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Superannuation

Draft report

This draft report was released on 2 August 2016. You are invited to examine the draft report and to make written submissions.

Submissions were due by 9 September 2016.

The final report is expected to be handed to the Australian Government in November 2016.

Under the Productivity Commission Act 1998, the Government is required to table the report in each House of the Parliament within 25 sitting days of receipt.

Please note: This draft report is for research purposes only. For final outcomes of this study refer to the research report.

Download the draft report

  • Report guide
  • Media release
  • Contents summary

The Australian superannuation system has grown rapidly since the introduction of the Superannuation Guarantee in 1992, both in terms of funds under management and coverage.

Almost all employed Australians contribute to superannuation. Collectively, Australians currently have around $2 trillion of assets in superannuation funds, comprising about 20 per cent of total household assets. Superannuation will continue to increase in relative importance as the system matures by the 2040s (chapter 1).

The sheer size of the superannuation system, combined with its compulsory and broad nature, makes the efficiency of the system paramount. Even small changes in efficiency can have significant impacts on the wealth and wellbeing of Australians. Competition is often a key way of promoting efficiency.

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About this report

In this draft report, the Commission has proposed criteria to assess whether, and the extent to which, the superannuation system is efficient and competitive in delivering the best outcomes for members.

The publication of these criteria is intended to provide transparency and certainty to the superannuation industry about how it will be assessed in the eventual review of the efficiency and competitiveness of the superannuation system.

The Australian Government has stated that the Productivity Commission will be asked to undertake this system-wide review following the full implementation of the MySuper reforms (after 1 July 2017) (figure 1).

The Commission has proposed assessment criteria and corresponding indicators for the superannuation system. The system is bigger than just the superannuation funds (the industry). It encompasses many horizontal and vertical relationships on the supply side, decisions of members on the demand side, and actions of regulators on both the supply and demand sides. The unique features of this complex system are discussed in chapter 2.

There is little precedent (including internationally) for what this study is trying to do, or for the ultimate assessment itself. Most studies of the efficiency of the Australian superannuation system have focused on operational efficiency and matters that readily lend themselves to measurement (such as returns and fees).

The system-wide perspective is unique and makes this a challenging task. The Commission encourages readers to keep this system perspective front and centre in their thinking as they consider the proposed assessment criteria and indicators.

Figure 1 Three-stage superannuation review Indicative timelines for Commission superannuation project. This figure shows how stages 1, 2 and 3 relate to each other over time — between 2016 and 2020. The stage 1 study to develop criteria to assess efficiency and competitiveness of the super system began in February 2016 and is due to report to Government by November 2016. Sitting adjacent to stage 1, is the stage 2 inquiry to develop alternative models for allocating default fund members to products, beginning in late 2016 and reporting to Government by August 2017. The outcomes from stage 1 will influence stage 3 and may influence stage 2. The stage 3 inquiry to review efficiency and competitiveness of the super system will begin sometime after the second half of 2017. The results of stage 3 and, possibly stage 2, will feed into the Government's consideration of the reviews' outcomes.

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This draft report does not contain findings or recommendations. However, the Commission welcomes feedback on all aspects of its proposed assessment approach. The Commission is particularly keen to receive feedback on the draft criteria and indicators. The criteria are summarised in table 1; the full set of criteria and indicators are set out in chapter 7.

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The Commission's approach

The Commission's approach in this study (stage 1) involves three steps (figure 2):

  1. Defining system-level objectives — what is the superannuation system trying to achieve?
  2. Formulating assessment criteria based on these objectives — that is, the performance standards by which to assess if the system-level objectives have been achieved.
  3. Identifying indicators and other evidence to facilitate the assessment.

What are the objectives of the superannuation system?

What is efficient ultimately depends on what you are trying to achieve: the objectives of the superannuation system (chapter 4). The Australian Government recently announced that the objective of superannuation is 'to provide income in retirement to substitute or supplement the Age Pension'.

