comprehensive recommendations in a broad range of areas encompassing:
A new “member-centric” architecture for the superannuation system
Improving the operational efficiency of superannuation funds
Addressing trustee and investment governance issues
Recognising the importance of insurance in superannuation
Enhancing the integrity of the industry and its participants and making the regulatory regime more effective
Improving the range of retirement options and products.
In all, the Cooper Review panel made 177 recommendations across 10 broad categories. In this Bulletin, we examine some of the key final recommendations relating to large APRA-regulated funds (that is, funds with more than five members) and provide comments on some areas of interest.
It is important to note that these proposals remain recommendations only. The government has not yet released its response to the proposals, although that response is expected to be released gradually over the next month or so. Many of the proposals will require legislative change and so — particularly in an election year — the response of the federal opposition will also be important. There will also need to be considerable industry review and consultation on much of the detail in the recommendations and the government’s response, as well as the actual implementation. The panel itself contemplates a minimum two year transition period to the start of the new regime, and suggests 2014 as an appropriate start date for default funds to have to be MySuper funds.
MySuper
At the heart of the recommendations are the “Choice architecture” and “MySuper” concepts which the review panel foreshadowed in its “MySuper” preliminary report released in April 2010. The panel has divided members into three main classes:
MySuper members — these are described in the final report as “members who simply want someone else to take care of it all for them”.
Choice members — members who want a choice of investment strategies but want their account to be administered for them.
Members who wish to be fully responsible for the administration and investment of their superannuation (these members typically operate an SMSF).
The eligible rollover fund and lost member sector is identified as a separate class of members, although the panel has expressed the hope that this sector would not continue as a material part of the super system if the SuperStream recommendations (discussed further below) are implemented.
The panel recommended that only a MySuper product should be eligible to be a default fund under the superannuation guarantee (SG) legislation. Further, only MySuper products should be eligible to be nominated for default fund purposes in awards approved by Fair Work Australia.
As foreshadowed in the MySuper preliminary report, MySuper products would have to satisfy a range of objective criteria, including the following:
MySuper trustees will be required to hold a new “MySuper” class of RSE licence granted by APRA, most likely as a variation to an existing licence.
MySuper funds must be able to accept all types of contributions (except where prevented by law).
The trustee of a MySuper product will need to formulate and give effect to a single diversified investment strategy at an overall cost aimed at optimising members’ financial best interests.
There should be no cross-subsidisation of costs between MySuper and other products offered by a trustee. Buy/sell spreads would be permitted if they are closely linked to charges incurred by the fund. Any performance fees charged must comply with a new performance fee standard to be introduced. Fees could not be subject to negotiation or rebates. No entry or contribution fees would be permitted and exit fees would be allowed on a cost recovery basis only.
Trustees would need to consider — on applying for a MySuper license and subsequently on an annual basis — whether they have sufficient scale (in relation to both assets and member numbers) to deliver optimal benefits to members.
Simplified disclosure would apply to MySuper products. Product disclosure statements (PDSs) would not be required and instead the panel envisaged that members would join online, with comprehensive information available to members online and hardcopies available on request. Benefit statements would continue to be issued, with members able to elect to receive statements online or in hardcopy.
The panel views MySuper as a “whole of life” product and so trustees would be required to offer a retirement income product, either on their own or in conjunction with another provider. The panel notes that extensive industry consultation would be undertaken in relation to this proposal.
Trustees offering MySuper products would need to maintain a facility for providing intra-fund advice to members. In addition, the panel noted a role for pro-active offering of intra- fund advice in relation to specific member needs or life stages.
Death and TPD insurance would need to be offered (where available, subject to fund demographics and occupational factors) on an opt-out basis. Trustees would have to develop an insurance management strategy and would continue to be responsible for the selection and administration of members’ insurance. The existing minimum death insurance provisions in the SG legislation would be abolished. Income protection insurance could be provided but would not be required. TPD definitions in trust deeds would be required by law to reflect the insurance policy definition.
MySuper funds would need to provide retirement benefit projections to members on a standardised basis to be determined in consultation with the industry. On the proposed basis, the retirement projection would be in current-day dollars and presented both as a lump sum account balance and an annual income stream. It would not consider any entitlement to the age pension.
