Industry awaits Government review findings

Increasing life expectancies and an ageing population mean that the Government is focusing on superannuation and the retirement income system more than ever before. These areas have been undergoing significant changes in Australia for many years.

It appears that for many years, the Federal Budget has contained a major superannuation announcement. The complexity and constant tweaking of the system has been affecting the industry and therefore consumers. The change and uncertainty ultimately undermines investors’ confidence in the system.

The Federal Government is currently undertaking a number of major reviews and inquiries into the areas of superannuation and the retirement income system. The Government claims that one of the goals of these reviews is to put in place a stable and sustainable system.

In this article, we:

• look at three major reviews expected to impact superannuation and the retirement income system;
• identify some of the issues that the reviews are examining; and
• consider the further direction of the reviews.

The Henry Review

The Australia Future Tax System, chaired by the Treasury Secretary Ken Henry (the Henry Review), claims to be the most comprehensive tax and retirement income systems review in 30 years.

The review panel issued a report on strategic retirement income matters in May 2009, in time for the Federal Budget. Some panel recommendations that were introduced in the 2009/10 Budget and legislated include:

• raising the age pension age to 67;
• introducing the work bonus measure; and
• halving the concessional contributions cap.

The review identified a number of additional issues where further investigation needs to be conducted. The specific recommendations concerning those issues will be contained in the final report, which will be released in December 2009.

A major focus of the Henry Review is the interaction of the three pillars of the retirement income system in Australia:

• the Age Pension;
• compulsory Superannuation Guarantee (SG) contributions; and
• voluntary superannuation contributions.

The initial conclusion is that the three pillars make the Australian retirement income systems robust and should be retained. But the levels of Government funding allocated to each pillar, and the incentives to use one pillar over another, are being examined.

One area of interest is the Age Pension means test. Under the current rules, Centrelink recipients are assessed under both the income and the assets test. The test resulting in the lower level of entitlements is then used. The panel believes that this system is complex and potentially inequitable.

The final report will include details of the suggested solution — a single means test. The single means test is proposed to remove the assets test, and extends the income test because it applies to a greater range of assets.

The other area under review is the role of the family home in means testing. Under the current rules, the principal home is exempt from both the assets and the income test, regardless of its value. The Panel has proposed that “consideration should be given to setting a limit (at a high level) on the value of the exemption provided in respect to owner-occupied housing”.

It will be interesting to see how this ‘high’ level is determined. Property prices vary significantly across Australia — will this be taken into account? Participating in the local community, shopping in the same area and interacting with the same neighbours all provide emotional security for retirees. These factors also should not be underestimated.

Adequacy of the second pillar (SG) is another issue considered by the Henry Review. The review received multiple submissions urging the Government to raise the compulsory rate of SG to 12 per cent. In the preliminary report, the panel stated that the current level of 9 per cent, combined with the Age Pension, would provide an adequate level of retirement income for low to middle-income earners.

The panel believes that increasing the SG rate will result in a net cost to the Government — that is, the loss in income tax due to reduced pre-retirement income will outweigh the tax collection revenue from super and a reduced Age Pension burden.

The other issue raised is that higher level of SG (eg, an increase to 12 per cent) will effectively mean lower level of pre-retirement income. The review believes that low and middle-income earners need access to capital and, therefore, would not welcome this change. Meanwhile, middle and higher income earners who are happy to sacrifice current consumption for future consumption can contribute under the voluntary arrangements (the third pillar).

A strong theme arising from the initial report is that the current superannuation tax concessions (especially those given to the third pillar) are fiscally unsustainable and inequitable. The Panel has raised the concern that a greater portion of tax concessions goes to high-income earners.

In its recommendations, the panel is set to advise how concessions can be used to provide a balance between high and low-income earners. The industry fears that halving the concessional contribution cap is only the first step in clawing back some of the generous super concessions of the last Government.

The Cooper Review

A superannuation review, chaired by a former deputy of the Australian Securities and Investments Commission (ASIC), Jeremy Cooper, is another major review to watch. The review is being conducted in three stages:

• phase one — the governance of super funds;
• phase two — operation and efficiency, including fees and charges, competition and complexity; and
• phase three — structure of super funds, including self-managed superannuation funds (SMSFs) and defined benefit funds.

The industry is particularly anxious about phase two of the review. The Cooper Review Panel released an issues paper on 16 October, identifying areas considered in phase two. The key focus is efficiency which, according to the panel, will be achieved by reducing the costs of running, managing and marketing superannuation funds. This reduction in costs is expected to flow on to members in the form of reduced fees.

How do super funds reduce costs? The issues paper contains a number of suggestions.

The panel suggests that costs may be reduced through a more effective design of the super system. Wider use of technology, paperless transactions, online annual reports and Government-administered default funds are some of the proposals.

Another suggestion is to simplify certain areas of the fund management and administration. Some of the simplifications identified are restricting the number of available investment options and standardising member forms. The issues paper also proposes having only a small number of distinct fees with standardised names. The idea is that these measures will enable a member to compare funds easily and accurately.

Another suggestion is that efficiency can be achieved by reducing fees that funds charge their members. The issues paper questions whether the use of active managers is appropriate in superannuation, given that higher fees are not necessarily offset by the higher returns. The issues paper also suggests a ceiling on the level of fees in super. The paper also proposes that the economies of scale will be achieved by having a smaller number of very large funds.

The review also questions the payment of trailing commissions in respect to members who are in the default funds and have never received financial advice. Shelf fees payable to dealer groups, master trusts and licensees for having a super fund on their investment menu or approved product list are also being examined. Even though the issuer rather than the client funds these costs, the panel believes these fees are subsidised by other charges applied to members’ accounts.

Exit fees, which have long been the subject of criticism, are also being closely looked at by the review, as are performance-based fees. The issues paper suggests that performance-based fees may not be in the members’ best interest, given that there is a large upside and no downside for the fund manager.

The Cooper Review is expected to make its recommendations by 30 June, 2010.

The Ripoll Inquiry

Bernie Ripoll MP, the Chair of the Parliamentary Joint Committee on Corporations and Financial Services, heads the inquiry examining the corporate collapses of Westpoint, Opes Prime, Storm Financial and others. Although this inquiry does not examine superannuation funds specifically, it is very likely that superannuation funds will be affected by its recommendations.

Among other issues, the inquiry will look at the role of trails and commissions in the financial advice process, including the:

• potential for conflicts of interest;
• need for disclosure and remuneration models for financial advisers; and
• appropriateness of existing distribution models.

The inquiry is particularly interested in the role played by advisers in enticing consumers to purchase financial products that subsequently failed those consumers. This review is looking at the role that commissions played in advisers recommending those products.

The inquiry has received about 400 submissions in total, from both the financial services sector and consumers. The Australian Securities and Investments Commission (ASIC) submission has shaken up the industry. In it, ASIC demanded a number of radical changes. These included the ban of not only commissions, but also volume-based bonuses, fees charged as a percentage of funds under management and ‘soft-dollar’ arrangements.

Mr Ripoll said that the common themes of the submissions were the issues of qualifications and licensing and a push for the distinction between product sales and advice.

The final report is due on 23 November 2009.

Conclusion

The industry is holding its breath for the changes the Government will initiate as the result of these reviews. It is important to remember that the final reports will only contain recommendations, which the Government will consider and then decide whether or not to introduce. With the Federal election coming up, these decisions will involve balancing the desire for the reforms against election pressures.

Alena Miles is a technical analyst at Zurich.