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PC News - May 2017

Assessing the performance of the superannuation system

In stage one of a three-stage review of Australia's superannuation system, the Productivity Commission has developed a framework for assessing the efficiency and competitiveness of the superannuation industry.Close-up photo of an office worker using a touchpad to analyze statistical data

The Australian superannuation system forms a major pillar of Australia's retirement income system. Over $2 trillion in funds are held under management by over 250 institutional funds and over 577 000 self-managed superannuation funds. Treasury forecasts that by 2040 there will be almost $8 trillion in funds under management.

The sheer size of the superannuation system, combined with its broad and compulsory nature, means the efficiency of the system is paramount. Even small system improvements can have significant impacts on the wealth and wellbeing of Australians.

The Financial System Inquiry (FSI), as part of its broad review of the financial system, examined the superannuation system, releasing a final report in 2014. Among other things, it found that there was a lack of price-based competition in the superannuation system, and that reforms and increasing fund sizes and consolidation have not delivered the fee decreases expected.

In response to the FSI, the Australian Government asked the Productivity Commission to undertake a study to develop criteria to assess the efficiency and competitiveness of the superannuation system. This study represents stage 1 of a 3-stage work program on superannuation to be undertaken by the Commission, culminating in a system-wide review of the system (figure 1).

Figure 1: Stage one in a three stage superannuation review

  • Figure 1 Stage one in a three stage superannuation review. 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.

There is little precedent, even internationally, for conducting such a broad review. This highlights the importance of the review, and in particular the task of setting out the assessment framework. The publication of the assessment criteria developed by the Commission is aimed at providing transparency and certainty to the superannuation industry and fund members about how the system will be assessed.

Part of the challenge of undertaking the review is that it is system wide. This means that the Commission will look beyond superannuation funds. On the supply side, vertical relationships will be important, and upstream financial service providers will be in the scope of the review. On the demand side, decision making by individuals, and how this is influenced by employers, acting as intermediaries, will be examined. The role that regulators such as the ATO and APRA play will also be included in the review.

The Commission's approach to developing assessment criteria

To develop the assessment framework, the Commission asked the following questions:

  1. What is the superannuation system trying to achieve; what are the system-level objectives?
  2. Based on these objectives, what are appropriate assessment criteria?
  3. Based on the assessment criteria, what indicators could be used for assessment?

The Australian Government has declared that the objective of superannuation is to provide income in retirement to substitute or supplement the age pension. This objective is broad and encompasses the wide set of policies and industries supporting retirement income, including voluntary private savings and the Age Pension.

To manage the scope of the assessment framework, the Commission defined five system-level objectives that are within the influence of the superannuation system and are specific to the principles of competitiveness and efficiency, as well as link back to the overarching objective set by the Australian Government (box 1).

Based on the system-level objectives, the Commission formulated assessment criteria and related indicators. In total, the assessment framework consists of 22 assessment criteria supported by 89 unique indicators (see table 1 for a full list of the assessment criteria). The indicators are wide ranging. They are qualitative and quantitative, and include input, output, behavioural and outcome indicators. They have been carefully chosen to minimise additional data requirements; much of the data required is already collected or can be constructed from existing data sources.

Assessment criteria and indicators provide ways of measuring performance, but they do not provide a reference-point; or a way of asking if the performance is 'good'. To assess performance, the Commission will rely extensively on benchmarking. Relevant benchmarks will be both cross-sectional and over time, and include funds and (international) markets. In some cases it will be appropriate to conduct 'negative tests', for example, are there barriers to entry in the superannuation market? For any assessment, the Commission will draw on the comprehensive suite of indicators developed and evidence-based interpretation.

Given the heterogeneity of the system, it will also be important to consider issues around market definition. In part this will be become clearer as the Commission conducts the assessment, but as a start the Commission has indicated it will be relevant to identify market segments that have distinct characteristics — such as choice and default segments.

Box 1: System-level objectives

  • Efficiency:

    • The superannuation system contributes to retirement incomes by maximising long-term net returns on member contributions and balances over the member's lifetime, taking risk into account.
    • The superannuation system meets member needs in relation to information, products and risk management, over the member's lifetime.
    • The efficiency of the superannuation system improves over time.
    • The superannuation system provides value for money insurance cover without unduly eroding member balances.

    Competition that promotes efficiency:

    • Competition in the superannuation system should drive efficient outcomes for members.
Table 1: Superannuation system-level objectives and criteria to assess efficiency and competitiveness
Assessment criteria Number of indicatorsa
The superannuation system contributes to retirement incomes by maximising long-term net returns on member contributions and balances over the member's lifetime, taking risk into account
Are long-term net investment returns being maximised over members' lifetimes, taking account of risk? 4
Are costs incurred by funds and fees charged to members being minimised, taking account of service features provided to members? 10
Do all types of funds have opportunities to invest efficiently in upstream capital markets? 4
Is the system effectively managing tax for members, including in transition? 3
Are other leakages from members' accounts being minimised? 5
The superannuation system meets member needs, in relation to information, products and risk management, over the member's lifetime
Is the system providing high-quality information and intrafund financial advice to help members make decisions? 7
Is the system providing products to help members manage risks over their life cycles and optimally consume their retirement incomes? 7
Are principal−agent problems being minimised? 7
The efficiency of the superannuation system improves over time
Does the system overcome impediments to improving long-term outcomes for members? 6
Are there material systemic risks in the superannuation system? 3
The superannuation system provides value for money insurance cover without unduly eroding member balances
Do funds offer value for money insurance products to members? 10
Are the costs of insurance being minimised for the level and quality of cover? 7
Competition in the superannuation system should drive efficient outcomes for members
Market structure
Is there informed member engagement? 8
Are active members and member intermediaries able to exert material competitive pressure? 7
Is the market structure conducive to rivalry? 2
Is the market contestable at the retail level? 3
Are there material anticompetitive effects of vertical and horizontal integration? 6
Conduct and outcomes
Do funds compete on costs/price? 6
Are economies of scale realised and the benefits passed through to members? 5
Do funds compete on member-relevant non-price dimensions? 5
Is there innovation and quality improvement in the system? 3
Are outcomes improving at the system level? 2

a Many indicators are used multiple times. In total there are 89 unique indicators.

How to Assess the Competitiveness and Efficiency of the Superannuation System

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