Submission to the Financial System Inquiry 7. Superannuation

This Chapter provides an overview of the role of superannuation in the Australian financial system, including the ways in which it differs from pension fund systems internationally. There are several features of Australia's superannuation system that define its importance in the financial system:

  • The superannuation and banking sectors combined dominate the Australian financial system. Superannuation assets as a share of GDP have more than doubled since the completion of the Wallis Inquiry in 1997, to be currently over 100 per cent.
  • Superannuation forms an important part of household and national saving given its objective to provide income in retirement.
  • The Australian superannuation sector appears to have supported the stability of the financial system by adding depth to financial markets, and providing a stable source of finance for other sectors, particularly since the global financial crisis.

There are a number of issues that would be noteworthy for further study by the Inquiry panel:

  • The role of the superannuation system has expanded with the growth of superannuation assets: while the superannuation system generally views itself as being in the asset management business, it is also, and increasingly so, in the intermediation business, taking savings and investing in a range of assets. Because of portability requirements and the ability of fund members to change their asset allocation, superannuation funds are exposed to liquidity risk. This risk will also increase as more members draw down their superannuation saving. Superannuation funds will need to balance the management of their liquidity risk with their investment profile.
  • There has recently been discussion in international forums about ways to boost funding for infrastructure investment. Some have proposed superannuation as a potential pool of funding to assist in this regard. It would not be appropriate to mandate superannuation funds to invest in particular assets to meet broader national objectives. Rather, trustees need to manage their investments in the best interest of the membership.
  • In addition to recent attention on the role of superannuation in financing infrastructure, several other developments warrant close monitoring in terms of their potential risks to the financial system and/or individuals' retirement incomes. These include self-managed superannuation funds (SMSFs) undertaking leveraged investment and the potential for superannuation funds to ‘search for yield’ in the current low interest rate environment.
  • The operating costs of Australia's superannuation funds are higher than in many other Organisation for Economic Co-operation and Development (OECD) countries, partly due to the defined contribution (DC) nature of Australia's superannuation system. While part of this is likely to flow through to relatively high fees, disengagement among members, as well as complexity and difficulty in making comparisons of fees across funds are also likely to play a role. Accordingly, consideration should be given to ways that competitive pressure may be placed on the fees charged by superannuation funds to end users.
  • Given the majority of Australia's superannuation fund assets are held in defined contribution schemes, individuals rather than employers or governments directly bear the majority of the risks (such as longevity, investment and inflation) associated with their retirement incomes. Accordingly, it will be important to ensure that the arrangements enable households to tailor their superannuation savings to suit their risk preferences and investment horizons at a reasonable cost.

7.1 Structure of the Australian Superannuation System

Australia has a three pillar approach to retirement saving that involves:

  • compulsory saving in superannuation funds via the Superannuation Guarantee (SG)
  • voluntary saving via contributions to superannuation or other investments held outside the superannuation system
  • a means-tested age pension.

The superannuation system is an important part of individuals' finances and the broader financial system. The compulsory savings pillar was introduced in 1986 to employees under industrial awards and was later extended to cover most employees via the SG, as provided for in the Superannuation Guarantee (Administration) Act 1992. The Act requires employers to contribute a fixed portion of employees' salaries (currently at least 9.25 per cent and scheduled to increase to 12 per cent by July 2019) into a superannuation fund. Individuals may also choose to supplement this with voluntary contributions. Both compulsory and voluntary contributions are invested on the member's behalf and (except in certain hardship circumstances) only become accessible once the individual reaches the legislated preservation age.

Individuals can invest their savings into a number of different fund types (APRA 2014; Graph 7.1):

  • corporate funds have more than four members and are established for the benefit of employees of a particular entity or a group of related entities, with joint member and employer control
  • industry funds have more than four members and have historically provided for employees working in the same industry or group of related industries. Many industry funds now offer membership to the public
  • public sector funds have more than four members and provide benefits largely for government employees or employees of statutory authorities, or are schemes established by a Commonwealth, State or Territory law
  • retail funds have more than four members and offer superannuation products to the public on a commercial basis
  • ‘small APRA funds’ have less than five members and are regulated by the Australian Prudential Regulation Authority (APRA; this segment is small with around $2 billion in total assets)
  • SMSFs have less than five members, all of whom are trustees or directors of the corporate trustee.

