Tag: Productivity Commission

It’s Time For A Broader Review Of Super

From The Conversation.

There’s a lot in the Productivity Commission’s landmark 722-page table-thumper of a report into Australia’s superannuation system, completed after nearly three years of invesigation. For now, I’ll make three comments.

The Commission gets the industry

First, it’s a very valuable report. The Productivity Commission (PC) has undertaken a deep analysis of the superannuation industry and collected a range of information that was previously unavailable. The research has been conducted with considerable care and diligence, backed by insight. I am confident the PC understands the industry. The report is a great resource that will probably be cited for years to come.

Yet sets itself against the industry…

My second comment relates to the gusto by which the PC has called out shortcomings of the system, and advocated for key changes. While the PC is aiming to be constructive, the report reads as quite critical.

It seems guilty of overstatement for dramatic effect, which I fear may inhibit moving forward. Many report headings read as if they are brickbats. It headlined two of its diagrams: “the character of member harm”. It sets the tone on page five:

The system delivers good outcomes for many members, but not all. The industry’s peak body submitted that “the Australian superannuation system is not broken, and is in fact a world class private pension system”. The evidence suggests otherwise.

In my view, the system is better described as being very good with room for improvement.

The PC has raised the ire of the industry, which will create a barrier to change as the advocacy ramps up.

While most of its recommendations are sensible, the idea of a panel selecting a “best-in-show” shortlist of 10 default funds is controversial.

The recommendation is being attacked on its potential shortcomings, when the debate ought to be around whether it is the best option among a set of imperfect alternatives. The simpler question of whether the PC’s recommendation is better than the current system is not being debated.

We are travelling down an adversarial path unlikely to build consensus around what needs to happen.

…and raises more important questions

Third, the PC has recommended further investigations going beyond its terms of reference. I will finish by focusing on Recommendation 30: an independent public inquiry into the role of compulsory superannuation in the broader retirement incomes system, including the net impact of compulsory super on private and public savings.

Surprising, there is no established position on how effective superannuation has been in working toward Australians supporting themselves in retirement. It is an open question whether the costly tax concessions attached to super provide an overall benefit to Australian society.

The Commission also wants the inquiry to examine who is hurt and who is helped by compulsory superannuation, both over time and at any point in time.

Recommendation 30. Superannuation: Assessing Efficiency and Competitiveness. Productivity Commission, December 2018

The PC is calling for an examination into the amounts being contributed into super, given that it called for the inquiry to be completed ahead of the the next scheduled increase in the compulsory contribution rate from 9.5% of salary to 10% in June 2021.

The PC was limited to examining the efficiency of the system under current policy settings. But the settings themselves are arguably the greatest barrier to the efficiency of the system, and its ability to serve the public. An inquiry into super’s place within the broader retirement income system would be an opportunity to work out how it can serve us best.

Too often the discussion is framed as if superannuation is the only resource supporting members through retirement. The call to lift the compulsory levy from 9.5% to 12% – some have argued for 15% or even 20% – epitomises this myopic perspective.

The reaction to a recent Grattan Institute report (Money in retirement: more than enough, November 2018) addressing various aspects of system design and questioning the need to increase the levy was revealing.

Grattan was lambasted for their stance, unfairly in my opinion. Much of the criticism came from those with a stake in seeing the levy increased, and mostly danced around the fringes of the argument. All this is indicative of an inability to have a thoughtful discussion over important policy issues.

Superannuation interacts with many other aspects of retirement support, including the social security system (specifically the aged pension), the tax system, other assets held by individuals, in particular whether they own a home, and personal circumstances.

Money siphoned off into super to support spending in retirement comes at the cost of lower spending power during the working years.

Placing more in superannuation might be entirely right for some, but might come at a cost for others.

They are good questions

The first interrelation between super and other features of the system needs to be better understood. There are various flags pointing to inconsistencies.

Claims that people are not saving enough for retirement do not gel with many retirees taking money out of super at the minimum rates.

Meanwhile the social safety net is substantial. The (single) aged pension of A$24,824 is 86% of the Association of Superannuation Funds “modest” living standard up to age 85, and 91% of it after age 91. And Australians have access to affordable health care.

Home ownership is a key determinant of capacity to support oneself through retirement, and it is only heightened by it being excluded from the pension means test. There can be a huge gap between retirees who own their home and those who do not.

Many low income earners struggle to establish themselves in life, yet are forced to invest in super, on which they may be taxed at greater rate than their current income tax rate.

The super system is designed around individuals, yet most people operate within households.

The PC is right to call for an inquiry into the entire system design. It would be an opportunity to examine the interaction of super with everything else, whether it is doing what it should, and whether it is treating different types of Australians in the way we would want.

Author: Geoff Warren, Associate Professor, College of Business and Economics, Australian National University

Super Reform On The Cards, Perhaps

The Productive Commission released their latest report today. We discuss the findings and consider the implications. Many people are not getting the maximum returns from their savings, thanks to poor fund choice, high fees, multiple accounts and insurance premiums.