The Government's objective is framed within the principles of fairness, adequacy and sustainability, and casts superannuation as only one part of the broader retirement income system. Retirement incomes are a function of many factors outside the influence of the superannuation system (such as government policy).

The Commission has therefore developed system-level objectives that are within the scope of influence of the superannuation system, are specific to the principles of competitiveness and efficiency, and link back to the overarching objective set by the Government.

Broadly speaking, the system-level objectives target the best interests of members. Competition in the superannuation system is not an end in itself, but an intermediate objective insofar as it drives more efficient outcomes for members.

Figure 2 The Commission's approach to assessment The Commission's approach to assessment. This figure shows the approach the Commission will take to assessing the efficiency and competitiveness of the superannuation system. This involves three steps: defining system-level objectives, formulating assessment criteria based on these objectives, and identifying indicators and other evidence to facilitate assessment.

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  • Proposed system-level objectives
    • The superannuation system maximises net returns on member contributions and balances over the long term.
    • The superannuation system meets member preferences and needs, in relation to information, products and risk management, over the member's lifetime.
    • The superannuation system provides insurance that meets members' needs at least cost.
    • The superannuation system complements a stable financial system and does not impede long-term improvements in efficiency.
    • Competition in the superannuation system that drives efficient outcomes for members.

Developing the assessment criteria and indicators

Formulating assessment criteria involves identifying attributes that a competitive and/or efficient superannuation system would be expected to have (chapter 3). As such, they are closely linked to the system-level objectives.

The Commission has taken current policy settings as given when developing the assessment criteria. This is done either by omission (the Commission is not proposing to assess the system on what is outside its influence, such as the overall adequacy of retirement incomes), or by recognising the influence of external factors when proposing criteria and in interpreting particular outcomes.

The Commission's proposed assessment approach relies heavily on benchmarking. The term 'benchmarking' is used broadly: performance will be benchmarked against others (for example, other funds or countries); against stipulated objectives (for example, an 'efficiency frontier' or a market benchmark); and over time.

In some parts of the assessment, the Commission will complement its benchmarking exercise with a 'negative test' — an examination of the barriers that may be impeding the efficiency and competitiveness of the superannuation system (such as barriers to entry).

The Commission will rely on a large number of indicators to facilitate collective assessment, along with evidence-based interpretation and judgment. This will include input and process indicators, output indicators, behavioural indicators and outcome indicators. Some indicators will be quantitative while others will be qualitative.

Some of the proposed indicators may be ambiguous and cannot be interpreted in isolation. Robust evidence and judgment will be required to interpret the meaning of each indicator. In some cases, this meaning may only surface in the presence of other indicators. This means that the indicators need to be considered and interpreted collectively to inform the assessment.

The interpretive narrative for the indicators is a role for the stage 3 review, although some elements will emerge in this study through the exercise of simply considering indicators.

The Commission has erred on the side of being as comprehensive and specific as possible with the indicators proposed in this draft report. The Commission welcomes feedback on whether the indicators are measurable and any material interpretation issues. Table 2 provides an example of the types of indicators proposed for two similar criteria.

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Criteria to assess competition

The Commission is proposing two complementary approaches to assess the nature and extent of competition in the superannuation system:

  • a 'structural' assessment of the market, which evaluates whether the conditions within the market are conducive to competition
  • an 'outcomes' assessment, which focuses on actual conduct and outcomes, and tests whether these are consistent with what is expected in a competitive market.

The second element in particular is necessary to keep the focus of competition on improving outcomes for members.

Structural assessment of the market

The Commission proposes to assess whether the current market structure is conducive to rivalry between incumbent providers of services. Measures of market concentration are often used to assess the degree of rivalry.

However, such measures can be ambiguous (for example, high concentration can be a consequence of economies of scale realised due to competition). Therefore, an indicator of market concentration needs to be accompanied by robust empirical evidence on how outcomes have changed following changes in market concentration.