The first five of these fund types are prudentially regulated and supervised by APRA. SMSFs are subject to compliance regulation and are overseen by the Australian Taxation Office (ATO). A small number of public sector funds are exempt from regulation by APRA and are instead subject to government supervision. All superannuation funds, including SMSFs, are set up as trusts with the sole purpose of providing retirement income. Trustees of funds as well as financial advisors to funds are overseen by the Australian Securities and Investments Commission (ASIC).[1]

The Australian superannuation system differs from pension funds of many of its OECD counterparts in two important respects. First, the majority of superannuation fund assets are held in DC schemes; that is, the benefit the member receives at retirement is dependent on the level of contributions, the time over which the contributions were made and the return on their investment. By contrast, the systems in some other countries are dominated by defined benefit (DB) schemes, where a sponsor (typically an employer or government) guarantees a certain benefit upon an employee's retirement based on factors such as salary and time employed at the employer. Second, other than a few public sector schemes, Australian superannuation funds are provided by the private sector. Many countries have a mix of DB and DC assets, and private and public sector provision.[2]

While DC schemes and private sector provision have become increasingly common in other countries, the introduction of compulsory superannuation encouraged this shift sooner in Australia (Broadbent, Palumbo and Woodman 2006; OECD 2009, 2013b). A key implication of moving to a mainly DC system is a shift in the burden of risks (such as longevity, investment and inflation) from the employer or government (in the case of public provision) to the individual. In countries that are dominated by DB schemes, an ageing population can expose employers or governments to shortfall risk, if growth in pension liabilities outpaces that of employers' revenue or the tax base.[3]

7.2 Recent Trends in the Australian Superannuation Sector

7.2.1 Growth of superannuation

Since the completion of the Wallis Inquiry in 1997, superannuation assets as a share to GDP have more than doubled to be over 100 per cent as at December 2013 (Graph 7.2). This is the result of many factors, including the compulsory SG, tax incentives and a change in expectations of retirement lifestyles.

The composition of the superannuation system has changed significantly over this period. As noted above, there has been a broad shift away from DB schemes toward DC schemes, with DB schemes' share down from about 15 per cent of superannuation assets in 1996 to less than 5 per cent in June 2013 (APRA 2004, 2014).[4] The decline in DB schemes has coincided with a decline in the share of superannuation assets held by public sector funds (most of the remaining DB funds in Australia are public sector funds). Throughout most of this period, the shares of assets held by corporate and retail funds fell, while those of industry funds and SMSFs rose; SMSFs accounted for around 30 per cent of superannuation assets at the end of 2013.

The growth in SMSFs has been particularly rapid, encouraged by legislative changes that have supported the strong growth in superannuation, especially SMSFs, over the past decade. In particular:

  • from 2005 individuals were permitted to choose which fund, including an SMSF, their employer's SG contributions are paid into
  • prior to the introduction of the Simplified Superannuation system in 2007, there was a transition period in which the after-tax contribution cap was temporarily lifted to $1 million. This drove a sharp rise in member contributions in 2006/07
  • from 2007, funds were permitted to borrow to purchase an asset under limited recourse conditions, increasing the accessibility and attractiveness of property investment via an SMSF. There are also a range of small business tax concessions that may influence small business owners to transfer business property into an SMSF (discussed below). These factors may have encouraged some, particularly younger individuals, to set up an SMSF.

The main driver of superannuation asset growth since the Wallis Inquiry has been contributions, which have generally exceeded investment earnings (APRA 2014; Graph 7.3). Similar to a number of other countries, both compulsory and voluntary superannuation contributions receive concessional tax treatment, which has influenced contribution inflow into superannuation funds; in particular, there is no tax payable on earnings and benefit payments for those aged over 60 years. For APRA-regulated funds, contributions have been largely driven by the employer SG. By contrast, for SMSFs, voluntary contributions have driven asset growth, particularly during the transition period prior to the introduction of the Simplified Superannuation system, as noted above.

The effect of contributions on superannuation asset growth is partly offset by benefit payments. Prior to the introduction of the Simplified Superannuation system there were restrictions on the amount of benefits that could be paid at concessional tax rates. In 2007, these restrictions were removed, eliminating the tax payable on retirement benefits from a taxed source (where tax on contributions and earnings has been paid) for those aged 60 years or over.

The choice of benefit payment is an important determinant of growth in superannuation assets. In particular, if benefit payments are taken in the form of an account-based income stream (pension), then assets will stay within the superannuation system for longer, whereas benefit payments taken as a lump sum will remove assets from the system more quickly. Since 2007, members have increasingly chosen income stream benefit payments. This is one area where there appears to be a different preference between fund types: for SMSFs, around 70 per cent of benefit payments are in the form of an income stream; whereas for other funds, income streams currently account for 40 per cent of benefit payments (ATO 2013). Consequently, if the share of superannuation assets held in SMSFs increases, then it is likely that the proportion of benefit payments taken as an income stream will also continue to increase.