In addition, APRA and ASIC have been asleep at the wheel, with more of a focus on the institutions compared with the interests of members.

Finally, industry funds often out perform retail funds.

The Productive Commission summary says:

  • Australia’s super system needs to adapt to better meet the needs of a modern workforce and a growing pool of retirees. Structural flaws — unintended multiple accounts and entrenched underperformers — are harming millions of members, and regressively so.
  • Fixing these twin problems could benefit members to the tune of $3.8 billion each year. Even a 55 year old today could gain $79 000 by retirement. A new job entrant today would have $533 000 more when they retire in 2064.
  • Our unique assessment of the super system reveals mixed performance.
    • While some funds consistently achieve high net returns, a significant number of products underperform, even after adjusting for differences in investment strategy. Underperformers span both default and choice, and most (but not all) affected members are in retail funds.
    • Evidence abounds of excessive and unwarranted fees in the super system. Reported fees have trended down but a tail of high‑fee products remains entrenched, mostly in retail funds.
    • Compelling cost savings from realised scale have not been systematically passed on to members as lower fees or higher returns. Much scale remains elusive with too few mergers.
    • A third of accounts (about 10 million) are unintended multiple accounts. These erode members’ balances by $2.6 billion a year in unnecessary fees and insurance.
    • The system offers products that meet most members’ needs, but members lack simple and salient information and impartial advice to help them find the best products.
    • Not all members get value out of insurance in super. Many see their retirement balances eroded — often by over $50 000 — by duplicate or unsuitable (even ‘zombie’) policies.
  • Inadequate competition, governance and regulation have led to these outcomes.
    • Rivalry between funds in the default segment is superficial, and there are signs of unhealthy competition in the choice segment (including product proliferation). Many funds lack scale, with 93 APRA‑regulated funds — half the total — having assets under $1 billion.
    • The default segment outperforms the system on average, but the way members are allocated to default products has meant many (at least 1.6 million member accounts) have ended up in an underperforming product, eroding nearly half their balance by retirement.
    • Regulations (and regulators) focus too much on the interests of funds and not members. Subpar data and disclosure inhibit accountability to members and government.
  • Policy initiatives have chipped away at some problems, but architectural change is needed.
    • Default should be the system exemplar. Members should only be defaulted once, and move to a new fund only when they choose. Members should also be empowered to choose their own super product from a ‘best in show’ shortlist, set by a competitive and independent process. This will bring benefits above and beyond simply removing underperformers.
    • All MySuper and choice products should have to earn the ‘right to remain’ in the system under elevated outcomes tests. Weeding out persistent underperformers will make choosing a product safer for members.
    • All trustee boards need to steadfastly appoint skilled board members, better manage unavoidable conflicts of interest, and promote member outcomes without fear or favour.
    • Regulators need clearer roles, accountability and powers to confidently monitor trustee conduct and enforce the law when it is transgressed. A strong member voice is also needed.
  • Implementation can start now, carefully phased to protect member (not fund) interests.

How Much Market Power Do The “Big Four” Hold?

The Productivity Commission Report into Competition in The Australian Financial System looked specifically at the role and function of the big four banks. Today we look at some of the evidence which they presented, in the light of the Green’s recently released policy on “Breaking Up the Banks”.

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Productivity Commission Report.

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How Much Market Power Do The “Big Four” Hold?



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How Much Market Power Do The “Big Four” Hold?

The Productivity Commission Report into Competition in The Australian Financial System looked specifically at the role and function of the big four banks. Today we look at some of the evidence which they presented, in the light of the Green’s recently released policy on “Breaking Up the Banks”.

Whilst the market dominance of the big four, Westpac, CBA NAB and ANZ does not necessarily in itself mean the market is not competitive, the Productivity Commission suggests that such dominance may allow them to stifle competition by maintaining prices at artificially high levels or limiting innovation without losing any market share.

In many banking systems globally, larger institutions have more market power, and Australia is no exception. Their sheer size allows the major banks to spread their fixed costs (such as investment in new IT systems) across a broader asset base. They are also able to grow more quickly, as they have greater capacity to respond to an increase in demand. At the same time, size can create challenges — for example, changes are more difficult to implement in very large systems. There is a tipping point beyond which large organisations are no longer efficient and they operate at declining returns to scale.

The clearest and most powerful advantage that larger banks have over smaller ADIs, and one that gives them substantial market power, is their ability to raise funds at lower costs. Larger banks have better credit ratings, and as a result, investors and depositors are willing to lend them funds at lower rates. In part, these credit ratings can reflect the ability of larger banks to hold more diversified lending portfolios. However, these ratings also benefit from explicit and implicit government guarantees, such as being considered ‘too big to fail’. Their lower costs of funding enable the bigger banks to maintain their profits and offset some of the increases in their costs resulting from regulatory change, which may prove more difficult for smaller institutions.