Members will be able to have part of their super in a MySuper product and part in a Choice product offered by the same trustee or in another Choice product altogether (Choice products are discussed further below). The panel envisages few barriers to members voluntarily moving out of or back into MySuper products (although it is not clear whether this would apply in the case of a corporate fund member who had since ceased to be employed by the employer sponsor). Members could only be compulsorily moved out of a MySuper product in certain limited circumstances and strict obligations would be imposed on advisers who sought to recommend such action to a member.
Trustees of MySuper products would have to operate under new high level principles-based duties. The report specifically states that there is no reason why any industry sector should be excluded from offering MySuper products.
The panel considers that conversion of an existing fund to a MySuper product should not be a costly exercise and contemplates that the scheduled review of modern awards in 2014 could be an appropriate start date for MySuper products to become defaults for SG purposes.
We believe the MySuper vision should be familiar to most superannuation funds and they should be able to convert to a combined MySuper/Choice fund from their existing structures. We do have concerns regarding some of the panel’s recommendations, including aspects of the scale test which seems to have no regard to any cost subsidies that may be provided by sponsoring employers. We still believe the industry can develop a cost effective way of including the age pension in retirement benefit projections. For most people, not including the age pension will materially underestimate their potential retirement income, which could cause them to make poor decisions.
We hope the strong focus on reducing costs does not discourage funds from investing in higher cost investment vehicles that can provide members with significant diversification benefits. It would be disappointing if an unintended consequence of MySuper was to stifle innovation and discourage trustees from seeking the best risk adjusted investment returns for their members. We strongly support a lengthy transition period, to enable funds to minimise transition costs which will ultimately be borne by the current generation of fund members.
Choice Products
Choice products represent the next level of engagement by members. As noted above, a Choice product could be offered by a MySuper trustee within the same fund and accessing the same administration and investment vehicles, although members, and costs, would need to be separately identified. Trustees of Choice products would generally be able to determine the extent to which they were different from MySuper products in terms of investment choices or retirement products. However, some requirements are recommended in relation to Choice products:
Entry fees would not be permitted and exit fees could be charged on a cost recovery basis only.
Bundled advice would not be permitted in any product, including Choice products. The cost of advice to employers could not be borne in any way by fund members. Up front and trailing commissions (including in relation to insurance) and volume payments would be prohibited in all products. Advice could be provided on request and the cost deducted from members’ accounts.
Trustees must offer a range of options to enable members to obtain a diversified asset mix, but members could elect not to be diversified and trustees would be under no obligation to assess the appropriateness of any member’s investment strategy. Trustees who discharge their duties in selecting and monitoring investment options would not be exposed to civil liability arising from any loss or damage suffered by a member in relation to the investment option.
Choice trustees would not be required to offer any insurance cover at all, or could offer any or all of death, TPD and disability income cover on an opt-in or opt-out basis.
SuperStream
Another key batch of recommendations relate to the “SuperStream” concept which was also the subject of a preliminary report. SuperStream is the name given to the panel’s proposals to modernise the “back office” of superannuation. The components of SuperStream include:
Using industry-wide standards to improve the quality of data when members enter the system
Electronic funds transfer (EFT) for all participants
Better use of technology, including straight-through processing
E-commerce solutions to replace paper
Extending the use of the TFN as an identifier throughout the system
Eliminating redundant processes, leading to simpler rollovers and consolidations.
The panel estimated that annual savings of up to $1 billion are achievable from the SuperStream reforms. Specific recommendations include the following:
Employers would be required to provide funds with specific member data for new fund members. Employers who failed to provide this data would be subject to an administrative penalty from the ATO per member per day, or may be deemed to have failed to meet their SG obligations.
Trustees should be able to use Tax File Numbers (TFNs) as a primary search key to link contributions and rollovers with member accounts and for certain other identification purposes.
A stakeholder group should be convened by APRA to devise standard forms for various processes. The government should be prepared to mandate the use of the forms if there is not near-universal voluntary uptake.
As a license condition, administrators must be able to provide e-commerce facilities to employers of all sizes.
Trustees should be able to auto-consolidate accounts without prior member consent within the same fund where the multiple accounts have not been established by deliberate action by the member.