7.2.2 Asset allocation

The asset allocation of Australian funds reflects their efforts to balance risk, return and liquidity requirements. Equities accounted for nearly half of Australian superannuation assets in 2012, which is high relative to other OECD countries (OECD 2013a; Graph 7.4).

By contrast, Australian superannuation funds have a much lower allocation to fixed income than many of their OECD counterparts. This lower allocation appears to be mainly due to low demand from funds, given that the size of Australia's bond market is in line with a number of other OECD countries as a share of GDP. Within the bond market though, there is a relatively limited supply of non-financial corporate bonds, as discussed in Chapter 5. This, alongside the relative risk-return and liquidity characteristics of the non-financial corporate bonds on offer may partly explain the tendency of superannuation funds to purchase equity of non-financial corporations rather than bonds. More generally, reasons for the current lower allocation to fixed income include:

  • performance and availability of equities. The introduction of superannuation coincided with a sustained increase in the share market and a number of privatisations targeted at retail investors (for example, Telstra), as well as demutualisations.
  • the relatively high dividend yield offered on Australian shares. This is the result of Australia's dividend imputation system that removes the double taxation of company profits for Australian shares. Most other developed countries tend to provide only partial or, in some cases, no relief to shareholders from this double taxation.
  • for SMSFs, limited access to, as well as lack of familiarity with fixed income products, particularly as similar yields are available on more familiar investment types, such as equity, property and deposits (Graph 7.5). The recent introduction of exchange-traded Commonwealth Government Securities (CGS) as well as fixed income exchange-traded funds (ETFs) may work to alleviate both these issues (although demand for exchange-traded CGS has been limited to date and investment in fixed income ETFs remains small compared with other asset classes).
  • SMSFs, compared with other fund types, have a large share of cash investments (including deposits), but a negligible share of debt securities (RBA 2013; Graph 7.6). Given that cash investments and some fixed income investments may be considered substitutes, this allocation may reflect the ease of investing in cash and term deposits compared with debt securities (SMSFs also have a low allocation to and have difficulty accessing foreign equities).

The share allocated to fixed income in the superannuation asset portfolio can have important implications for the returns on and risks to superannuation portfolios. While equities present members with the possibility of higher rates of return, they can leave them exposed to timing and market risks as the equity market may be underperforming at the time of, or during, retirement (Deloitte Access Economics 2012). By contrast, fixed income assets, particularly those with longer terms, provide a stable income stream that assists in protecting retirees from longevity and market risk, but typically carry credit, reinvestment and inflation risk. It is possible, therefore, that as the population ages, superannuation funds will look to allocate towards fixed income.

The high asset allocation to equities and relatively low allocation to fixed income is common across all superannuation fund types, but in other respects asset allocations differ noticeably. Retail funds typically have a higher allocation to cash and, along with corporate funds, a higher allocation to debt securities than other APRA-regulated funds. APRA-regulated funds tend to have similar allocations to property; however, retail funds typically have a lower allocation to unlisted property than other funds.

SMSFs directly hold a larger share of property assets than other fund types, at 16 per cent of their assets. The bulk of SMSF property holdings are in commercial property, which is likely due to a range of incentives for small businesses to hold property through an SMSF. In particular, the tax arrangements provide an incentive for a small business owner to transfer their business property (and other business assets) into their SMSF. Once the property is in the fund, the fund can lease the property to the business owner at a commercial rate and the rent paid by the business owner can be claimed as a business expense, reducing the taxable profit of the business, while the income to the SMSF will generally be taxed at a lower rate.

7.3 The Cost of Superannuation Services

7.3.1 The drivers of costs

Though international comparisons are not straightforward, the operating costs of Australian superannuation funds are higher than in many other OECD countries (Graph 7.7). This reflects a number of interrelated factors:

  • Defined contribution structure and economies of scale. According to the OECD, countries with privately managed DC systems and a large number of small funds typically have higher operating costs than countries with a few relatively large funds offering DB schemes (OECD 2013b). Larger superannuation funds can achieve economies of scale, reducing operating expenses as a share of total assets: larger not-for-profit superannuation funds in Australia tend to realise lower expense ratios compared with smaller comparable funds (Cummings 2012). The ongoing consolidation among superannuation funds should lead to greater economies of scale.
  • Investment strategies. In Australia, superannuation funds generally pursue more active investment strategies, leading to higher investment management costs compared with most other countries (Deloitte Actuaries and Consultants 2009). Active investment strategies are also common for DC pension funds in the United States for which costs tend to be relatively high (Ashcroft 2009). In principle, more expensive, active investment strategies could potentially yield higher returns to compensate for higher costs, although empirical evidence that active investors outperform the broader market over the longer term is limited (Fama and French 2010; Dyck, Lins and Pomorski 2013; Standard & Poor's 2013).
  • Asset allocation. The asset allocation of Australian superannuation funds is more heavily weighted in growth and some alternative asset classes compared with most other countries. Higher allocations to these types of assets, which are relatively expensive to manage, contribute to relatively high investment management costs for Australian superannuation funds.