Larger operators also benefit, to an extent, from integration, which gives them the ability to exert additional control over some markets. Vertical integration allows larger institutions to have more control over the costs of their inputs, while smaller entities rely on third parties to access funding markets and other types of services. In effect, small ADIs compete against the major banks, but also depend on them to access the funds that allow them to continue competing. Cross-product (conglomerate) integration gives the larger institutions the opportunity to cross subsidise some of their products, and also offer consumers an integrated bundle of services, which may help to lock customers into the provider and raise customer switching costs.

Despite the consolidation of some smaller players, the major banks still maintain substantial market power — because the difference in size between them and the other providers in the market is exceptional. Based on the value of their assets in April 2018, ANZ (the smallest of the majors) was seven times bigger than Macquarie, the next bank by size of assets. Twenty banks (ranking 5th to 24th by size of assets) would need to merge in order to match ANZ. Only if all banks in Australia, other than the big four, merged would they be able to rival the biggest two — Westpac and the CBA.

An important aspect of banks’ size is their geographical reach, either through branches or other distribution networks. In 2017, there were about 5300 bank branches, over 390 credit union branches and 74 building society branches. The major banks accounted for 60% of all branches, and only two other ADIs (Bendigo and Adelaide Bank and Bank of Queensland) had branches in every state and territory.  Major banks are also strongly represented in other distribution networks, such as mortgage brokers.

At the same time, customer satisfaction levels reported by individual banks, including the major banks, remains high. While consumers may be disillusioned with the banking system, it seems they are satisfied with their chosen institution. Of course, consumers may not always be aware of the alternative services and prices available from other institutions — or even their own institution — that may be more suitable for their circumstances.

Australia’s major banks have some of the strongest business brands in our economy. Industry estimates put the value of their brands between $6 and $8 billion, with CBA having the highest brand value. Their public image has been affected by a series of scandals and the continued community perception that they do not operate in their customers’ best interests

The major banks benefit from the perception that they are safe, stable institutions, and that the government will step in to help them if needed. This supports their existing market power, and in some cases increases it further — during the global financial crisis (GFC), consumers transferred some of their savings to the major banks, as they were perceived as safer. Even when no financial crisis looms, small institutions may find it difficult to attract consumers from rivals that are perceived as safer. This is despite the fact that retail deposits benefit from the same government guarantee, regardless of ADI size.

Consumer behaviour may also contribute to market power; the low levels of consumer switching and a general disengagement from financial services help ADIs maintain their position in the market, and make it harder for new competitors to gain any significant market share.

The major banks benefit from a substantial asset base and stable market shares, which give them the ability to cope more easily with regulatory change, while also investing and innovating — which in turn can contribute further to their market power.  Small institutions argue that their regulatory burden is disproportionately large. For some, the pace and extent of regulatory change has left them limited resources to increase market share.

Measures introduced by the Australian Government and APRA are intended, in part, to offset the cost advantages of large banks — examples include the major bank levy and potentially the specific prudential regulation imposed on domestically significant banks, which applies to the big four banks. It has been argued by Government that when such regulations raise the costs of the major banks, they may help smaller competitors.

But the PC says the objective of competition policy is not to assist some competitors by adding burdens to others, but rather to have the least necessary intervention that is consistent with allowing choice and innovation to meet consumer interests in an efficient manner. Viewed simply, to raise the cost of businesses that have market power — while doing nothing to address adverse use of that market power — risks seeing those costs imposed on customers.

They conclude that the major banks benefit from advantages of scale, scope and branding which give them substantial market power and the ability to remain broadly insulated from competitive threats posed by smaller incumbents or new entrants. They concluded that this balance of power gives the major banks the ability to pass on cost increases and set prices that maintain high levels of profitability — without losing market share.

While high concentration on its own is not necessarily indicative of market power resulting in inefficient pricing or (tacitly collusive) oligopolistic behaviour and the major banks have all argued that vigorous competition in the banking system is evident in a number of market outcomes, their analysis shows that major banks are the dominant force in the market. As a result, they are able to charge higher premiums above their marginal costs, compared with other institutions. Approximately half of the loan price that major banks charge is a premium over the marginal cost — double the margin that other Australian-owned banks have.

In fact, they say, over the past five years, changes to prudential regulations have increased the cost of funding for the major banks. However, and as has been anticipated by regulators, they have been able to recoup these higher costs by increasing interest rates for borrowers.  According to the ACCC, the big four banks tend to disregard the pricing decisions of smaller lenders — rather, they focus on the expected reactions of the other majors and any changes they may make to interest rates. As a result, each of the banks examined by the ACCC ‘generally aim to set their headline variable rates to broadly align with the big four banks’ . The major banks view this behaviour as an attempt to compete and maximise their profits — but the end result from a consumer point of view is non-competitive pricing. The lack of price competition is reinforced by obfuscation. The prices that ADIs advertise are often not indicative of what consumers actually pay, as we discussed the other day.