The Commission plans to assess the contestability of the market by looking at barriers to entry and exit. There are two main barriers to entry that can give rise to incumbency advantages in superannuation: default fund status and vertical/horizontal integration.

  • Defaults are an important policy feature of the superannuation system, and will be taken as given. The relevant assessment therefore is whether the process of selecting defaults is contestable and competitive.
  • Vertically and horizontally integrated entities often benefit from access to well-developed distribution channels and economies of scope. While being a barrier to entry, this may not necessarily be inefficient. Concerns would arise, however, if this integration led to anticompetitive behaviour.

Traditional assessments of competition tend to end here (the supply side). However, the Commission's assessment will extend to the demand side (the member side, including their intermediaries).

The Commission considers that some level of member engagement is required to signal preferences, and to ensure that the benefits of wholesale-level competition flow through to the member. However, the quality of decision making is the ultimate goal.

Measures of member engagement need to be accompanied by consideration of financial literacy and how (and what form of) member engagement relates to better outcomes. The Commission has proposed a number of criteria and indicators to assess the level of member-driven competitive pressure (chapter 5) and welcomes feedback on these.

Assessment of conduct and outcomes

Product proliferation, high advertising expenditure, competition on irrelevant non-price (non-fee) aspects and high search costs are potentially signs of unhealthy competition. In contrast, in a market where competition is facilitating efficiency, funds would compete on factors that are relevant to members, which are most often fees and returns.

The Commission plans to assess whether there is a high degree of competition on costs, and whether there is a decline in costs and subsequently fees charged to members over time.

There is a need to consider fees in tandem with other features that members value (such as returns and service quality). But in the long run, and as other markets have consistently demonstrated, it is possible to achieve both lower prices (or in the case of superannuation, lower fees) and higher quality.

Economies of scale have been identified as a potential source of efficiency in the superannuation system, and competition is a key way to realise economies of scale. (Scale can also be achieved from exogenous growth in the system due to regulatory fiat.)

The Commission will assess (in stage 3) the magnitude of unrealised scale economies and the extent of pass-through of benefits of economies of scale to members. Further details on the proposed measurement approach can be found in chapter 5.

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Criteria to assess efficiency

The Commission is proposing criteria that span all three aspects of efficiency: operational, allocative and dynamic. They also cover the three phases of superannuation: accumulation, transition and retirement. Standalone criteria are proposed for insurance within superannuation. Further information on the efficiency criteria can be found in chapter 6.

The proposed assessment criteria rely heavily on quantitative benchmarking using historical data — an ex post assessment of efficiency. Assessments of current and expected efficiency are facilitated using qualitative indicators.

The assessment of efficiency will sometimes draw on the same indicators used to assess competition (as can be seen in the example in table 2), as the two often go hand-in-hand.

Maximising net returns (after fees and taxes) is the most important way in which the superannuation system contributes to adequate and sustainable retirement incomes. The Commission will focus on assessing system-wide long-term net returns, and compare them to various benchmarks.

The assessment will also be applied to particular segments (for example, institutional superannuation funds and self-managed superannuation funds), where it can provide insights about system-wide performance.

The Commission plans to take a straightforward approach to risk adjustment by benchmarking net returns at the asset-class level and by comparing net returns among products with similar risk characteristics.

A related criterion is whether the system minimises costs and fees, since higher fees will reduce net returns, all else equal. The Commission also proposes to assess whether there are any institutional or market impediments to investment in upstream capital markets (for example, is fund size an impediment to investing in certain asset classes?) that may be leading to higher costs and/or lower returns.

Assessing whether the superannuation system achieves allocatively efficient outcomes is impossible, given the wide variation in individual members' circumstances and preferences. However, the Commission will assess whether inputs and behaviours in the system are consistent with allocative efficiency.

For example: are funds collecting information on their members and using it to design products that better meet member needs? Are funds using lessons from behavioural finance to help members make better decisions? The assessment will rely significantly on qualitative and case study information.