7.3.2 Fees to end users

The extent to which the relatively high costs of Australian superannuation funds flow through to higher fees is difficult to gauge. Similar to costs, fees for superannuation funds are not directly comparable internationally due to differences in the structure of superannuation systems (for example, the prevalence of DB versus DC schemes in different countries) and in fee-charging methods. In a comparison of DC superannuation fund fees in Australia, Ireland, the United Kingdom and the United States, Ashcroft (2009) finds that average fees among cheaper non-retail public offer funds in Australia were in line with or slightly higher than comparable funds in the United Kingdom, while fees charged by Australian retail funds were considerably higher. Fees for DC pension funds in the United States were also found to be relatively high. Overall, having a commercial provider of superannuation services, and being in a fund with an active investment strategy appear to be the major drivers of superannuation fund fees.

Another factor that may contribute to higher superannuation fees is the lack of engagement among fund members.[5] While the long-term nature of superannuation saving might make beneficiaries somewhat disengaged from the system, complexity and difficulty in making comparisons of fees across funds is also likely to play a role. Disengagement can lead to inefficiencies and increased fees in the superannuation system, due to a lack of competition and the opportunity costs associated with asset allocations and investment strategies that are not appropriate to individuals' risk-return profiles.

To address some of these issues, the Cooper Review into Australia's superannuation system suggested that there was scope to reduce costs and fees, as well as inefficiencies in superannuation funds' administrative procedures (Commonwealth of Australia 2010). Following these recommendations, the Commonwealth Government introduced the MySuper initiative on 1 July 2013.[6] MySuper:

  • requires private sector funds to offer a simple, low-cost product suitable for the majority of workers who are currently in the default option of their superannuation fund
  • provides greater transparency about fund performance and fees
  • aims to encourage consolidation among superannuation funds.

The Review also identified an overreliance on manual processing. In response, a package of measures was introduced – known as SuperStream – aimed at improving superannuation funds' back-office efficiency through encouraging greater use of technology.

While the above measures address some of the drivers of member fees, a potential remaining issue is whether the current fee structure itself promotes efficiency and competitive pressure in the superannuation system. One reason why normal competitive forces do not generally bear on superannuation fees is that member disengagement means the majority of individuals accept their employer's nominated fund and do not seek out information about fund fees. Superannuation funds may therefore have limited incentive to lower their fees to attract members, since the usual decision-maker – the employer – does not benefit from lower fees and is therefore less likely to be influenced by them.

7.4 Household and National Saving

7.4.1 Retirement income management

The superannuation system plays an important role in channelling household saving and supporting an individual's income in retirement. There are two related challenges in achieving these goals:

  • increasing life expectancies imply that individuals will be spending longer in retirement and thus require a larger amount of retirement savings (longevity risk)
  • the ageing of the population more generally means that proportionally fewer people of working age are available to support retirees.

Both of these factors contribute to pressure on government spending in many countries via the provision of age pensions (or, in some cases, government-provided DB schemes).

Treasury estimates suggest that the Australian retirement income system is adequate to meet these challenges (Rothman 2007). For example, progressively increasing the SG contribution rate to 12 per cent will increase the percentage of the individual's pre-retirement income paid out in superannuation upon retirement. However, while individuals are expected to become more reliant on their superannuation savings as their primary source of retirement income, it is expected that most individuals will continue to rely on the age pension for a portion of their retirement income, especially if they are still exposed to substantial market risk in the drawdown phase; this will remain true even after the system fully matures, which is projected to occur after 2030. Continued reliance on the age pension as the system matures reflects in part that, due to increased life expectancies, older individuals may require the age pension in the later years of retirement.

A report published by Deloitte Actuaries and Consultants (2013) also suggests that longevity risk is a concern for both the government and individuals. The findings suggest that currently the average 65 year old does not have sufficient superannuation to fund a modest or comfortable standard of living in retirement.[7] According to Deloitte's projections, the average younger Australian (who will receive SG contributions for a full lifetime) will have enough superannuation to fund a modest living standard in retirement with a life expectancy of up to 94 years, and a comfortable living standard if they have a life expectancy of up to 77 years.[8] This compares with a current average life expectancy (at birth) of almost 80 years for a male and 84 years for a female (ABS 2013).