The PC concludes that oligopoly behaviour and the ability to use market power adversely are evident Indeed, the major banks themselves are unable to identify competitive threats in the domestic markets, and they focus on large technology companies overseas as their future potential competitors. Such threats have yet to eventuate, and will in any event need to exist in the regulated environment that consciously limits rivalrous behaviour.  Whilst the ‘tail’ of smaller providers aims primarily to match the major banks in their pricing, they are subject to similar or, at times, more costly regulation and do not benefit from the funding or efficiency advantages of the major banks, so they are often unable to offer prices that are substantially lower. Some of the smaller banks, in particular foreign institutions, operate in niche markets (such as agribusiness) where they can potentially benefit from specialisation and set prices that reflect their capacity to price discriminate. Others, such as credit unions and other mutually owned institutions, are consolidating in order to benefit from economies of scale. But in the market for retail banking services, it is the major banks that dominate, and other players follow their lead.

So, standing back, the Big Four are dominant, exert structural market power to the detriment of their customers and the broader society. We are paying through the nose to bolster their profitability. Something needs to change. I will share my own thoughts in a subsequent post.

Poor price information in the home loan market

We look at the Productivity Commission commentary on home loan rates and disclosure.

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Poor price information in the home loan market



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Poor price information in the home loan market

The Productivity Commission report into Competition in The Financial Services Sector has shone a light on home loan pricing, and especially the fact that it is almost impossible for consumers to effectively compare products and prices. We think this is deliberate obfuscation by the industry. So today we look at home loan pricing section of the report in more detail.

The so called standard variable rate (SVR) is the starting point. This is an artificial price, an interest rate that each lender sets by taking into account their cost of funds, operating costs and target profit margins. Lenders make reference to their own SVR when pricing home loans and advertising home loan interest rates. They use it as their benchmark rate to which a margin may be added or (more usually) subtracted when making offers to consumers. Linking actual home loan interest rates to an SVR in this way allows lenders to easily increase or decrease prices on all variable rate loans on their books in response to changes in business or regulatory conditions.

 

The SVR provides a useful mechanism for each bank to control its entire book of variable rate mortgages while price discriminating between customers. While SVRs are individually set by each bank, they are public information and the SVRs set by different ADIs are closely related.

But the SVR is a source of misinformation for consumers The SVR is the advertised price of a home loan. But it is not the true market price, for almost anyone. Moreover, this ‘rate’ provides consumers with little useful information. It does not provide a meaningful price benchmark for the consumer regarding the actual price of home loans being offered in the market, as most home loans are priced below the SVR.

Almost no-one has to pay the SVR. In addition, customers might not have full information about the products and prices offered by other providers, preventing them from making an informed choice. For instance, transparency in the small business and home loan markets can be poor given the prevalence of unadvertised discounts to the standard variable rate, in many cases negotiated directly. Under these circumstances a customer will have difficulty determining the competitive price without incurring large search costs.

Looking at unpublished data on actual home loan interest rates, the PC found that, the overall discounting relative to the SVR is more prevalent among major lenders, discounting is slightly more widespread for loans issued to investors compared to owner-occupiers; this is more pronounced for non-major lenders. The shares of investor and owner-occupier loans at or below the SVR issued by non-major lenders have been similar in more recent years.

This strongly suggest there is no ‘discount’, just a hidden price that varies between consumers at the discretion of the lender. ASIC noted “that pricing and comparative pricing of mortgages is somewhat opaque at the moment, partly because the standard variable rate is not what a lot of people get, and it’s hard to know whether the discount you’re getting is the same as the discount other people are getting.”

These unpublished discretionary discounts can apply to a substantial portion of loans — for example, NAB submitted that, as at June 2017, discretionary pricing was being applied to up to 70% of new NAB-branded home loans. With the majority of successful home loan applicants offered a lower rate than the SVR, this suggests that the discretionary ‘discounts’ being offered by lenders, including those offered as part of a home loan package, are potentially being used to lull consumers into feeling good about accepting the offer without further negotiation on price or other aspects of the home loan.

In 2017 Deloitte noted that the long-term average discount on lenders’ back books was about 70 basis points. The ACCC reported that discounts on the headline interest rate on home loans by the four largest banks range from 78 to 139 basis points, over the period of 30 June 2015 to 30 June 2017. For major banks, the gap between SVRs and actual interest rates has increased over time. While only some of this gap is likely due to discounts on SVR, the gap nevertheless is in line with ASIC’s finding that, for most banks, the discount margin for home loans was larger in 2015 than in 2012. Similarly, RBA research found that interest rate discounts increased between 2014 and 2017, with home loan discounts higher for newer and larger loans.

In addition to most consumers paying below the SVR, it is difficult for consumers to reliably discover the actual price for the loan they anticipate seeking, as few of the discounts offered to consumers are public. While anecdotes, apps and websites abound, there is no benchmark against which to genuinely judge the market price. Information about individually-negotiated or discretionary discounts are usually not published. The ACCC noted that ‘lenders know the size of discounts they are prepared to offer and the type of borrowers they are prepared to offer them to but this information is not publicly available’.