The current exemption from initial customer identification under the AML/CTF legislation should be abolished, with the identification to be satisfied if the member has provided a TFN which has been confirmed by the ATO. Rollovers could then be effected without further identification and transfers between funds would be required to be processed electronically within two business days.
The ATO should be the sole regulator of all aspects of superannuation contributions, with APRA retaining responsibility for overseeing the solvency of defined benefit funds.
Employers would be required to remit SG and salary sacrifice contributions no less frequently than member after tax contributions (currently monthly and not more than 28 days after the end of the month in which they were due).
In our view, SuperStream will deliver a much more efficient superannuation system with more effective use of technology. Getting employers and fund administrators up to speed will require significant time, skilled resources and an initial cost, but for greater benefit in the long term.
Trustee and Fund Governance Issues
The panel noted that due to the special purpose of superannuation and the public policy goal of enhancing the retirement incomes of members, everyone involved in the superannuation system needs to have and be seen to have high standards of governance. While the panel acknowledged that there is no evidence of systemic failure of trustee governance in the superannuation system, they believe there are shortcomings that need to be addressed and improvements that can be made.
In total, twenty recommendations were made by the panel in relation to governance. Major proposals include the following:
Creating a new statutory office of ‘trustee-director’ with all statutory duties to be included in the SIS Act. This recommendation has resulted from the lack of coordination between the SIS Act and Corporations Act and the ambiguity surrounding directors’ responsibilities that are outlined in that legislation. This will also incorporate a re-write of section 52 of the SIS Act to distinguishing between the duties of trustee-directors as individuals and the duties of the trustee company.
Equal representation on trustee boards should no longer be mandatory. The panel believes the introduction of choice of fund and changes in the industry over time have materially changed the trustee landscape.
Non-associated trustee directors should be introduced on all boards, and boards should have a majority of non-associated trustee-directors where the trustee does not have equal representation. The panel has acknowledged that a member of the fund could be a ‘non-associated’ trustee-director as long as they were free of connections to, or associations with, employer sponsors, the appointer, entities related to the trustee, employer groups, unions or service providers and they were not a current or former executive of the fund.
A conflict policy including a matrix of relationships will be required to be prepared by trustees and included as an APRA licence condition.
A superannuation industry council (coordinated by APRA) should be established to develop a Code of Trustee Governance. If such a body is not established within two years then APRA should create the code.
We broadly support many of the measures proposed, and indeed, many reflect recommendations made in our submissions. We believe, though, that the equal representation model has served corporate and industry superannuation funds well, and are not convinced that the proposed non-associated directors model would be similarly successful for such funds, or whether the cost of professional non-associated directors would be reasonable compared to the value they might add. We note with some surprise the panel’s comment in support of this measure that equal representation leaves many members unrepresented, as the majority of corporate and industry funds now include groups such as pensioners and retained members in the equal representation process.
Operational Risk Reserves and Liquidity Risk Management
Capital adequacy and liquidity were key elements identified by the panel as ensuring the stability of the superannuation system and the security of members’ benefits. Liquidity issues may not only impact on day to day operations such as investment switching and portability transfers, they can also lead to loss of confidence in the system. However, illiquid assets may have attractive features as an investment option. The panel also identified that the increased size of funds, while delivering economies of scale, tends to concentrate risk.
Accordingly, the panel recommended new capital requirements for trustees (on a risk-weighted basis) be introduced over time, with trust deeds deemed to include provisions enabling trustees to maintain dedicated operational risk reserves. Legislation would define both a minimum dollar risk reserve and a maximum reserve as a percentage of fund assets, and APRA would have the power to increase the minimum level of the reserve required by a particular fund if it assessed it as necessary. Both the minimum and maximum would be developed in consultation with the industry. Risk factors which would be taken into account include the level of indemnity insurance held by the trustee and the extent to which service providers have their own insurance. The panel noted that the capital proposals should be neutral between different industry sectors and phased in over time to avoid imposing an undue burden on current members.
In relation to liquidity, the panel recommended that Risk Management Plans (RMPs) should explicitly include a liquidity management component, to ensure trustees identify and manage risk at both a fund and investment option level. The RMP should have particular regard to the liquidity of options offered to members in the retirement phase. It also recommended that the exception in the portability rules relating to illiquid assets be maintained for Choice products, but that members’ consent should no longer be required provided there is adequate disclosure before a member selects an illiquid investment option.