7.4.2 Supporting demographic change

Australia, like other countries, is undergoing a demographic shift. Specifically, the baby boomer generation has largely reached preservation age, meaning an increasing proportion of fund members are moving into drawdown phase. The DC nature of Australia's system means that it is important to ensure that the current incentives and retirement products work to manage the risks faced by retirees, and the risks to the government (through the provision of the age pension). Two key risks for an individual's retirement income management are longevity risk (discussed above) and investment risk (that invested retirement savings perform poorly because of market fluctuations – market risk – or are not appropriately diversified, leading to lower-than-expected retirement income or volatile income streams at the time of retirement).

An important part of ensuring that individuals are able to appropriately manage the risks they face is the availability of appropriate retirement products. Currently, most retirees choose to take their superannuation either as a lump sum or an account-based pension. Taking superannuation as a lump sum may mean that individuals exhaust their funds within the early years of retirement, while for account-based pensions, the individual is fully exposed to investment risk, but may mitigate longevity risk, at least in part, by staging the withdrawal of their account balance.

One alternative product that could provide greater protection from longevity and investment risk is annuities. Traditional annuities, which provide a guaranteed income stream over a specific term, life expectancy, or lifetime, can be purchased from prudentially regulated life insurers. In the case of a lifetime annuity, the longevity and investment risk faced by retirees can be transferred to the insurer. In contrast, term or life expectancy annuities hedge against investment risk, but may only partially mitigate longevity risk depending on the term chosen.

Despite these benefits, the current annuity market in Australia is quite small. While the market has never been particularly large it has shrunk substantially since the early 2000s, possibly because a number of incentives to buy annuities rather than take lump sums or account-based pensions (such as more attractive asset test exemptions and, in some cases, tax discounts) were removed.[9] More recently, the low interest rate environment globally may have reduced the attractiveness of annuities for potential buyers. There may also be a mismatch between retirees' needs and the income stream of the annuity – for instance, retirees may wish to spend more of their money in the early part of retirement (Commonwealth of Australia 2009). However, most annuities have limited flexibility with early withdrawals often incurring a penalty. There are some insurers that have begun to offer hybrid products with features of both account-based pensions and annuities. They usually provide some form of guaranteed income over a fixed term or lifetime.

7.4.3 Importance in national saving

Besides ensuring adequate retirement income, another motivation behind the introduction of the SG was to boost national saving, which had been declining from a peak in the mid 1970s. The importance of superannuation to national saving has grown since the introduction of the compulsory superannuation system in 1986, rising from a bit under 20 per cent of gross national saving in 1989 (the earliest data available) to 35 per cent today (Graph 7.8).[10] This reflects the gradual increase in the compulsory contribution rate, an increase in employee coverage from around 40 per cent of total public and private sector employees in the mid 1980s to more than 90 per cent a decade later, as well as increases in voluntary contributions (Gruen and Soding 2011). The contribution of superannuation to national saving is likely to increase further in the next few years as the contribution rate gradually increases.

The impact of (compulsory) superannuation on aggregate household and national saving depends on the extent to which households offset increases in saving through superannuation by reducing other forms of saving. Compulsory superannuation would be expected to increase aggregate saving if there are households that are financially or liquidity constrained and thus unable to offset their superannuation contributions by reducing other savings or increasing borrowing (Edey and Simon 1996; Gruen and Soding 2011). Additionally, compulsory superannuation might lead to increases in voluntary saving for retirement by alerting households to the importance of retirement planning or making it more convenient for households to save (Connolly 2007). Superannuation might also increase household saving by resolving uncertainty around the adequate level of saving for retirement, particularly for those households that are myopic and underestimate the need to finance consumption in old age (Connolly and Kohler 2004). Several empirical studies have found that increased saving through superannuation is not entirely offset by reductions in other forms of saving, and thus increases household saving overall. Using aggregate data, Connolly and Kohler (2004) find that less than half of the increased saving through superannuation has been offset by a reduction in voluntary saving, thus increasing households' saving rate, other things being equal.[11]

7.5 Interrelationship with the Banking Sector

Together, the superannuation and banking sectors dominate Australia's financial sector. The two industries are interconnected through a number of channels including: retail superannuation funds that are part of banking groups' wealth management businesses; banking groups' provision of services to other funds; superannuation funds' role in the funding of banks; and banks' lending to superannuation funds.