Furthermore, since the decision criteria for discretionary discounts vary across lenders, borrowers may find it difficult to identify and assess the discounts for which they are eligible. But the potential savings from the total discounts are significant with borrowers potentially saving almost $4000 in the first year of the loan — highlighting the need for price transparency.

Despite the empirical evidence to the contrary, CBA sought to claim that the information available is indicative of the rate received. The PC says the “CBA’s linkage of advertised rates, comparison websites and the actual end rates paid by customers implies an ease of access to information that cannot be observed in practice”.

To the contrary, brokers in discussion with the Commission confirmed that consumers are generally only able to be certain of the actual size of their ‘discount’ once they have formally had their home loan application assessed. For a complex product, the idea of starting again, if the offer is unattractive, is a substantial barrier to pro-competitive customer behaviour (despite potentially being the best course of action). A consumer’s main focus is buying the property; the home loan facilitates this goal.

Next, bundling increases complexity of pricing. Many financial institutions offer package home loans: a bundle of products that usually includes a home loan, a transaction, offset or savings account, a credit card, and some types of insurance.

Consumers are attracted to home loan packages as lenders offer ‘discounts’ on the interest rate, including the SVR, or waive fees on some or all of the components of the package. However, bundling of a number of products into a home loan package can obscure the price of individual products making it difficult for consumers to assess the value of each individual component. It can also lock consumers into ongoing use of products that become less competitive over time as financial circumstances change).

The RBA said that “product bundling and a lack of transparency in the pricing of mortgages (with the prevalence of large unadvertised discounts in interest rates from advertised standard variable rates), are impediments to competitive outcomes”.

But this means that comparison rates are meaningless. The National Consumer Credit Protection Act requires that when advertising home loan products, lenders provide a comparison rate that includes the interest rate as well as most fees and charges. The purpose of comparison rates is to allow consumers to compare products with different fees and charges.

However, comparison rates are calculated using SVRs as the base interest rate. While comparison rates could potentially improve the competitiveness of the home loan market, they are only as useful as the interest rates on which they are based. As discussed above, for more than 90% of customers, SVRs (or the advertised rate) are not the market rate.

ASIC highlighted that the comparison rate is based on the advertised rate, not on the rate that people get when they either talk to a broker or a lender. So again, it’s not a very good guide as to whether the rate you are being offered is a good rate. It also doesn’t include other things that, you know, affect the cost of the loan like LMI, because the requirement is that a comparison rate include mandatory fees, but not contingent fees, and LMI, being a contingent fee is not included within the comparison rate.

The P&N Bank also noted the lack of relevance of the comparison rate: “While the home loan comparison rate methodology was a way of demonstrating comparability across product rates and fees, we acknowledge that it may not reflect real life scenarios based on borrower type, LVR, actual loan terms/amounts — or how pricing strategies are applied over the duration of that loan.  And a submission from Home Loan Experts, a specialist mortgage broker, further noted the lack of understanding of comparison rates among consumers “We have not seen a customer use comparison rates or one that understands them. They are largely ignored by the industry and customers alike. For this reason, we recommend scrapping them altogether. And finally Canstar noted additional problems with the comparison rate — the assumptions used in formulating the rate are no longer representative of the lending market (including the loan.

SO when you are buying a home loan, the rate you get is frankly rigged, and you will never know whether you really ever got a good deal. That might help support bank profits, but once again consumers are being taken to the cleaners, and the regulators appear happy to support the poor customer outcomes. Frankly this is a disgrace,

Final Productivity Commission Financial System Report Is Out

We review the recommendations from the PC Report, out today, which highlights that much needs to be done to put power back into the consumer. We are being taken the the cleaners at the moment…

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Final Productivity Commission Financial System Report Is Out



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Final Productivity Commission Financial System Report Is Out

The final report [674 pages !] has been released earlier than expect, and contains a series of recommendations which will have significant impact on the industry. It also passes the weight test… A best interests test is recommended in the home loan market (a change from not unsuitable).

They call out regulatory failure and conflicts of interest across the sector, referring to opaque pricing, unsuitable products, no reward for customer loyalty as well as product complexity and faux competition.  Major players have too much market power, and have fingers in multiple segments of the market. Customers lose out as a result.

“It is a fundamentally important fact that no Australian financial system regulator has the responsibility of putting competition first. Indeed, ASIC does not yet even have competition in its objectives. Nor, until this Inquiry, did other members of the Council of Financial Regulators emphasise that interest in a discernible fashion”.