We support these measures as a means of enhancing the security of members’ benefits and public confidence in the superannuation system. In our view, the capital requirements would be best met via reserves within a fund, rather than capital held by the trustee external to the fund. We would encourage APRA to consider the use of tools such as such as an appropriate form of financial condition report, consistent with the regulation of other significant financial institutions, as part of its prudential risk management framework.
Investment Governance
One of the key issues acknowledged by the panel was that poor investment governance puts a fund’s goals at risk. Complex investment manager fee arrangements, potential conflicts between investment managers and members’ interests and the different variety of investment structures within the superannuation industry lead to a lack of transparency for members.
Some of the key recommendations from the panel include:
Amending Section 52 of the SIS Act to require trustees to consider the costs involved, taxation consequences and the availability of independent valuation information when setting their investment strategy
The development by APRA of a new enforceable performance-based fee standard
A focus on managing investments for after-tax returns
Establishing a requirement for funds to have a proxy voting policy and to disclose voting behavior on the fund website.
We believe the recommendations made will enhance the investment governance of superannuation funds and look forward to the industry consultation in developing the performance-based fee standard to be prepared by APRA.
Defined Benefit Funds
Defined benefit funds are acknowledged as having served members well over a long period, because they provide greater certainty about the amount of members’ retirement benefits and because members do not bear investment risk, which enables such funds to invest for the long term.
The panel noted that defined benefit members are not subject to the same concerns about fees, or issues over the appropriateness of asset allocations, as accumulation members. Accordingly, the panel recommended that where the defined benefit is used for SG compliance, this fund (or section of a hybrid fund) will automatically qualify as a default fund. Such a fund would not need to meet the MySuper criteria.
The panel commented in some depth on the protection of members’ benefits in defined benefit funds. The panel recognised that the financial strength of each sponsoring employer is different and that a balance needed to be struck between protecting members’ benefits, avoiding the creation of large surpluses, and avoiding placing employers under too much financial pressure. Ultimately, and in line with the view put in Towers Watson’s submissions, the panel decided that member protection should focus on vested benefits rather than SG minimum benefits. Accordingly, the panel recommended that APRA issue a prudential standard focusing on the protection of vested benefits in defined benefit funds.
Other recommendations in relation to defined benefit funds include the following:
The Corporations Act should be amended to clarify that defined benefit contributions are afforded the same level of protection as accumulation contributions in the event of employer insolvency.
Defined benefit funds which currently self-insure death and disability benefits continue to be permitted to do so.
Finally, the panel encouraged policy makers to have regard to the complexities that are created in defined benefit funds through regulatory changes that are designed primarily for accumulation funds. The panel felt it important that the costs in respect of these funds not be unnecessarily increased.
It is very pleasing to see that the Review panel has recognised the continuing importance of defined benefit funds and we commend the panel for its recommendations in relation to these funds.
Insurance in Superannuation
The panel noted the importance of insurance inside superannuation, especially given the small number of individuals who have any personal insurance cover outside their superannuation. Accordingly, the panel considered that trustees of funds which provide insurance (MySuper or otherwise) should have a statutory duty to manage their fund’s insurance with the sole aim of benefiting members, similar to their role in investing fund assets.
Many of the recommendations made in relation to insurance have been considered elsewhere in this Bulletin. Others worthy of note include the following:
The SIS legislation should be amended to deem the definition of TPD in a fund’s trust deed to be the same as that in the relevant insurance policy.
Trustees should be required to publish the terms and conditions of each type of insurance cover offered by the fund on their websites, as well as provide a plain English explanation of the policy terms, premium information for each category of members, and a TPD claim success rate on a basis to be determined in consultation with the industry.
Up-front and trailing commissions should be prohibited on any insurance offered to any superannuation entity, including SMSFs.
The SIS legislation should be amended so that binding death benefit nominations would be invalidated when certain life events (such as divorce) occur in respect of a member. If this recommendation was implemented, then binding nominations could expire after five years rather than the current three years.
Subject to a suitable transition period, self-insurance should be prohibited except in the case of defined benefit funds which are currently allowed to self-insure.