7.5.1 Retail superannuation funds

Over recent decades, Australian banking groups have diversified into the wealth management sector, prompted by the changes in retirement savings arrangements and the associated growth of superannuation. From the late 1990s, the four major banking groups achieved this by acquiring prominent life insurance/funds management businesses (Hall and Veryard 2006; Ryan and Thompson 2007). Consequently, a number of retail superannuation funds are part of banking groups: about 55 per cent of retail superannuation funds' assets are held in funds run by banking groups.[12] Banking groups benefit from these funds both through the fees they earn as well as the potential cross-selling of products to their superannuation customers.

Apart from the direct ownership of funds, banking groups also earn fees through the provision of services to other superannuation funds. For instance, a large proportion of not-for-profit, and to a lesser extent some for-profit, superannuation funds outsource aspects of funds management including asset management, asset custody, advice and insurance to outside firms such as banking groups (Liu and Arnold 2010; Donald et al 2013). In particular, banks' focus on the provision of financial advice, trading platforms and other services to SMSFs has increased recently.

Income from aggregate wealth management represented about 10 per cent of the major banking groups' total income in 2013.[13] As a share of income, most major banking groups' wealth management income fell following the crisis and remains low relative to pre-crisis levels.

7.5.2 Provision of bank funding and borrowing from banks

Another way superannuation funds are connected to the banking sector is through their provision of funding to Australian banks. About 25 per cent of superannuation funds' assets are claims on banks in the form of deposits, shares and debt securities (Graph 7.9). Over the last decade the share of banks' funding provided by superannuation funds has increased significantly to around 15 per cent. Part of this increase is likely due to increased demand for assets from superannuation funds as growth in superannuation assets has outstripped growth in bank assets over this period. It may also result from a shift in asset allocation by superannuation funds. In particular, as highlighted in Chapter 5, superannuation funds' allocation to bank deposits has increased significantly over the last decade, to be higher than many OECD countries (OECD 2013a). Growth in deposits held by superannuation funds has likely been driven by a number of factors including:

  • increased market volatility exhibited by other assets, particularly equities, following the financial crisis
  • fund members moving into different life stages and requiring different investment strategies – as the population ages, a higher proportion of members are approaching retirement and are increasingly likely to demand conservative assets with steady cash flows such as deposits. This is partly evident in the high allocation to deposits by SMSFs, who have a higher proportion of members in, or near, retirement, than other fund types (though, as discussed above, part of this high allocation may be due to the ease of investing in term deposits)
  • the liquidity needs of superannuation funds – the introduction of portability requirements in 2004 may have increased funds' demand for relatively liquid assets such as deposits[14]
  • relative asset returns – following the crisis, banks have offered returns on term deposits that are similar to those on other assets.

Banks are also exposed to superannuation funds through their lending activity. As noted above, the ability to borrow to purchase an asset under limited recourse conditions has appealed to SMSFs since the introduction of legislative changes in 2007.[15] The value of SMSFs' direct property holdings has increased quite rapidly over this period (Graph 7.10). However, available data suggest the exposure of the banking sector to SMSFs through this channel is small.

7.5.3 Financial stability implications

The superannuation sector has grown significantly over the past couple of decades and become an increasingly important component of household assets and Australia's financial system. Despite this growth, Australia's superannuation system is more likely to play a stabilising role in the financial system, rather than a destabilising one, particularly compared with the banking sector. There are several reasons for this:

  • Unlike banking liabilities, the majority of superannuation liabilities have little or no leverage, which substantially reduces the risk of superannuation funds' default, and a subsequent wealth shock to households. Superannuation funds are also not typically reliant on debt funding and so their funding, unlike banks, is not vulnerable to dislocations in funding markets (although superannuation funds' asset holdings may still be vulnerable to dislocations in funding markets).
  • While the size of Australia's superannuation sector is large, the degree of concentration in the industry is low: the five largest and ten largest superannuation funds by assets in 2013 accounted for 16 per cent and 27 per cent of total industry assets, respectively.[16] Although – as noted above – it likely raises operating costs, the low level of concentration in the superannuation industry reduces the risk that the asset allocation choices of one or two relatively large superannuation funds could have wider implications for the superannuation industry or the financial system more broadly.
  • Interconnectedness between superannuation funds is much lower than in the banking sector. Superannuation funds do not engage in trading with each other, whereas interbank borrowing and lending is significant. Given the low level of interconnectedness, the effects of financial distress of an individual superannuation fund are likely to be largely confined to that fund, and there is limited potential for the impact to spread to other funds and propagate through the broader financial system. It is important to note, however, that while superannuation funds are generally not linked directly, funds often share the same service providers such as custodians (Donald et al 2013).
  • Although direct interconnections are small, superannuation funds that have common asset allocation strategies are exposed to the same shocks, leading to correlation of fund performance. Correlation among superannuation funds could exacerbate financial market volatility if funds seek to reduce their exposure to certain securities or asset classes during a crisis, which could in turn encourage further selling. The low level of concentration in the industry, noted above, may somewhat mitigate this.

