Superannuation trustees facing regulatory upheaval

From the Future of Financial Advice changes to the Cooper Review recommendations, superannuation trustees are facing significant change but, as Damon Taylor writes, the devil will be in the detail.

Having seen Jeremy Cooper’s recommendations out of the 2010 Super System Review and, more importantly, the Government’s response to them, 2011 is already shaping up to be a busy year for Australia’s super industry.

To date there has been plenty of policy talk but the interesting question, according to Jason Marler, director of business strategy and operations at Russell Investments, is what the Government’s 2011 walk will be.

“The Government released a fairly comprehensive response to the Cooper Review in December of last year where they largely accepted most of the recommendations,” he said.

“I think it was 130-odd out of 177 recommendations that they’ve accepted; some were in principle, a small number were deferred and others they’ve just noted for later implementation.”

As to what Government action there would be over the next 12 months, Marler said that it would largely revolve around industry consultation.

“The first step for the Government will be to establish some consultative sub groups, some of which have already started, but a lot will happen before the final form of the regulation is drafted,” he said.

“I do expect that draft sometime this year but I don’t think the legislation in its final form will come through all at once.

“We’re talking about a lot of change here so I expect they might wait on some of the bigger and more contentious ones until after the Greens get control of the Senate in the middle of the year,” Marler continued.

“That may allow easier passage in the back part of the year.”

Echoing Marler but also speaking to MySuper in particular, Russell Mason, worldwide partner at Mercer, said that with so much policy debate set to occur, the next 12 months would be a period of strategy and planning for fund trustees.

“The Government has signalled quite clearly that they’re going to adopt the Cooper recommendations,” he said.

“And a number of those recommendations — SuperStream for instance, using tax file numbers and so on — they’re good changes and the industry will welcome them.

“Will we see the beginnings of the SG [superannuation guarantee] increase to 9 per cent and a quarter per cent that’s been flagged for July 2013?” Mason asked.

“I don’t know but I don’t think that will have a great impact on the long-term strategy and actions of fund trustees.

“The main thing here is that trustees need to prepare themselves for these changes and have a look at the competitiveness of their fund because if MySuper in its current form comes in, we’re going to see a lot of competition and at that point the challenge shifts to differentiation.”

Superannuation guarantee

Of course, in terms of policy specifics, the one of most profound significance to superannuants is the potential rise of the superannuation guarantee from 9 per cent to 12 per cent. And according to Robin Bowerman, principal and head of retail for Vanguard Investments, it is a move that cannot come soon enough.

“The SG rise is due to come in by 2019 with the Future of Financial Advice reforms due from July 2013,” he said.

“Realistically though, I think much of the industry would ask why the wait for that rise from a 9 per cent SG to 12 per cent? Why wait until 2019?

“It could certainly be implemented sooner, particularly given the economic environment we’re in, a strong economy and full employment,” Bowerman continued.

“I think the Government’s probably been conservative around that, however, I think the caveat that Chris Bowen [former Minister for Financial Services, Superannuation and Corporate Law] and then Bill Shorten [current Minister for Financial Services and Superannuation] have legitimately put out there is that this is a significant step for the superannuation industry and it’s the right thing to do, but it is conditional upon the financial planning industry getting its house in order to ensure that we remove discriminatory commission practices and so on and so forth.”

Bowerman said that people shouldn’t underestimate the fact that Bowen had made it pretty clear that he’d managed to win cabinet support for going from 9 per cent to 12 per cent on the basis that the financial planning industry adopt more transparent fee practices.

“And in terms of logical sequence, it makes good sense,” he said. “You clean out distribution channels, remove the commission issues that have really held the industry back from a credibility point of view and then the 12 per cent SG kicks in from 2019.”

Yet while the SG increase is undoubtedly well supported from the superannuation industry itself, the reality is that a change of this magnitude does not go unchallenged, and Marler said an employer backlash was a definite possibility.

“It’s certainly possible,” he said.

“The Coalition’s position on this is to oppose the 9 per cent to 12 per cent SG on the grounds that it will put strain on smaller businesses that essentially cannot pass it through as a wage trade-off.

“Larger businesses can obviously do that very easily but, in saying that, the increase from 9 to 12 per cent is in very small increments over a lengthy period until 2019,” added Marler.

“It’s not going to have any large, one-off, immediate impact for business and my view is that because it’s done so gradually and over such a long period of time, employees won’t see it as a wage trade-off at all.

“But that’s effectively what will happen, certainly for the large businesses, as this is implemented. Indeed, that was what happened when the SG was first introduced and award superannuation before that in the 1980s.”

For Marler, the reality surrounding any SG increase was that there would still be a significant under-provisioning for retirement within Australia.