Some of the key recommendations:

  • The Commission recommends the introduction of a best interest obligation for all providers in the home loans market — whether as a lender or mortgage broker — who interact directly with consumers seeking a home loan.
  • Mortgage Brokers trail commissions should be phased out (but not replaced by a fee for service). “At its simplest, brokers have a strong incentive — regardless of what may be in their customer’s best interest — to give preference in their loan recommendations to lenders that pay higher commissions. This may be uncommon, but there is no obligation for transparency of the payment to prove it.”
  • ASIC to ensure that the interests of borrowers are adequately safeguarded in the LMI market.
  • use of the term ‘advice’ should be limited to effort that is undertaken on a client’s behalf by a professional adviser.
  • APRA is singled out for myopic regulation. “Interest rates increased on both new and existing investment loans, boosting lenders’ profit on home loans. Up to half of the increase in lenders’ profit was in effect paid for by taxpayers, as interest on investment loans is tax deductible. We estimated that the cost borne by taxpayers as a result of changes in home loan investor rates following APRA’s intervention on interest-only loans in 2017, was up to $500 million per year (which may be partly offset by increased tax paid by the lending institutions on their profits)”.
  • ACCC should focus on encouraging competition across the industry and safeguarding the interests of consumers.
  • The new payments system needs a proper access regime.
  • The Payments System Board of the RBA should ban, by end-2019, all card interchange fees as a way to reduce distortions in payment choices and the flow-on costs of these distortions to merchants.

Here is their release:

  • The Australian economy has generally benefited from having a financial system that is strong, innovative and profitable.
  • There have been past periods of strong price competition, for example when the advent of mortgage brokers upset industry pricing cohesion. And technological innovation has given consumers speed and convenience in many financial services, and a range of other non-price benefits.
  • But the larger financial institutions, particularly but not only in banking, have the ability to exercise market power over their competitors and consumers.
    • Many of the highly profitable financial institutions have achieved that state with persistently opaque pricing; conflicted advice and remuneration arrangements; layers of public policy and regulatory requirements that support larger incumbents; and a lack of easily accessible information, inducing unaware customers to maintain loyalty to unsuitable products.
  • Poor advice and complex information supports persistent attachment to high margin products that boost institutional profits, with product features that may well be of no benefit.
    • What often is passed off as competition is more accurately described as persistent marketing and brand activity designed to promote a blizzard of barely differentiated products and ‘white labels’.
  • For this situation to persist as it has over a decade, channels for the provision of information and advice (including regulator information flow, adviser effort and broker activity) must be failing.
  • In home loan markets, the mortgage brokers who once revitalised price competition and revolutionised product delivery have become part of the banking establishment. Fees and trail commissions have no evident link to customer best interests. Conflicts of interest created by ownership are obvious but unaddressed.
  • Trail commissions should be banned and clawback of commissions from brokers restricted. All brokers, advisers and lender employees who deliver home loans to customers should have a clear legally-backed best interest obligation to their clients.
  • Complementing this obligation, and recognising that reward structures may still at times conflict with customer best interest, all banks should appoint a Principal Integrity Officer (PIO) obliged by law to report directly to their board on the alignment of any payments made by the institution with the new customer best interest duty. The PIO would also have an obligation to report independently to ASIC in instances in which its board is not responsive.
  • In general insurance, there is a proliferation of brands but far fewer actual insurers, poor quality information provided to consumers, and sharp practices adopted by some sellers of add-on insurance products. A Treasury working group should examine the introduction of a deferred sales model to all sales of add-on insurance.
  • Australia’s payment system is at a crucial turning point. Merchants should be given the capacity to select the default route that is to be used for payments by dual network cards — as is already possible in a number of other countries. The New Payments Platform requires a formal access regime. This is an opportunity — before incumbency becomes cemented — to set up regulatory arrangements that will support substantial competition in services that all Australians use every day.
  • More nuance in the design of APRA’s prudential measures — both in risk weightings and in directions to authorised deposit-taking institutions — is essential to lessen market power and address an imbalance that has emerged in lending between businesses and housing.
  • Given the size and importance of Australia’s financial system, and the increasing emphasis on stability since the global financial crisis, the lack of an advocate for competition when financial system regulatory interventions are being determined is a mistake that should now be corrected. The ACCC should be tasked with promoting competition inside regulator forums, to ensure the interests of consumers and costs imposed on them are being considered.

 

Superannuation is still mired in the same old issues

From The Conversation.

The Productivity Commission’s latest report on superannuation asks whether the current system is working for members – and answers firmly in the negative.

The report identifies four factors that can chip away at super fund members’ retirement benefits:

What is also clear from the evidence laid out in the report that the not-for-profit sector, including industry super funds, generally outperforms the retail sector. Generally they offer lower fees and higher returns, although there are some industry funds that rank among the lowest-performing.

Despite recent reforms such as the 2013 launch of MySuper, the superannuation system is still beset with the same problems of rising fees and patchy performance. And there is still no substitute for just hopping on the internet and proactively checking that your super is in the best possible hands.

The situation is made complex by the highly segmented nature of Australia’s superannuation system. Besides the public sector funds, the most significant sectors are the retail sector and the not-for-profit funds, including industry funds (see figure 1.5 here). These sectors compete for as large a slice as possible of the overall pool.

Self-managed superannuation funds are also a rapidly growing sector of the market, however the regulatory framework applied to these funds has some significant differences to the rest of the market.