The Commission's assessment of efficiency will potentially have to consider trade-offs between short-run operational efficiency and long-run dynamic efficiency.

For example, a high degree of competition and lean margins may increase the risk of entity failure that affects stability and confidence in the system. Therefore, the Commission also proposes to assess the extent of systemic risks in the superannuation system.

Transition and retirement phases

The transition and retirement phases have not received as much policy or market attention as the accumulation phase of superannuation. And yet this is when members typically have the largest balances and the efficiency of the system comes to the fore.

While some in the system are now focusing more on these phases, the Commission plans to assess whether the system is meeting the needs of members during these phases, including via product innovation that addresses tax effectiveness, transition and longevity risks.

Insurance

The cost of insurance held through superannuation detracts from retirement balances and ultimately retirement incomes. However, policy dictates that life and total and permanent disability insurance are bundled with superannuation on an opt-out basis in default products.

Given this constraint, the Commission plans to assess whether trustees are offering the most appropriate insurance for their members, and whether the costs of insurance are minimised for the type and level of cover provided.

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Data needs

Assessing the efficiency and competitiveness of the superannuation system will be data intensive. Some data relating to the assessment criteria and indicators are already publicly available.

Other data have been collected, but have not been made public. And in some areas, the data simply do not exist. Chapter 7 discusses data needs and availability in more detail.

The Commission's guiding principle for the ultimate assessment in stage 3 will be to draw on data that are already collected from the system as much as possible. This includes regulator data as well as data held by the private sector.

New data will be sought only where it is feasible to collect within the short-to-medium term and the benefits of collection are likely to exceed the costs.

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Table 1 Competitiveness and efficiency assessment criteria for the superannuation system
Competitiveness Efficiency
Demand-side characteristics (members and member intermediaries)

Is there sufficient member engagement to exert competitive pressure?

Are members and member intermediaries able to make informed decisions?

Is there low market segmentation along member engagement lines?

Do active members and member intermediaries have sufficient countervailing power?

Are principal–agent problems being minimised?

Supply-side characteristics (through the supply chain)

Is there rivalry among incumbent providers?

Is the market contestable?

Are there material anticompetitive effects of vertical and horizontal integration?

Conduct and outcomes

Do funds compete on costs?

Are economies of scale utilised and the benefits passed through to members?

Do funds compete on relevant non-price dimensions?

Is there innovation and quality improvement in the system?

Are outcomes improving at the system level?

Net returns

Are net investment returns being maximised over the long term, taking account of service features provided to members?

Are costs incurred by funds and fees charged to members being minimised, taking account of service features provided to members?

Do all types of funds have opportunities to invest efficiently in upstream capital markets?

Is the system effectively managing tax for members, including in transition?

Member needs and preferences

Are member preferences and needs being met by:

  • minimising unpaid contributions and lost accounts?
  • funds collecting relevant information to ensure their product offerings are suitable for their diverse member bases?
  • the system providing high-quality information and financial advice to members to help them make decisions?
  • the system providing products and information to help members optimally consume their retirement incomes?
  • member balances being allocated in line with their risk preferences and needs?

Is the system using lessons from behavioural finance to design products and 'lean' against well-known biases in how people make decisions?

Are trustees acting in the best interests of members?

System stability

Are there material systemic risks in the superannuation system?

Insurance

Do funds offer insurance products that meet members' needs?

Are the costs of insurance being minimised given the type and level of cover?