“At the moment, I think Rice Warner estimates that that under-provision is about $900 billion,” he said.

“So something like increasing the SG from 9 per cent to 12 per cent will go part of the way to addressing this gap that’s building up as Australia’s population gets older and the proportion of retirees to workforce members grows larger.

“Will it get all the way there?” Marler asked. “No, definitely not. Depending on the individual circumstances, 9 per cent is enough for a small number of people but for most people, you’re looking at somewhere between 12 and 20 per cent to make sure they can live adequately, sustainably, comfortably in retirement.”

MySuper changes

Of course, the other side of Cooper’s superannuation reform coin is the introduction of the MySuper legislation.

While an increase in the SG, and by extension Australia’s retirement savings pool, has been met with significant industry support, MySuper continues to prompt debate and discussion which, according to Marler, is undoubtedly warranted.

“Broadly speaking, I would say that I support the concept of MySuper and what it’s trying to achieve,” he said.

“And I would define those things as making superannuation simpler and easier for members to understand, having high quality default arrangements for those who are disengaged, having the necessary protections as well for those who are disengaged by potentially removing some of the conflicts and structures that exist in the industry, having outcomes transparency and also having a trustee focus on maximising value and net outcomes for members.

“All of those objectives are very good ones and I would certainly support them in that context, but the big question then becomes how you achieve them and how you get there,” Marler continued.

“The Cooper Review’s response to that was to create this thing that they call MySuper and a lot of the debate will come down to the final form of the regulation.”

Marler added that the significant and industry-wide discussion that had been taking place in recent months had raised legitimate concerns around MySuper and many of those concerns remained unaddressed.

“One of those concerns is around entrenching member disengagement and I think there’s some substance to that,” he said.

“I would say MySuper actually makes it harder in some circumstances for individuals to make simple choices. For example, it’s currently very easy for a member of a superannuation fund to move from a balanced 70/30-type portfolio, which is the default that most of them are in, to a slightly less risky investment style, so being 50 per cent growth assets, 30 per cent growth assets — something like that.

“It’s very easy for them to do an investment switch and there’s not a lot of hassle in doing that,” continued Marler.

“But the way Cooper is setting up MySuper will mean that’s a big change, you lose some protections because you’re suddenly no longer disengaged and you’ve actually got to change a fund or a product to do that.

“The last thing we want is people saying that it’s all too hard for them to move out of their MySuper product, especially when it’s in their interests to do so.”

More focused on the benefits MySuper has been tipped to bring, Bowerman said that any super system that was more transparent and that encouraged greater understanding on the part of fund members and investors had to be a good thing.

“So far, there’s been quite a bit of discussion on two levels. Number one is that it might reduce the incentives for people to be involved with their superannuation,” he said.

“But I think there’s also a good amount of behavioural finance research which shows that a lot of people, albeit more at a lower account balance level, just aren’t going to be engaged in the way the industry wants people to be.

“So, to me, the architecture that the Cooper panel recommended makes absolute sense,” Bowerman continued.

“If people really don’t want to be that involved in it and they just want it to be done properly for them, then the trustees have the responsibility to look after them and actually do that with what you might call a benevolent paternalism-type framework.

“It will be the trustees who will really be the people charged with looking after it and making sure of good outcomes and then, as you move up the scale and you’re saying that you do want to select investments or want to have more choice about it, you can.

"To me, it’s a range of options that makes great sense.”

Yet while he acknowledged that the goal of transparency, as mentioned by Bowerman, was one that the Government had firmly in mind, Marler said that he remained concerned about some the unintended consequences of MySuper.

“Cooper and the Government and the Cooper Review panel, they’ve very much stressed that their objective is maximising net outcomes for members,” he said.

“But what we’ve seen so far with the move to greater transparency and greater homogeneity of product is that people are almost clustering together and offering the cheapest headline price and product that they can, so putting together a mix of passive investment styles and less features for members to get the headline price down.

“So while Cooper and the Government will say no, no, no, that’s not the intent at all, the trustee should be taking into account the value delivered to members. I would suggest that there’s already some evidence out there that says people will go for a simple product, a low cost product that you can sell as a headline MySuper offering,” Marler continued.

“And at the end of the day, that may not deliver the best outcomes or value for the members.”

Providing a counterpoint to Marler’s argument, Bowerman said that low cost did not necessarily mean low return.

“It can often mean the reverse and, within Cooper, the way we’ve read it is that it’s not saying you must go for the lowest cost option,” he said.

“It’s saying that if you’re going to pay higher fees for a particular type of fund, whether that’s private equity or a hedge fund, that’s fine but you need as trustee to be very confident that you’re actually going to get a higher return to justify the higher fees.