The Australian superannuation sector appears to have supported the stability of the financial system by adding depth to financial markets, and providing a stable source of finance for other sectors. In particular, since the global financial crisis Australian superannuation funds have provided an alternative source of finance to Australian firms and banks, allowing them to raise equity in the domestic share market, and alleviating some of the funding pressures associated with the increase in global risk aversion and the pull-back from domestic and global debt markets. Around half of net equity financing for banks and private non-financial corporations since the financial crisis has been sourced from superannuation funds.

Despite the above factors, the fact that the pool of superannuation savings is large and provides a source of funding for other sectors in the economy means that the system should continue to be carefully monitored. In particular, superannuation funds can be exposed to liquidity risk, although potentially to a lesser extent than the banking sector, which could have implications for financial system stability in some circumstances. Choice of fund regulations and portability requirements mean that superannuation funds are required to be able to transfer a member's assets within 30 days of receiving a request to do so.[17] This could be difficult for funds with relatively large allocations to illiquid assets, particularly if a fund receives multiple requests at the same time. Liquidity risk may also arise from members simultaneously shifting their asset allocations or withdrawing funds in response to a shock in asset markets. While this risk is partially mitigated by preservation rules, portfolio shifts could become more pronounced over the longer term as an increasing share of workers reach preservation age and potentially become more engaged and active in asset allocation decisions.

There are three specific recent developments in the superannuation system that bear close monitoring. First, as SMSFs increase in importance within the sector, the fact that they can leverage raises concerns about SMSF members being exposed to greater financial risks (including excessive concentration in a single asset) than they understand they are taking. To the extent that banks are lending to SMSFs, they appear to be managing the potential risks of limited recourse borrowing arrangements by their frequent requirements for personal guarantees from SMSF members, minimum fund net asset requirements, and lower maximum loan-to-valuation ratios than often imposed on their other property lending.

Second, given the low interest rate environment globally in recent years, investors are increasingly ‘searching for yield’. Superannuation funds, seeking higher returns without exposure to excessive volatility, may shift their asset allocation away from assets such as cash, bonds and equities and further towards higher risk and alternative asset classes such as private equity, hedge funds, unlisted property and infrastructure, in order to increase returns or meet performance benchmarks. This could potentially increase the exposure of individuals' retirement savings to a higher level of risk than may be desirable. In addition, increased demand for alternative assets could potentially lead to asset prices outstripping market fundamentals. Similarly, at least some of the increase in property investment by SMSFs is a new source of demand that could potentially exacerbate property price cycles. It should be noted, however, that DC funds have less incentive to ‘search for yield’ than DB funds as they do not offer a guaranteed income stream (Antolin, Schich and Yermo 2011).

Third, with the increasing pool of superannuation funds, some have proposed that those funds may be better tapped into for productive investments in the economy, such as infrastructure. This highlights the potential for an increase in the maturity transformation role of superannuation funds: taking the savings of individuals, which may be called upon at short notice under portability requirements, and investing in longer-dated assets. This function of the superannuation system needs to be balanced with appropriate liquidity management for the reasons discussed above (Debelle 2013).

Therefore, while overall the near-term risks of the fast-growing superannuation system appear limited, the increased demand of superannuation funds for different asset types warrants ongoing monitoring. In particular, given the large pool of superannuation savings, investment allocation choices have the potential to influence asset price cycles and also raise liquidity management issues for superannuation funds.

7.6 Investment in infrastructure

The potential for the superannuation sector to play a greater role in financing infrastructure projects has gained considerable attention in recent years. This has been driven by the more general attention by international forums, such as the Group of Twenty (G20), on how to fund long-term investment given the fiscal constraints faced by many governments, particularly in developed countries. While superannuation funds have a pool of funds that could potentially be used to assist funding for productivity-enhancing projects, it is unlikely that this pool of funds will be the sole solution to financing infrastructure investment in Australia. Given the risks inherent in infrastructure investment, funds need to manage these risks against the benefits infrastructure assets provide, bearing in mind that the purpose of superannuation is to act as a vehicle for building retirement savings for members.

In any case, as discussed in Chapter 5, Australian superannuation funds already have relatively high allocations to infrastructure assets compared with other countries (albeit largely indirect investment via equity funds; Graph 7.11). This has been enabled by the significant number of privatisations in Australia since the early 1990s, and less restrictive regulations on Australian pension funds' investments in illiquid assets compared with many other countries (Inderst and Della Groce 2013).