Table 2 Illustrative excerpt of indicators
Competition criterion: Do funds compete on costs? Efficiency criterion: Are costs incurred by funds and fees charged to members being minimised, taking account of service features provided to members?
  • Costs relative to assets and member base: wholesale (by service) and retail (by segment)* (input)
  • Margins: wholesale (by service) and retail (by segment)* (output)
  • Investment management fees by asset class compared to other countries* (output)
  • Alignment of the structure of member fees and underlying costs (output)
  • Transparency and efficacy of fee disclosure by funds, including for distinct services (behaviour)
  • Costs relative to assets and member base: wholesale (by service) and retail (by segment)* (input)
  • Margins: wholesale (by service) and retail (by segment)* (output)
  • Investment management fees by asset class compared to other countries* (output)
  • Pass through of benefits from scale economies (wholesale and retail) to members* (output)
  • Investment costs and fees across equivalent products and between market segments (input, output)
  • Relationship between investment fees and returns (output)
  • Use and disclosure of performance attribution by funds (behaviour)
  • Administrative costs and fees at system level and for market segments (input, output)
  • Cost savings from SuperStream (output)
  • Relationship between level of administrative fees and quality of member services (output)
* Indicators marked with an asterisk are common to both competition and efficiency.

How to assess the superannuation system's performance

The Productivity Commission has released its proposed framework to assess the efficiency and competitiveness of Australia's $2 trillion superannuation system.

'Our superannuation system is large, complex and has broad reach. This means even small system improvements can offer significant financial benefits to Australian workers, particularly in their retirement.'

'We have developed a framework that will allow us to assess how well our super system is able to meet its primary purpose of providing retirement income,' said Commissioner Angela MacRae.

This study represents the first in three stages of superannuation work by the Commission.

'This is the first important step in our work. Undertaking a system-wide assessment of the competiveness and efficiency of our super system is challenging and novel. It has not been done before. Getting the foundations right matters most — and we know there are no silver bullets.' said Productivity Commission Deputy Chair Karen Chester.

The draft report proposes a comprehensive framework to be used in stage 3 to assess the super system's efficiency and competitiveness. The framework comprises system-level objectives, corresponding assessment criteria and a suite of performance indicators supporting each criterion.

The system-level objectives for superannuation identified by the Commission are specific to competition and efficiency and revolve around the best interests of members.

'Competition is not an end in itself. It will be assessed in terms of the benefits it can deliver for members.'

'In defining our assessment criteria, current policy settings are taken as a 'system given' to ensure our assessment focusses on what is within the system's field of influence,' said Karen Chester.

The Commission is seeking feedback on whether the objectives, criteria and indicators are fit for purpose. The draft report also foreshadows the Commission's data needs and seeks views on addressing data gaps.

The Commission welcomes post-draft submissions from interested parties by 9 September 2016. The Commission will also be consulting with stakeholders via industry roundtables, and will be releasing a final report later in the year. Information can be found at the Productivity Commission's website.

Our proposed assessment framework: a snapshot

Our proposed assessment framework:  a snapshot
Background information

Mary Cavar (Assistant Commissioner) 03 9653 2187

Leonora Nicol (Media, Publications and Web) 02 6240 3239 / 0417 665 443

This study consists of a guide to the report, seven chapters and seven appendixes.

Chapter 1 provides relevant background to the study.

Chapter 2 dissects the characteristics of the superannuation system that are pertinent to the assessment framework.

Chapter 3 details the assessment framework guiding the study.

Chapter 4 contains the system-level objectives that the Commission has used as a reference point by which to guide criteria and indicators.

Chapters 5 and 6 contain the criteria and indicators the Commission is proposing in order to assess the competitiveness and efficiency of the superannuation system.

Chapter 7 summarises the criteria the Commission has developed and draws out the key challenges and required evidence that will be involved in applying the criteria in the future.

Appendix A contains material on submissions and consultation processes.

Appendix B examines the literature on member decision making and Australians' superannuation knowledge and behaviour.

Appendix C analyses corporate tendering for default superannuation contributions and what it can reveal about the competitiveness of the system.

Appendix D assesses the current status of the market for retirement income products.

Appendix E considers the key lessons from international experiences and comparisons.

Appendix F discusses the impact of the superannuation system on overall financial stability.

Appendix G outlines how the trends in the SMSF sector will be factored into the Commission's framework.

Appendix H describes the system's regulatory environment and how it may impact on competition and efficiency.

Printed copies

Printed copies of this report can be purchased from Canprint Communications.