“So I think the debate around that has become a little off track; they’re sort of missing the point that the Cooper panel is making when they were really saying that fees, particularly on an after-tax basis within a super fund, are a really important driver of the net return an investor gets.

“And as we saw through the global financial crisis, a lot of high cost active strategies basically failed to deliver what investors thought they were paying for.”

According to Bowerman, the other key aspect of MySuper related to the price pressure and additional competition that could be brought to the table.

“So despite the fact that we’ve got a great superannuation system and the industry has, by and large, done a good job of it, what we haven’t seen is a lot of price pressure or margin pressure to bring fees down,” he said.

“Now, Vanguard in the US is actually roughly the same size as the total Australian superannuation system — it’s about $1.5 trillion — so if you look at Vanguard as almost a case study, well fees on the funds there have reduced dramatically as they’ve gone from being a relatively small player at $100 million to $200 million up to $1.5 trillion.

“Fees have gone to about a third of what they were 25 to 30 years ago,” Bowerman added.

“So that’s a good example of where I think the benefit of scale is proven, and we haven’t actually managed to pass that through as an industry to the end investor, to the fund member, as well as we could have.

“That’s why the SuperStream reforms, in terms of clearing up the back-office, will be fantastic and, together with MySuper, will actually provide a very clear, transparent way for people to compare the fees that they pay for their MySuper option versus another MySuper option.

"So as that transparency introduces price competition and price pressure, ultimately that’s got to be good for the end investors.”

FOFA reforms

But while MySuper is certainly set to take centre stage in 2011, the final piece of legislative change waiting in the wings is the Future of Financial Advice reforms.

Announced on ANZAC Day 2010, their impact upon financial planning has been significant but, according to Mason, that impact has not yet been shared by the super industry.

“We haven’t seen a lot of impacts at this stage but what I think we have seen is a lot of funds looking at the financial planning services they provide,” he said.

“Now that we’re moving towards a level fee-for-service playing field, we’ll see planners forced to do away with commissions and effectively move to a fee-for-service model.

“As a result, a number of the industry funds are saying ‘we’ll just put a toe in the water’ or ‘so far we haven’t really adopted financial planning and advice for our members, but maybe now’s the time to do it and do it on a cost effective and competitive basis’,” Mason continued.

“So I would expect that during the course of the next 12 to 18 months, you’ll see a number of funds look at the way they offer advice to members or look to get financial planning licences; look to become authorised corporate reps of other financial planning organisations; look at having embedded planners in their fund.

“There’s a number of models, all with their various pros and cons, that allow the funds to get closer to their members and also to offer a full financial planning service to their members, so I expect this time next year, a lot more funds will be offering financial planning and in far more sophisticated ways.”

For his part, Marler said that one of the interesting things that had come out of the Future of Financial Advice reforms related to the value proposition of advisers and advice.

“You’ve probably seen some of the research around what consumers are prepared to pay for comprehensive advice and it comes in at about $300 or $400, something like that,” he said.

“But the cost of actually delivering full financial advice right now could be five or 10 times that amount, so there’s a big gap there.

Cost-effective advice

“I think one of the key issues and challenges for the industry will be how we deliver cost-effective advice, and not least in that challenge is that we’ve got a lot of older financial advisers — who have done financial advice in the old paradigms — who are retiring and selling off practices and all sorts of things,” Marler continued.

“So there’s less of a new wave of advisers coming through and more customers who are going to need advice, so the baby boomers who are just coming into retirement phase, and arguably that transition to retirement and retirement phase are where people have the greatest need for advice.

“The very big challenge for the industry is how advice, and it doesn’t matter whether it’s single issue, intra-fund or full financial plan, the challenge is how that advice is to be delivered cost effectively.”

So with plenty on the policy radar in 2011, the challenge is clearly navigating what will undoubtedly be a significant amount of legislative change. What will bring individual funds, service providers and the wider super industry safely through to the other side?

The answer, according to Marler, is preparation.

“For us, the key thing is preparing for these changes,” he said.

“We’ve seen this in a lot of businesses already, as they launch new products that look very much like MySuper products.

“That will be the recipe for success in my mind. Whilst we’ve got transition periods, whilst the final form of the regulations isn’t known in lots of these areas, it seems pretty likely that we’re going to head in this direction, and the planning for that can occur right now,” Marler continued.

“To my mind, this won’t be some big bang thing. The timeframes for these changes, whilst they overlap, are significantly different, so I don’t think it’s so much going to be a focus this year.

“The focus this year will be on preparing and getting your business models and structures right to enable the implementation to be straightforward in the years to come. And in that, it’s a case of the earlier you start the better.”