Tracking your super

Most employees have the right to choose their superannuation fund (although around one million don’t), and if they don’t nominate a fund, employers will pay contributions into a default fund.

As the new report points out (see figure 1.2 here), up to 40% of superannuation members hold multiple super accounts. In some cases this may be a deliberate choice – someone with a self-managed super fund may might, for example, choose to have their employer contributions paid into a conventional fund. But often multiple funds are a consequence of employees being enrolled into a new default fund instead of paying contributions into an existing fund.

A range of tools is now available to help people consolidate their super, so as not to lose any of their savings. In the 2018 federal budget the government announced that it would reduce the paperwork involved in this process by allowing the Australian Taxation Office to consolidate inactive super accounts with balances less than A$6,000.

MySuper

The primary aim of MySuper, introduced in 2013, was to provide a simple default product that meets the needs of members who are not engaged with their superannuation. They have no entry fees, offer simpler insurance and services, and lower administration fees that are charged on a cost-recovery basis.

But although the effects of MySuper are generally positive, the 2013 reforms may also have contributed to the erosion of funds identified by the new review.

This report confirms (see chapter 3, p.127 here) that super fund fees in Australia are among the highest in the OECD, and the upward pressure on fees continues. Just this month, the Commonwealth Bank announced that it would pass the costs of regulation onto some superannuation products.

One of the consequences of introducing the fee charging limitations for MySuper accounts was that the previous member protection standards that limited fees on low-balance accounts was repealed. In the 2018 federal budget the government announced that fees would be capped in respect of certain low balance accounts.

MySuper products must provide also life insurance on an opt-out basis. Insurance in superannuation has also been under scrutiny, with inappropriate or junk policies being included in superannuation. The government has announced proposals to change this to an opt-in system.

This report adds to the evidence that overall the current structure of not-for-profit funds is serving members well. Although it supports proposals to require the trustees of industry funds to increase the number of independent directors, the Productivity Commission highlights the need for a stronger focus on trustee skills and addressing conflicts of interest.

Take responsibility for your super

It is concerning that many of the problems identified by the new report are the same ones that arose in the 2014 Financial System Inquiry, the 2015 Cooper Review, and in the evidence to the Financial Services Royal Commission.

Most of these issues raised have been part of the discussion for the past decade. The fact that they are still on the table shows a level of inertia in the system, and a reluctance by the industry to address its problems.

So how can we, as individuals, protect our retirement nest egg? The key is to engage with the superannuation system, and not just as we approach retirement.

Compare your super fund’s fees and returns with those of the best performing funds, and then choose accordingly. Reduce your fees and insurance premiums by consolidating your accounts, and make sure that any insurance in the fund meets your needs.

The difference at retirement is worth it – up to A$407,000 for a 21-year-old by the time they finish their career.

 

Author: Helen Hodgson, Associate Professor, Curtin Law School and Curtin Business School, Curtin University

Super Is A Lottery – Productivity Commission

The Productivity Commission has released their draft report on the $2.6 trillion superannuation system.  And they have done it again! A powerful ~500 pages of insight which cuts to the heart of the system. They raise some very imp0ortant points which shows the system is a lottery. They call for substantial reform. Five million member accounts are being shortchanged.

We see some similar patterns of behaviour  to those revealed in the current Royal Commission.  Not working for the best outcomes of members. Poor governance. Excessive fees. Poor disclosure and hidden charges and commissions. No wonder more households have chosen self managed super alternatives! They also question the current regulatory framework.

Performance varies thanks to fees

Embedded fees and multiple funds erode returns significantly, especially from “retail” funds. Australians pay over $30 billion a year in fees on their super (excluding insurance premiums).

Fees can have a substantial impact on members — for example, an increase in fees of just 0.5 per cent can cost a typical full-time worker about 12 per cent of their balance (or $100 000) by the time they reach retirement.

Fees charged by retail funds remain relatively high, at least for choice products. Roughly 14 per cent of member accounts appear to be paying annual fees in excess of 1.5 per cent of their balances. Fees can explain a
significant amount of the variation in net returns across super funds. Funds that charge higher fees tend to deliver lower returns, once both investment and administration fees have been netted off. Moreover, at least 2 per cent of accounts are still subject to trailing adviser commissions — despite such commissions being banned for new accounts by the Future of Financial Advice laws.

The Government says this highlights that some superfund operators have their snout firmly in the trough! Many of these reside within the big banks!

There is no shortage of regulation in the super system. Regulation is essential for a complex system holding large amounts of money and characterised by many disengaged members and potential conflicts of interest. But at times the regulators appear too focused on funds and their interests rather than on what members need.

Regulators need to focus more on member outcomes

The key regulators — APRA and ASIC — are doing well in their core duties of prudential regulation (APRA) and financial product and advice regulation (ASIC). There have been improvements over many years, and these will continue with recently proposed reforms to boost each regulator’s toolkit. Legislating an ‘outcomes test’ for MySuper products will give APRA greater scope to lift standards and remove authorisation from funds that are failing to act in the best interests of members (especially on mergers). And ASIC’s new product intervention powers will strengthen its ability to guard against upselling.