We support measures to improve members’ understanding and appreciation of the insurance benefits provided to them. Plain English explanations of policy terms will need careful drafting to ensure that any differences from the exact policy terms do not expose trustees to uninsured claims. While the recommendations on binding nominations will reduce the possibility of inequitable outcomes, they will also extend the time taken to pay death benefits as enquiries will need to be made regarding any relevant changes in the deceased member’s circumstances.
Longevity Issues
Ultimately superannuation is savings for retirement. Yet the chapter entitled “Retirement” contains less recommendations than any other section of the report.
The panel recommends MySuper be an integrated retirement product, by requiring it to include one type of income stream product either through the fund or in conjunction with another provider. Trustees of MySuper products would be required to proactively offer intra-fund advice to members both as they approach retirement and in the retirement phase.
More than 50% of a person’s income in retirement will be sourced from post-retirement investment earnings. Trustees would therefore be required to devise a separate investment strategy for post-retirement members in MySuper products, which has regard to issues such as inflation and longevity risk.
In our view, post-retirement remains the great challenge that has yet to be addressed effectively by the industry. The Henry review acknowledged that a structural weakness in the current system is a failure to provide products that enable a person to manage longevity risk. Insurance companies have already started to innovate in this area with a few “next generation” annuity style products being launched in the past twelve months. The question now is how funds will develop their own longevity pooling products, on their own or in partnership with others. Either way, the biggest challenge will be to convince members that this is a real problem and that an annuity style product can play an important role in managing their retirement risks.
Outcomes Transparency
A number of the panel’s recommendations are aimed at improving the transparency of superannuation. The panel believes it is essential that members be given information that is simpler, forward looking and standardised to assist in making comparisons, and that much disclosure needs to be directed to member proxies such as advisers, regulators, researchers and analysts to enhance competition between funds and sectors. Targeted regulation has been identified as the solution to this issue. Accordingly, the panel has recommended a range of initiatives, some of which are summarised below.
APRA should develop new “outcomes reporting standards” in consultation with the industry. These would exist as an overlay to the existing accounting standards and facilitate comparable reporting on investment performance and costs at investment option level. They would apply to all funds, including MySuper products. All funds would be required to publish investment option performance tables in a standardised format in accordance with these standards on their websites. Any disclosure of past performance of a MySuper or Choice product will have to be accompanied by a standardised measure of the uncertainty or volatility associated with the return, again in accordance with the standards. The standards would also cover how investment returns should be calculated in terms of tax and costs and the basis for all fees and costs disclosure.
All funds should be required to have a website. The website would be required to disclose basic information including the fund’s trust deed, most recent audited accounts and audit report, actuarial review report, PDSs and other prescribed disclosure documents.
APRA should be the sole agency responsible for collecting data for all public purposes (excluding tax purposes) from all funds except SMSFs.
A new “product dashboard” should be developed and used to summarise investment strategies of MySuper products and Choice investment options (including asset class options). The dashboard would cover, in simple visual format, each strategy’s target investment return, risk target or range of possible outcomes, and a new projected fees and costs measure which the panel calls a Total Annual Expense Ratio (TAER). The dashboard would form an outcomes reporting standard that would be developed in consultation with the industry.
All trustees of MySuper products would be required to participate in APRA approved benchmarking surveys that would measure their relative efficiency against peers in a number of key areas. The results of the surveys would be published by APRA.
All funds would be required to publish their entire portfolio holdings on a six monthly basis, both to APRA and on the fund website.
The government should establish a central website about superannuation, including standardised disclosure of tax and other relevant information. All funds would be required to link their websites to this site.
We are supportive of improvements in the transparency of superannuation and endorse the establishment of a central government website about superannuation, which would simplify standard disclosure to members. Standardised measures of risk and return, as well as standardised labels for investment options, are also long overdue. It is also pleasing that the panel has moved away from the idea — published in a preliminary report — of separate financial statements and audits for MySuper and Choice sections of funds. However, there is potential for concern with the detail of some of these measures, particularly in relation to employer sponsored funds which are not open to the public. It is also unclear how these measures will apply to defined benefit funds.
Contact
For further information please contact your Towers Watson Consultant or Actuary:
The information in this publication is general information only and does not take into account your particular objectives, financial circumstances or needs. It is not personal advice. You should consider obtaining professional advice about your particular circumstances before making any financial or investment decisions based on the information contained in this document.
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