There are several characteristics of infrastructure assets that superannuation funds could potentially find attractive. As discussed in Chapter 5, brownfield infrastructure assets are seen as a good fit for superannuation funds because of their potential to provide maturity matching with liabilities and hedge inflation (through inflation-linked assets), as well as to provide a stable real income stream. Unlisted infrastructure equity investments are generally less correlated with other financial market assets, and hence may provide diversification benefits to superannuation funds. Infrastructure assets – often being natural monopolies – face limited competition, although the sector is exposed to regulatory risk.

Compared with most other assets though, infrastructure investments, particularly direct investments, are relatively expensive to manage. Infrastructure projects are inherently complex and superannuation funds often lack the expertise to make infrastructure investment decisions themselves. While some funds have made the decision to build this capability in-house, most have traditionally had to pay external asset managers to manage the asset and advise them on the investment process. The scale of infrastructure projects also means that investors generally have to form consortiums to invest directly, with the cost of liaising, coordinating and negotiating between investors being significant. The scale of the transactions in Australia also tends to be relatively high compared with Canada and the UK where financing tends to be through smaller and more structured investment products (Deloitte Access Economics 2013).

The unlisted nature of many infrastructure investments means that there tends to be a lack of transparency and accessibility compared with exchange-traded assets. Consequently, information on infrastructure projects is not readily available and has to be sought out, valuations are often infrequent, and there can be considerable uncertainty associated with some infrastructure investments.

The degree of liquidity of infrastructure assets also varies considerably, and superannuation funds investing in relatively illiquid assets could face a potential mismatch between the long-term nature of infrastructure investments and the need to maintain sufficient liquidity to accommodate any adjustments beneficiaries make to their investment portfolios, as discussed above. This liquidity risk may increase over time as an increasing share of the population reaches preservation age and withdraws funds from the system.


ASIC only oversees SMSF trustees if the fund is set up with a corporate trustee. [1]

For more information on the structure of pension systems around the world, see OECD (2013b). [2]

For more information on the distribution of risks for employers and employees under DB and DC systems, see Broadbent et al (2006). [3]

Excludes the DB component of hybrid funds. [4]

The level of disengagement in Australia can be gauged from data that suggest that of the majority of workers who are in the default option of their current superannuation fund, only a small share made an active choice for that option (Commonwealth of Australia 2010). [5]

Superannuation funds have been able to offer a MySuper product from 1 July 2013. Since 1 October 2013, employers have been required to pay contributions to a fund that offers a MySuper product for employees who are in a default fund. Superannuation funds offering MySuper products will need to transfer the existing balances of their default members to a MySuper product by 1 July 2017. [6]

Benchmarks for modest and comfortable living standards are based on the Association of Superannuation Funds of Australia's (ASFA's) Retirement Standards. The ASFA defines a modest living standard as better than the age pension but lacking some of the luxuries associated with a comfortable lifestyle, such as occasional travel. [7]

These projections assume a worker currently aged 30 with a salary of $60,000 and a current balance of $27,000. [8]

For a discussion of the development of the annuity market in Australia, see Bateman and Piggot (2010). [9]

Household, government, non-financial corporation and financial corporation saving are measured directly as net acquisitions of financial and non-financial assets less net incurrence of liabilities (from the financial and capital accounts). Gross national saving is measured as the sum of saving from these four sectors. The net flows data include compulsory and voluntary contributions into funded superannuation less withdrawals from these funds. [10]

FitzGerald and Harper (1992), FitzGerald (1993), Covick and Higgs (1995) and Gallagher (1997) estimate offset coefficients between 30 and 50 cents per dollar. Morling and Subbaraman (1995) find a much larger offset coefficient for net superannuation contributions of 75 cents per dollar; although their results are not strictly comparable to the other studies (see Connolly and Kohler (2004) for further details). [11]

Around 80 per cent of financial conglomerates containing a smaller licenced bank are included. [12]

Wealth management includes superannuation, insurance and other funds management income. [13]

In 2004 trustees were required to transfer funds within 90 days; this was reduced to 30 days in 2007. [14]

While APRA regulated funds can borrow from banks under certain conditions, this does not appear to be a common practice amongst funds. [15]

Total industry assets include the assets of APRA-regulated funds (except for pooled superannuation trusts), SMSFs, exempt public sector superannuation schemes that report to APRA, and life office statutory funds. [16]

There are some exceptions to the 30-day portability requirement for illiquid assets. [17]


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