However, there is some confusion around the two regulators’ respective roles, given both have long held powers to police bad behaviour by trustee boards. For example, ASIC has traditionally been responsible for regulating conflicts of interest, but APRA has increasingly encroached on this role through its prudential standard setting. While much of APRA’s work is pre-emptive and out of public view, ASIC has traditionally been reactive (responding to misconduct only after the fact) and public. It has become increasingly unclear which regulator has primary responsibility for trustee conduct — with the risk of misconduct falling between the cracks and a lack of clear regulator accountability.

Strategic conduct regulation appears at times to be missing in action. Ideally, this would involve a regulator proactively identifying actual or potential instances of material member harm, investigating the underlying conduct and taking enforcement action in a way that provides a valuable public deterrent to future poor conduct. To date, there has been a deficit of public exposure of poor conduct (and associated penalties) to demonstrably discourage similar behaviour by others — now and in the future.

There are yawning gaps in data

A further area of weakness is how data on the system are collected. The regulators’ data collections are largely focused on funds and products, with a deficiency of member-based data. And there are major gaps and inconsistencies in the datasets held by regulators — such as the returns and fees experienced by members of individual choice products, funds’ outsourcing arrangements and details of the insurance members hold through super. Our funds survey was designed to plug some of these gaps, but — as noted above — many responses fell well short of ‘best endeavours’, which of itself proved revealing .

Regulators have done much to improve the breadth and depth of their data holdings in recent years, but this has been off a low base. Major differences in definitions persist across regulators, and poor quality disclosure by funds appears to go unpunished. Progress has been slow in some areas because of industry opposition (largely on the basis of short-term compliance costs) and the lack of a strong member voice to give impetus to change.

The result is poor transparency, which leaves members in the dark as to what they are really paying for and makes it harder for engaged members to compare products and identify the best performing funds. This suppresses competitive pressure on the demand side, and gives rise to the perverse risk of worse outcomes for members who do get engaged. The lack of transparency also makes it hard for regulators to effectively monitor the system and to hold funds to account for the outcomes they

The draft report makes the following key points:

  • Australia’s super system needs to adapt to better meet the needs of a modern workforce and a growing pool of retirees. Currently, structural flaws — unintended multiple accounts and entrenched underperformers — harm a significant number of members, and regressively so. Fixing these twin problems could benefit members to the tune of $3.9 billion each year. Even a 55 year old today could gain $61 000 by retirement, and lift the balance for a new job entrant today by $407 000 when they retire in 2064.
  • Our unique assessment of the super system reveals mixed performance. While some funds consistently achieve high net returns, a significant number of products (including some defaults) underperform markedly, even after adjusting for differences in investment strategy. Most (but not all) underperforming products are in the retail segment. Fees remain a significant drain on net returns. Reported fees have trended down on average, driven mainly by administration costs in retail funds falling from a high base. A third of accounts (about 10 million) are unintended multiple accounts. These erode members’ balances by $2.6 billion a year in unnecessary fees and insurance.The system offers products and services that meet most members’ needs, but members lack access to quality, comparable information to help them find the best products.  Not all members get value out of insurance in super. Many see their retirement balances eroded — often by over $50 000 — by duplicate or unsuitable (even ‘zombie’) policies.
  • Inadequate competition, governance and regulation have led to these outcomes. Rivalry between funds in the default segment is superficial, and there are signs of unhealthy competition in the choice segment (including the proliferation of over 40 000 products). The default segment outperforms the system on average, but the way members are allocated to default products leaves some exposed to the costly risk of being defaulted into an underperforming fund (eroding over 36 per cent of their super balance by retirement). Regulations (and regulators) focus too much on funds rather than members. Subpar data and disclosure inhibit accountability to members and regulators.
  • Policy initiatives have chipped away at some of the problems, but more changes are needed.
  • A new way of allocating default members to products should make default the exemplar.Members should only ever be allocated to a default product once, upon entering the workforce. They should also be empowered to choose their own super product by being provided a ‘best in show’ shortlist, set by a competitive and independent process.An elevated threshold for MySuper authorisation (including an enhanced outcomes test) would look after existing default members, and give those who want to get engaged products they can easily and safely choose from (and compare to others in the market). This is superior to other default models — it sidesteps employers and puts decision making back with members in a way that supports them with safer, simpler choice.
  • These changes need to be implemented in parallel to other essential improvements. Stronger governance rules are needed, especially for board appointments and mergers.  Funds need to do more to provide insurance that is valuable to members. The industry’s code of practice is a small first step, but must be strengthened and made enforceable.  Regulators need to become member champions — confidently and effectively policing trustee conduct, and collecting and using more comprehensive and member-relevant data.

Written submissions can be made by Friday 13 July 2018.